Spitzer Opens a New Offensive on Wall Street

The self-styled dragon-slayer of Wall Street is swinging from the heels again.

New York Attorney General Eliot Spitzer and elected officials from two other states rolled out a plan Monday aimed at the companies that manage money for state pension funds. The proposal aims to spell out how big financial institutions should disclose conflicts of interest and smoke out corporate wrongdoers.

The push marks Spitzer's latest effort to clean up Wall Street, after this spring's high-profile settlement with Merrill Lynch (MER Quote - Cramer on MER - Stock Picks). And though investors and analysts said they'll have to see more details before they can weigh the plan's effect on a scandal-sickened marketplace, it seems clear that reform of one variety or another is very much on the securities industry's agenda right now.

"Almost daily, we learn of a new scandal in corporate America," Spitzer said at the Monday morning press conference in New York City, where he was joined by officials from California and North Carolina. "As Wall Street customers we are now fighting back."

More Demanding

Spitzer and the other state officials say they're targeting money management firms, after seeing state pension funds lose billions in stock and bond investments in a series of corporate scandals. In a year already tarnished by the meltdowns of Enron, Global Crossing and others, the worries about corporate ethics have resurfaced most glaringly in the last week at telecom giant WorldCom(WCOME Quote - Cramer on WCOME - Stock Picks).

The state officials say that since Capitol Hill has been slow to respond to the crisis in corporate America and on Wall Street, it's up to the states to demand that money management firms abide by the highest ethical standards and become more vigilant in protecting investors from corporate chicanery.

Now the three states will require money managers to annually disclose how their portfolio managers and research analysts are compensated. Money managers also will have to provide detailed information about their procedures they use to analyze investment opportunities. And money managers must divulge any potential conflicts of interest between the investment advice they offer and other financial work and services that their firms are involved in. (For instance, some money management firms are owned by investment banks that do stock and bond underwriting.)

"If you want our money, here are terms," said North Carolina Treasurer Richard Moore, who was joined at the Spitzer press conference by New York Comptroller H. Carl McCall and California Treasurer Philip Angelides.

The three states collectively account for roughly $220 billion in state pension fund investments. State pension funds were some of the biggest losers in the WorldCom debacle, collectively seeing some $2 billion in stock and bond investments go up in smoke. In the coming weeks, the officials said they expect the administrators of other state pension funds to sign onto their effort to clean up Wall Street.

Talk, Talk

But it's not clear just how much of an impact the new initiative will have beyond some saber-rattling and grabbing headlines for the officials -- three of whom are either up for re-election or seeking higher office this year. The officials, for instance, gave no indication that they've taken steps yet to dismiss or replace any of the money mangers they've been using to manage their state's pension investments. The furthest anyone would go on that point was Moore, who said he considers all the money management firms retained by North Carolina's pension funds to be on "probation" as of this moment.

To some extent, much of what the state leaders are demanding of money-management firms is nothing new and something they're already required to do under existing securities laws. Unlike brokerage firms, money mangers and other investment advisors owe a fiduciary duty to their clients and can be sued if they breach that obligation and deal with a client in an unfair manner.

"Investment mangers are held to a higher standard than a broker," says David Tittsworth, executive director of the Investment Counsel Association of America, a trade association for some of the largest money management firms. "You basically have two choices -- you either rid yourself of a conflict of interest, or you tell your client about it."

The elected officials also said they will ask any Wall Street investment bank doing business in their states to voluntarily abide by the terms of the settlement that Spitzer's office reached last month with Merrill Lynch following a high-profile investigation into conflicts of interest at the nation's biggest securities firm. The officials warned that any firm that doesn't voluntarily take steps to separate its investment banking businesses from its stock-research operations runs the risk of being barred from doing any more work for those states.

The linchpin of the Merrill-Spitzer settlement is a plan to alter the way stock analysts are compensated. Merrill can no longer link an analyst's salary to the number of investment banking deals the analyst helps the firm attract. Merrill must also disclose in all stock research reports whether it has or expects to receive investment-banking fees from a company. Merrill signed the deal and also agreed to pay a $100 million fine, after Spitzer released a series of damaging emails that showed some Merrill analysts privately harbored serious doubts about the stocks they were touting.

Even before the press conference, a number of Wall Street firms already were moving toward enacting portions of the settlement. There's a growing suspicion that investors will accept nothing less.