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[Senate Hearing 107-1026]
[From the U.S. Government Publishing Office]

                                                       S. Hrg. 107-1026

                 ISSUES AND PERSPECTIVES IN ENFORCING 
     CORPORATE GOVERNANCE: THE EXPERIENCE OF THE STATE OF NEW YORK

=======================================================================

                                HEARING

                               before the

     SUBCOMMITTEE ON CONSUMER AFFAIRS, FOREIGN COMMERCE AND TOURISM

                                 OF THE

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 26, 2002

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation

                      U.S. GOVERMENT PRINTING OFFICE
91-441 PDF                 WASHINGTON : 2006
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       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

              ERNEST F. HOLLINGS, South Carolina, Chairman
DANIEL K. INOUYE, Hawaii             JOHN McCAIN, Arizona
JOHN D. ROCKEFELLER IV, West         TED STEVENS, Alaska
    Virginia                         CONRAD BURNS, Montana
JOHN F. KERRY, Massachusetts         TRENT LOTT, Mississippi
JOHN B. BREAUX, Louisiana            KAY BAILEY HUTCHISON, Texas
BYRON L. DORGAN, North Dakota        OLYMPIA J. SNOWE, Maine
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
MAX CLELAND, Georgia                 GORDON SMITH, Oregon
BARBARA BOXER, California            PETER G. FITZGERALD, Illinois
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida
               Kevin D. Kayes, Democratic Staff Director
                  Moses Boyd, Democratic Chief Counsel
      Jeanne Bumpus, Republican Staff Director and General Counsel
                                 ------                                

     Subcommittee on Consumer Affairs, Foreign Commerce and Tourism

                BYRON L. DORGAN, North Dakota, Chairman
JOHN D. ROCKEFELLER IV, West         PETER G. FITZGERALD, Illinois
    Virginia                         CONRAD BURNS, Montana
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
BARBARA BOXER, California            GORDON SMITH, Oregon
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida

                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on June 26, 2002....................................     1
Statement of Senator Boxer.......................................     5
Statement of Senator Dorgan......................................     1
    Prepared statement...........................................     3
Statement of Senator Edwards.....................................    19
Statement of Senator Fitzgerald..................................    17
Statement of Senator McCain......................................    16
Statement of Senator Nelson......................................    20
Statement of Senator Wyden.......................................     4

                               Witnesses

Spitzer, Hon. Eliot, Attorney General of the State of New York...     6
    Prepared statement...........................................    12

 
                 ISSUES AND PERSPECTIVES IN ENFORCING 
                       CORPORATE GOVERNANCE: THE 
                  EXPERIENCE OF THE STATE OF NEW YORK

                              ----------                              

                        WEDNESDAY, JUNE 26, 2002

                                       U.S. Senate,
    Subcommittee on Consumer Affairs, Foreign Commerce and 
                                                   Tourism,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:30 a.m. in 
room SR-253, Russell Senate Office Building, Hon. Byron L. 
Dorgan, Chairman of the Subcommittee, presiding.

          OPENING STATEMENT OF HON. BYRON L. DORGAN, 
                 U.S. SENATOR FROM NORTH DAKOTA

    Senator Dorgan. I will call the hearing to order. This is a 
hearing of a Subcommittee of the Commerce Committee. We are 
meeting today to hear from the Attorney General, Eliot Spitzer 
from the State of New York. I am constrained to make a few 
comments at the start of this hearing.
    There are matters in this morning's newspaper that relate 
to a series of hearings we have been holding in this 
Subcommittee. This Subcommittee has heard over recent months 
from executives of the Enron Corporation and others on the 
issue of corporate governance, and especially issues that 
affect the Enron Corporation and investors and employees of the 
Enron Corporation.
    This morning's news on the front page of the Washington 
Post about another company, World Com (the headlines say its 
books are off by $3.8 billion) raises once again, as has been 
raised nearly every day in recent months, the issue of 
corporate governance. What can investors rely upon? What is 
happening in corporate business in this country? We see 
restatements of earnings every day now. Seldom do we see 
statements of $3.8 billion, but the table where Mr. Spitzer 
sits, the person who did the Powers report, which on behalf of 
the board of directors looked inside the Enron Corporation, 
said that what the board of directors found inside the Enron 
Corporation was, ``appalling.''
    In a rather short period of time they said that that 
corporation reported $1 billion of earnings that it did not 
have, and it kept off the books debt that existed as a 
liability to the corporation. These are the kinds of things 
that are going on all too often in this country now, and we see 
reports on them virtually every day: restatements of earnings, 
in some cases massive restatements of earnings, inversions 
where corporations have decided to renounce their citizenship 
and become citizens of another country so they can save on 
their tax bill in this country--which I think is fundamentally 
unpatriotic, I might say--the question of the behavior of 
corporate CEO's, boards of directors, the question of the 
accounting firms who were supposed to be involved in oversight 
and the enforcement of standards, and the spectacle of the 
people at the top of these companies getting rich while people 
at the bottom are losing everything.
    I said some months ago that with respect to the Enron 
Corporation what I saw was a culture of corruption, and Mr. Lay 
took great umbrage at that. These stories, and especially the 
information unearthed by Attorney General Spitzer about 
security analysts who were pumping stocks that they knew to be 
dogs, they knew to be not of sound value, but who nonetheless 
were pushing these stocks and marketing these stocks to unaware 
consumers, show us that it was even more than a culture of 
corruption.
    We have heard a lot about the bursting of the speculative 
bubble in this super-turbocharged economy of the 1990's, 
especially the bubble over technology firms, but we see that 
this was more than just a bubble whose bursting was inevitable. 
There was more than that. There was greed and dishonesty, and 
what we are reading about daily and what this Subcommittee has 
learned over recent months is appalling.
    There must be some accountability here, and in this 
Subcommittee we are trying to get to that. The method by which 
we accumulate capital in this country requires that people have 
confidence, that they can rely on the people who run our 
corporations, that they can rely on the representations of 
accountants, and that they can rely on security analysts. We 
have learned that in many cases the fact is they cannot rely on 
any of those people.
    Accountability and responsibility do not just apply to poor 
people, and they do not just apply to the bottom of the 
economic ladder. Let some one go buy a six-pack of beer on food 
stamps and you have people jumping off the buildings here 
trying to proclaim how awful that is. Well, let us see if the 
same people are willing to stand up at this point and talk 
about stealing in the corporate suite, or talk about 
misrepresentation or criminal behavior in accounting firms, or 
misrepresentation by security analysts. Let us see if the same 
people care as much about accountability and responsibility at 
the top as they do about accountability and responsibility 
among poor people.
    So let me make one final point. I think all of this, 
including this morning's information, ought to persuade some of 
the regulators in the regulatory agencies to hang their head in 
shame. They have been AWOL, gone fishing for a long, long time. 
All of this has happened at a time when regulators have sat on 
their hands, and those who have been critical of Mr. Spitzer 
for using his authorities as a state regulator to do that which 
federal regulators should have been involved in the first place 
have no cause to be critical of anyone. I suggest to all of 
those who have been critical of Mr. Spitzer for using the reins 
of state government to take effective action that they spend a 
little more time asking hard questions of the Securities & 
Exchange Commission and others. Where was the SEC ? Where were 
these regulators? We paid them. Why didn't they do their job? I 
suggest they spend a little more time worrying about that, and 
a little less time worrying about State regulators who are in 
many cases digging into these issues with an aggressive 
approach and a vigor that I commend.
    Well, I have more to say, but I will put my entire 
statement in the record. This morning's news is once again 
unnerving to this country's economy. It is simply one more 
piece of evidence that there is an avarice and a corruption and 
a greed that exists in some areas in this country that 
desperately cries out for effective regulatory oversight. The 
American people--who rely on the representations of those who 
run corporations, those who run accounting firms, those who are 
involved in security analysis--have to be able to trust those 
folks, and when that trust is broken (and it is) it has 
dramatic consequences for the methods by which we accumulate 
capital in our country, and will have a dramatic impact on this 
country's economy.
    I want this economy to do well. I want it to succeed. I 
want it to grow again. We have the capacity to do that, but we 
must address these questions. These questions are basic, and 
very troubling to all the American people. Many of the American 
people have now become investors in their 401(k) program, which 
they now refer to as a 201(k) or a 101(k) program, as it 
shrinks and shrinks and shrinks virtually every single day. 
Then they read the stories that suggest they have lost money 
not because they made a bad investment, but because someone 
misrepresented stocks to them, or because someone in the 
corporate boardroom stole money, or because accountants who 
were paid a lot of money to look over the shoulder of the 
corporations that were reporting income and expenditures were 
enablers, enabling the corporation to misrepresent its books to 
the ultimate investors.
    Well, I spoke longer than I intended. Let me say welcome, 
Mr. Spitzer, to the Committee. We have been reading of your 
work and want to ask some questions about it and have you 
testify, and then have the opportunity to ask questions.
    Let me call on my colleague, Senator Wyden.
    [The prepared statement of Senator Dorgan follows:]

              Prepared Statement of Hon. Byron L. Dorgan, 
                     U.S. Senator from North Dakota
    We are in the middle of a crisis in corporate responsibility.
    Almost every day we see more reports in the news media about 
companies restating their earnings. Sometimes these restatements go 
back 2, 3, 4 years and cover billions of dollars.
    Not only are ordinary investors understandably outraged as they 
watch their life's savings disappear; they feel deceived because they 
know that their losses are the fault of poor corporate behavior, and a 
lack of oversight by federal regulators.
    The ability to accumulate capital for public corporations in our 
economic system requires trust--trust in accounting firms, corporate 
financial statements, security analysts, and confidence in those who 
run our public corporations.
    My concern is that with all that has gone on in corporate America 
in the past few months that this trust has been broken by a complete 
breakdown in corporate responsibility.
    It is no wonder then that the investing public is having a hard 
time putting its trust in corporate America when:

        Consumers now know that some of the ``books were cooked'' with 
        the help of the accountants and boards of directors that were 
        willing to look the other way;

        Consumers now know that many of the so called ``independent'' 
        analysts who pushed individual stocks on TV were sometimes 
        anything but ``independent'' as they pumped stocks in which 
        their firms had a financial stake, and

        They have a sense that those at the top made off with millions 
        while the ordinary investor has been taken for a ride.

    The question that has to be asked is where were the public and 
private watch dogs that are supposed to ensure that these things do not 
happen? Where were the ``independent'' analysts? And most importantly 
where was the Securities and Exchange Commission (SEC) while all of 
this was occurring?
    Today, we are going to hear from one man who has actually done 
something to address the problems surrounding conflicts of interest 
with investor analysts.
    He is New York's Attorney General Eliot Spitzer. Last month, Mr. 
Spitzer announced a $100 million settlement with Merrill Lynch 
following allegations that the company's advice was tainted by 
conflicts of interest.
    Mr. Spitzer's investigation revealed that Merrill Lynch analysts 
reportedly inflated their ratings on certain stocks to boost the firm's 
related investment banking business. He showed that even as analysts 
pushed individual stocks, behind the scenes they were secretly 
referring to some as ``junk'' and ``dogs.''
    As with many industries, the regulation of securities has been a 
shared federal-state responsibility. Mr. Spitzer's extraordinary 
efforts have shown the valuable role that state authorities can play in 
protecting consumers.
    It also shows that the fed regulators have been paper tigers in 
recent years, and it demonstrates how important it is for us to have 
federal regulators that are aggressively engaged in protecting 
consumers from this kind of chicanery.
    While I recognize the desire for uniformity I think the solution 
lies in having the State Attorneys General work together with the SEC.
    Reliable analysis based on a sound ethical and legal foundation is 
the key to a stable marketplace. Attorney General Spitzer has set the 
example, and it is up to the SEC to follow his lead.
    I look forward to hearing from Mr. Spitzer on these important 
issues.

                 STATEMENT OF HON. RON WYDEN, 
                    U.S. SENATOR FROM OREGON

    Senator Wyden. Thank you, Mr. Chairman. Let me commend you 
for being willing to stay at this task. We have had a number of 
hearings on Enron, and I think what often happens in this town, 
somebody does one hearing and then just moves on, and you have 
been willing to be persistent and stay at it, and that is what 
it really takes and, of course, that is what Mr. Spitzer has 
done in the State of New York. He has been a pioneer and it is 
so good to know that somebody on the front lines is actually 
out digging and excavating the critical materials that are 
needed to make these cases. We are very glad that he is here, 
and look forward to his remarks.
    Mr. Chairman, let me pick up on something that you touched 
on. Today, the stock market is no longer the exclusive province 
of the wealthy. We have got millions of working families whose 
hopes and aspirations are tied to the stock market, to their 
retirement accounts and others, and it will be devastating if 
the American people walk away and say, this is a rigged game, 
that the rules are fixed, and our country cannot afford that. 
We have got to make sure that there are rules on the books and 
that they are enforced, and that in a number of areas that the 
rules are strengthened.
    I want to bring to the Committee's attention Fortune 
Magazine, not exactly a radical left-wing rag, ran a cover 
story just recently entitled, ``In Search of the Last Honest 
Analyst,'' and it seems to me this cover story is a clear 
indictment of the problem and why this hearing is important as 
anything else.
    What we have seen in recent days is what amounts to a 
spectacle, a spectacle of analysts snickering behind the backs 
of American investors as they sell them lemons, and I think 
that what people thought the analyst industry was all about was 
being an expert observer, and much of its behavior seems more 
typical of used car salesmen. They do an aggressive sales job, 
then go into the back room and snicker about how they just sold 
an investor a lemon, and I think we do need to examine a number 
of these key issues, and particularly one that I want Attorney 
General Spitzer to review with us is the conflict of interest 
laws, or lack thereof, that are on the books today.
    For example, attorneys are subject to conflict of interest 
rules, they have to disclose conflicts, and it seems that there 
is little, if anything, that would in effect ensure that an 
investor goes into these kinds of transactions with full 
disclosure and a full array of the facts.
    Let me wrap up by commenting on the overall business 
picture, Mr. Chairman, because I was going to talk about the 
World Com situation as well. I do not subscribe to the notion 
that the majority of people in this business, in American 
business are crooks. I just do not buy that notion. I think the 
majority of people are honest and sincere in their views, but 
what we have seen too often, as the chairman has pointed out, 
is what amounts to a triangle of deception involving corporate 
executives, audit firms, and investment analysts.
    What Chairman Dorgan is doing is ensuring that today we 
take a look at the third leg of the triangle, the analysts. I 
think it is high time. I am looking forward to Mr. Spitzer, 
commend him for his good work on the front lines of New York 
State, and thank you again, Mr. Chairman, for being willing to 
stay at it. This is not the typical sort of approach to 
hearings, where you sort of do one and you hit and run. You 
have been willing to stay at it, and that is what it is going 
to take.
    Senator Dorgan. Senator Wyden, thank you very much. Senator 
Boxer.

               STATEMENT OF HON. BARBARA BOXER, 
                  U.S. SENATOR FROM CALIFORNIA

    Senator Boxer. Thank you, Mr. Chairman. Thank you for 
inviting Attorney General Spitzer here to testify on corporate 
governance and investment counseling practices at Wall Street 
firms.
    Mr. Chairman, it takes courage to do what the Attorney 
General is doing on a daily basis, and that is trying to weed 
out the corruption on Wall Street, and the reason it takes 
courage is, these people are very powerful and they are very 
wealthy, and they have a lot of people around them to protect 
them from the law, and so it takes courage. It also takes 
courage, Mr. Chairman, for you to do a lot of the things you do 
in this Subcommittee. I have been wanting to say that publicly 
for a long time. It means a great deal to me that you are 
willing to take on these issues, because we rub people the 
wrong way, and I am glad we do because they cannot get away 
with it, because what happens on Wall Street impacts Main 
Street, and we represent Main Street, or we should. We should.
    Mr. Spitzer, I wanted you to know that I was a broker on 
Wall Street many, many years ago, when 12 million share days 
were overwhelmingly exciting. It was such a low volume of 
trades in those days, and I just want to speak to you as 
someone who went into that business because I wanted to help 
people do well, and I was quite young, and I could tell you 
this, we counted on the work that the people in the firms did 
to analyze those stocks. I felt so good, so comfortable with 
it, and I could tell my clients who were not very wealthy, who 
were just saving for their retirement, that this was real. I 
also counted on the big four at that time, the big four 
accounting firms. Boy, if they stamped their approval on it, 
you knew it was real.
    I long for those days, and if anything good comes out of 
this it would be, maybe we can get back to those days where 
being honest and being true and being sincere, and as Senator 
Wyden believes a majority of the people are, if those are the 
people that would take the leadership we will not have 
headlines like this in search of the last honest analyst.
    Let me close in this way. Just today's headline in the 
Washington Post, ``Corporate Scandals Taking Toll on Markets,'' 
and it shows how the scandals track with the prices of stocks, 
and then even a broader statement on the next page, a headline, 
``Scandal's Impact Felt on Dollar and the Economy,'' so what we 
are doing here today with your leadership, Mr. Chairman, is 
trying to get to the bottom of why we are in such shaky times, 
and I think you have invited someone here today who has shown 
his courage, his conviction, his leadership, and it is 
wonderful that you are really honoring him with this invitation 
to come before the Senator. I thank you very much.
    Senator Dorgan. Senator Boxer, thank you very much. 
Attorney General Spitzer, again we welcome you to the 
Committee. We have followed your work with interest. We think 
it is important work done at a very important time, and you 
know and I know and my colleagues know that your work has been 
lauded by some and criticized very significantly by others. I 
must say to you that I also invited Congressman Baker to be 
present today, who has been critical of having an Attorney 
General involved in the things you are involved in, and he 
elected not to be here. I wanted to also give him the 
opportunity to make a statement, but in any event, we are 
delighted to have you, and why don't you proceed. Your entire 
statement will be made a part of the permanent record; you may 
summarize as you wish, and then we would like to pursue some 
questions.

STATEMENT OF HON. ELIOT SPITZER, ATTORNEY GENERAL OF THE STATE 
                          OF NEW YORK

    Mr. Spitzer. Chairman Dorgan, Senators Wyden and Boxer, 
thank you for your kind words. Senator Dorgan, let me simply 
begin by saying I am aware of the praise, and I am thankful for 
that and your kind words, especially this morning. I also have 
noted the criticism in passing over the past weeks and months, 
and I appreciate your commenting on it.
    Thank you for the invitation to be here this morning. This 
morning the stock market has taken another hit. At my last beep 
from back home the market was down 180 points at the opening. 
This is because the credibility of another major corporation 
has been shattered. The investing public's confidence in 
corporate governance is dropping precipitously, and throughout 
this crisis of accountability there has been a void, a vacuum 
in leadership from federal regulators. It is time for the SEC 
to wake up. It is time for Congress to pass fundamental reform, 
and it is time for our blind faith in Wall Street's capacity to 
regulate itself to come to an end.
    Several months ago, my office announced the results of an 
investigation that showed the degree to which the investing 
public had been fundamentally misled by one of the largest 
institutions on Wall Street. Unfortunately, several ongoing 
investigations that I am conducting have revealed similar 
problems in other major investment houses. It is absolutely 
essential that we now take steps to restore investor confidence 
in the marketplace. The way to do so is through true industry-
wide reform that changes the way business is done at investment 
banks and assures individual investors that their interests are 
protected and that the information they are receiving is 
truthful.
    My office's continuing investigation and my testimony today 
are aimed at achieving reforms that are necessary to achieve 
that goal. I would like to start with a very brief description 
of my office's findings with respect to Merrill Lynch, simply 
to demonstrate the nature of the infractions and the 
protections that are necessary to prevent similar wrongdoing in 
the future.
    First, the evidence showed that Merrill Lynch's publicly 
stated assessment of stocks was often false, and did not 
represent the privately stated opinions of the firm's analysts. 
For instance, Merrill Lynch was urging customers to buy 
Lifeminders while Merrill Lynch's analysts were referring to 
the company as, `` POS.'' Let me simply say that POS is a 
euphemism for an extremely poor investment.
    Second, the evidence revealed that the analysts writing 
stock reports at times functioned essentially as sales 
representatives for the firm's investment bankers, using 
promises of positive research coverage to bring in new clients 
and stock offerings. Favorite investment banking clients 
received advance viewings of analysts' reports, and were 
offered an opportunity to change those reports themselves. In 
one revealing e-mail exchange, an investment banker said to an 
analyst, ``we should aggressively link coverage with banking.'' 
That is what we did with go2net. If you are very bullish, they 
will love you.
    Research could also be used to punish companies. In one 
instance, a company was downgraded when Merrill Lynch did not 
get the company's investment banking business, and in another, 
a stock was downgraded to please a competitor who was a client 
of Merrill Lynch.
    Third, the evidence demonstrated that a key element of 
research analysts' compensations was the success of the 
investment banking activities they pursued, rather than the 
accuracy of their buy-sell recommendations to the public.
    These problems were well-recognized within Merrill Lynch. 
Management itself acknowledged the problem, saying, ``we are 
off-base on how we rate stocks and how much we bend backward to 
accommodate banking,'' but nothing meaningful was done. Henry 
Blodget, the senior Internet analyst, described the conflict in 
one particularly damming e-mail. Blodget, frustrated by the 
lack of guidance about how to handle certain investment banking 
situations, threatened to do the unthinkable, render an 
unbiased evaluation. His words are shocking, ``If there is no 
new e-mail forthcoming on how ratings should be applied to 
sensitive banking clients, we are just going to start calling 
the stocks like we see them, no matter what the ancillary 
business consequences are.''
    Because of the conflict of interest I have described, the 
company's investment advice was tainted. Companies that were 
poor investments, companies that were disparaged internally, 
still received strong ratings. Even as stocks plummeted, the 
buy recommendations on investment banking clients remained 
firm. Individual investors who depended on Merrill Lynch's 
stock analysis and investment advice were misled, and left to 
rely on stock ratings skewed to please investment banking 
clients. In short, a major Wall Street firm exploited its 
massive retail client base as a tool for bringing in new 
business. There is no telling how much individual investors 
lost as a result.
    On April 8, 2002, my office obtained an order in state 
supreme court putting in place temporary remedies to largely 
deal with the abuses we found. Thereafter, on May 21 of this 
year, we and Merrill Lynch reached a settlement involving 
monetary payment and permanent remedial changes in Merrill 
Lynch procedures. The terms of the settlement have been widely 
reported, and I will not burden the record by repeating them 
here. It included serious structural reforms in Merrill Lynch's 
operations, as well as the penalty of $100 million intended to 
emphasize to the management and shareholders of Merrill Lynch 
the gravity of the company's infractions.
    I should add that it is to Merrill Lynch's credit that they 
have acknowledged the problem and implemented certain necessary 
reforms. We believe the settlement was a fair one, tailored to 
the abuses we found at Merrill Lynch, but the settlement dealt 
only with Merrill Lynch. We believe that the problem extends 
beyond Merrill, and it is our job, under New York State law, to 
respond to fraud in the marketplace. Further investigations and 
enforcement proceedings are necessary, as is industry-wide 
reform.
    Remarkably, throughout our investigation, which has now led 
us to examine the documents of a significant number of 
companies, there is absolutely no evidence that any compliance 
department ever took any action to stop behavior that clearly 
violated internal rules, state and federal law. The failure of 
the industry's much-vaunted compliance structure is appalling.
    A few critics, however, as the Chairman mentioned, are 
alarmed that a state prosecutor conducted the investigation and 
obtained the settlement. For example, Congressman Baker, in a 
letter to each of the 50 State Attorneys General, criticized 
the action of New York, saying it would produce confusion in 
the market, and harm the interests of investors. Congressman 
Oxley, Chairman of the House Financial Services Committee, went 
further, writing in a May 31 letter to the New York Times that 
the settlement with Merrill was, ``a State regulatory coup.''
    These allegations are wholly without basis, and reflect a 
flawed understanding of the necessary role that the states have 
played in protecting the integrity of the securities markets. 
The Merrill investigation and settlement was not a state 
excursion into rulemaking. My office became aware of possible 
fraud by Merrill. We investigated it. We exposed Merrill's 
practices to public view. We commenced a proceeding, and we 
reached a settlement with Merrill which provided for both a 
monetary penalty and substantive relief.
    As Attorney General of New York, I have legal duty to 
enforce the Martin Act, a law that predates the federal 
securities acts, and that has been integral to protecting 
investors for over 80 years. Unlike rulemaking, which is the 
province of the SEC and the securities SRO's, the settlement we 
reached with Merrill was a resolution of an enforcement 
proceeding against the firm. It imposed no rule on the 
securities industry as a whole. Indeed, it imposed no change on 
a firm other than the firm investigated, Merrill Lynch.
    The settlement required specific remedial actions to be 
undertaken by Merrill and no one else. It was tailored to deal 
with the specific abuses we had evidence of at Merrill. It was 
negotiated with Merrill, and it is binding on Merrill and 
Merrill alone.
    It is quite true that after we reached our settlement with 
Merrill Lynch, I said I hoped the industry as a whole would 
adopt the reforms Merrill Lynch was undertaking. That is 
because that I believed then, and believe now, that the reforms 
represented good practices that could well be adopted by other 
firms or imposed by the SEC. I am gratified that several large 
Wall Street firms apparently agree, and have voluntarily 
adopted the Merrill reforms. I hope other firms follow their 
lead, and that they do even more to address the potential 
conflict of interest that exists.
    Critics of state action overlook the absence of federal 
action that made the Merrill investigation and reforms 
necessary. The analysts' conflict of interest we investigated 
had been widely reported in the press for years, but until we 
published the Merrill Lynch e-mails, virtually nothing had been 
done about it. There was no meaningful new SEC regulation to 
address the problem, no legislation to correct the abuses, no 
serious enforcement actions against those who were defrauding 
the public. During the period of this federal enforcement 
vacuum, untold millions of individual investors lost vast sums 
of money.
    Congressman Baker held hearings on the issue of analysts' 
conflict of interest, but those hearings utterly failed to 
uncover the damning evidence revealed by our investigation. 
Indeed, those hearings failed to include testimony from 
industry insiders, even though those are the individuals with 
the most extensive knowledge of the conflicts, and his hearings 
produced no proposal for reform, even though such reforms were 
desperately needed.
    The NASD proposed new regulations on analysts which were 
accepted by the SEC at its June 8 meeting, but those 
regulations are simply inadequate. Indeed, if those rules had 
been in effect, the abuses we discovered at Merrill Lynch all 
would have been perfectly within the bounds of federal 
regulations. With respect to analysts' compensation, the only 
restriction imposed by the new regulations is a ban on 
compensating an analyst on a per-transaction basis, i.e., a 
flat fee per transaction, or percentage of the investment 
banking fee from each transaction. All other methodologies and 
procedures to compensate analysts for generating investment 
banking revenue, including those ended at Merrill by the 
settlement, are permitted to continue.
    The new regulations disclosure requirements are also 
inadequate in several respects. They totally fail to address 
clear disclosure upon termination of coverage, serious abuse we 
found at Merrill, and also failed to require firms to disclose 
whether analysts authoring research reports solicited 
investment banking business in the past year, something we feel 
strongly investors should be told.
    In considering the attacks made by critics of state action, 
one must consider the alternatives they support. A case in 
point is H.R. 3763, a bill that originated in Chairman Oxley's 
and Representative Baker's committee, which on the issue of 
analyst conflicts requires absolutely no action from anyone. 
Its sole directive is to the SEC to study and report back to 
Congress on any final rules a self-regulatory organization may 
in the future deliver to the SEC. It is difficult to conceive 
of a more passive or inadequate response to the problem.
    The Merrill investigation and settlement has spawned 
another movement, one that is very dangerous to investors. I am 
referring here to the behind-the-scenes effort to pass 
legislation that would eviscerate the ability of states to 
effectively prosecute securities fraud. The threat is very 
real. Representative Baker, in a letter to all of the Nation's 
Attorneys General, has threatened that he would introduce 
legislation which would supersede state efforts in this area. 
Two weeks ago, an amendment to the Sarbanes bill was 
circulated. It would have stripped state prosecutors of their 
power to obtain substantive relief from analysts who have 
conflicts of interest.
    This is no time to curtail the powers of state regulators 
to pursue securities fraud. Continued state enforcement is 
essential if individual investors are to receive the continued 
protection they need and deserve. The state security regulators 
are the cops on the beat to ensure that the investing public is 
protected from fraud, whether that fraud is perpetrated by a 
small bucket shop or one of the biggest investment institutions 
in the world.
    For years, many in Congress have aggressively promoted the 
concept of increased federalism, a belief that the Federal 
Government should scale back its involvement in our Nation's 
affairs. I opposed that effort when it began, and I still 
oppose it now. However, I believe that the Congress and the 
Federal Government cannot have it both ways. If Congress and 
the Executive Branch decide to curtail federal oversight of 
areas such as securities, they must recognize it is the 
responsibility of state securities regulators such as myself to 
step in to protect the investing public.
    Several Members of Congress and some leaders of the 
financial industry have said that what is truly needed is a 
uniform national standard. Let me be very clear. I agree it 
would be best for the SEC to use its powers to impose nation-
wide rules to regulate analysts to prevent the sort of abuses 
we discovered in the Merrill Lynch cases, but so far that has 
not happened, and when and if it does, the enforcement of those 
regulations and actions to curtail abuses will be of paramount 
importance. It will be incumbent on federal and state 
regulators to continue our efforts to vigorously pursue 
enforcement actions and obtain significant relief when it is 
necessary to protect the investing public.
    Finally, I want to be very clear what this case is about. 
Wall Street spends millions of dollars each year to convince 
individual investors to put their life savings in the hands of 
the large investment houses and the brokers. What they have not 
told investors is that their investment advice has been 
compromised by a desire to win investment banking clients. 
Regular people, not Wall Street professionals, have lost a 
collective fortune by relying on the tainted advice of the 
biggest and most trusted names in the world of finance.
    Do not take it from me. Listen to the words of one 
investment analysts at Merrill Lynch who wrote, ``we are losing 
people's money and I do not like it. John and Mary Smith are 
losing their retirement because we do not want an investment 
banking client to be mad at us.''
    I do not like it either, and neither should anyone who has 
the power and responsibility to regulate or prosecute this 
industry. As I said at the beginning of my testimony, one of my 
primary goals is to restore the confidence of the investing 
public in Wall Street. Unfortunately, as a result of the abuses 
that have occurred, including those we see on the front pages 
of the papers today, the American people simply do not believe 
the advice they are being given by the Wall Street securities 
firms. We need to change that perception, and let me list 
quickly several of the reforms that are absolutely necessary.
    First, we need to rebuild the wall between research 
analysts and investment bankers, to eliminate pressure from the 
investment bankers for more favorable research reports. This 
must include careful thought to the precise aspects of every 
interaction with investment banking clients that analysts are 
permitted to participate in.
    Second, we need to ensure that analysts' compensation is 
not based on investment banking revenue so that analysts are 
considering the interests of the investing public and not their 
own wallets.
    Third, we need to provide greater disclosure to the public. 
For example, investors should be told how frequently a firm 
issues buy or sell recommendations on stocks in particular 
sectors. All research reports should reveal whether the 
investment banking firm has received compensation from the 
subject company, and firms must state when and why they have 
discontinued research coverage of a company.
    Finally, every firm should have an independent committee 
that reviews all research recommendations to confirm that the 
research recommendations are based upon sound objective 
analysis.
    Implementation of these four fundamental reforms will give 
confidence to the Mr. and Mrs. Smith mentioned in the Merrill 
Lynch e-mail that the recommendations provided by Wall Street 
firms are objective and honest.
    I thank you for giving me the opportunity to testify today, 
and I look forward to answering your questions.
    [The prepared statement of Mr. Spitzer follows:]

               Prepared Statement of Hon. Eliot Spitzer, 
               Attorney General of the State of New York
    Chairman Dorgan and distinguished Members of the Subcommittee, 
thank you for inviting me to testify before you today on the important 
issue of investment banking reform.
    There is no question that the investing public has diminished faith 
in Wall Street. We have seen that not only in public opinion polls, but 
also in the performance of the stock market over the past year. Several 
months ago, my office announced the results of an investigation that 
showed the degree to which the investing public had been misled by one 
of the largest institutions on Wall Street. Unfortunately, several 
ongoing investigations have revealed similar problems elsewhere. Those 
deceptions--Enron, Global Crossing, and other scandals--have led many 
small investors to withdraw from the markets. It is absolutely 
essential that we now take steps to restore investor confidence in the 
marketplace. The way to do so is through true industry-wide reform that 
changes the way business is done at investment banks and assures 
individual investors that their interests are protected and that the 
information they are receiving is truthful. My office's continuing 
investigation and my testimony today are aimed at achieving reforms 
that are necessary to achieve that goal.
    I would like to start with a brief description of my office's 
findings with respect to Merrill Lynch, simply to demonstrate the 
nature of the infractions and the protections that are necessary to 
prevent similar wrongdoing in the future.
    First, the evidence showed that Merrill Lynch's publicly stated 
assessment of stocks was often false, and did not represent the 
privately stated opinions of the firm's analysts.
    For example, while Merrill Lynch publicly was giving the company 
Infospace its highest rating in the fall of 2000, the firm's analysts 
privately were branding said InfoSpace ``a powder keg'' and ``a piece 
of junk.'' This particular stock remained on Merrill Lynch's list of 
highest recommended stocks for many months even after these internal 
warnings. In the same vein, Merrill Lynch was urging customers to buy 
``Lifeminders'' while Merrill Lynch analysts privately were referring 
to the company as a ``POS'' Let me simply say that POS is a euphemism 
for an extremely poor investment.
    Second, the evidence revealed that the analysts writing stock 
reports at times functioned essentially as sales representatives for 
the firm's investment bankers, using promises of positive research 
coverage to bring in new clients and stock offerings.
    Individual mandates for investment banking services are worth 
millions of dollars, and are the major income stream of a securities 
firm. As a result, there is incredible pressure to win investment 
banking deals and to secure and retain investment banking clients.
    Because of the risk that research conclusions relied upon by the 
general public could be manipulated to assist in obtaining investment 
banking clients, the two realms must remain independent. Merrill 
Lynch's internal policy manual stated ``opinions expressed by analysts 
must be objective. Any indication that a research opinion is less than 
totally objective, or that it may have been influenced by a business 
relationship of the firm, could seriously damage the firm's reputation 
and lead to potential legal liability.''
    Yet the reality was very different. Research was openly and largely 
used as a sales hook for investment banking clients. Indeed, the 
internet unit never recommended that investors sell any stock and 
rather than recommend a ``sell'' on a given stock Merrill Lynch would 
simply drop coverage. Favored investment banking clients received 
advanced viewings of analyst reports and were offered an opportunity to 
offer changes. In one revealing e-mail exchange, an investment banker 
said to an analyst: ``we should aggressively link coverage with 
banking--that is what we did with go2net . . . if you are very bullish 
they will love you . . . '' This was a situation in which Merrill Lynch 
was trying to win a new client. In another example, an institutional 
investor e-mailed Henry Blodget asking, ``What's so interesting about 
GOTO except banking fees???'' Blodget responded, ``nothin.'' Blodget's 
candid opinion was not reflected in the initiation research report, nor 
did the report disclose that Merrill Lynch had promised research 
coverage in exchange for GoTo's investment banking business.
    Research could also be used to punish companies. In one instance a 
company was downgraded when Merrill Lynch did not get the company's 
investment banking business and, in another example, a stock was 
downgraded to please a competitor.
    Third, the evidence demonstrated that a key element of research 
analyst's compensation was the success of the investment banking 
activities rather than the accuracy of their buy-sell recommendations 
to the public. For example, the head of equity research wrote to 
analysts soliciting information on their involvement in investment 
banking so compensation could be calculated: He said:

        We are once again surveying your contributions to investment 
        banking during the year . . . please complete details on your 
        involvement in the transaction, paying particular attention to 
        the degree your research coverage played a role in origination, 
        execution and follow-up. Please note as well, your involvement 
        in advisory work on mergers or acquisitions, especially where 
        your coverage played a role in securing the assignment and you 
        made follow up marketing calls to clients. Please indicate 
        where your research coverage was pivotal in securing 
        participation in high yield offerings.

    These problems were well recognized within Merrill Lynch. 
Management itself acknowledged the problem--saying ``we are off base on 
how we rate stocks and how much we bend backwards to accommodate 
banking.'' But nothing meaningful was done. Henry Blodget, the senior 
internet analyst, described the conflict in one particularly damning e-
mail. Blodget, frustrated by the lack of guidance about how to handle 
investment banking situations, threatened to do the unthinkable--render 
an unbiased evaluation. His words are shocking: ``If there is no new e-
mail forthcoming on how `ratings' should be applied to sensitive 
banking clients, we are just going to start calling the stocks like we 
see them, no matter what the ancillary business consequences are''.
    Because of the conflict of interest I have described, the company's 
investment advice was tainted. Companies that were poor investments--
companies that were disparaged internally--still received strong buy 
ratings. Even as stocks plummeted, the buy recommendations on 
investment banking clients remained firm. Individual investors who 
depended on Merrill Lynch's stock analysis and investment advice were 
misled, and left to rely on stock ratings skewed to please investment 
banking clients. In short, a major Wall Street firm exploited its 
massive retail client base as a tool for bringing in new business. 
There is no telling how much individual investors lost as a result.
    On April 8, 2002 my office obtained an order in State Supreme Court 
putting in place temporary remedies to partially deal with the abuses 
we had found. Thereafter, on May 21, 2002, we and Merrill Lynch reached 
a settlement involving a monetary payment and permanent remedial 
changes in Merrill Lynch procedures.
    The terms of the settlement have been widely reported, and I will 
not burden the record by repeating them here. It included very serious 
structural reforms in Merrill Lynch's operation, as well as a penalty 
of $100 million, intended to emphasize to the management and 
shareholders of Merrill Lynch the gravity of the company's infractions. 
I should add that it is to Merrill Lynch's credit that they have 
acknowledged the problem and implemented necessary reforms. We believe 
the settlement was a fair one, tailored to the abuses we found at 
Merrill Lynch. But the settlement dealt only with Merrill Lynch. We 
believe that the problem extends beyond Merrill Lynch, and it is our 
job under New York State law to respond to fraud in the marketplace. 
Further investigations and enforcement proceedings are necessary as is 
industry-wide reform.
    Remarkably, throughout our investigation, which has now led us to 
examine the documents of a significant number of companies, there is 
absolutely no evidence that any compliance department ever took action 
to stop behavior that clearly violated internal rules and state and 
federal law. The failure of the industry's much vaunted compliance 
structure is appalling.
Beyond Merrill Lynch
    A few critics, however, are alarmed that a state prosecutor 
conducted the investigation and obtained the settlement.
    For example, Congressman Richard Baker (Chairman of the House 
Subcommittee on Capital Markets, Insurance and Government Sponsored 
Enterprises) in a letter to each of the 50 state attorneys general, 
criticized the action New York took as an improper attempt to impose 
state rules on a national marketplace which, if emulated by other 
states, would produce confusion in the market and harm the interests of 
investors. Congressman Michael Oxley, Chairman of the House Financial 
Services Committee, went further, writing in a May 31 letter to the New 
York Times that the settlement with Merrill was a state ``regulatory 
coup'' which would lead to a ``balkanization'' of rulemaking and 
oversight.
    These allegations are wholly without basis and reflect a flawed 
understanding of the necessary role the states have historically played 
in protecting the integrity of the securities markets. The Merrill 
investigation and settlement was not a state excursion into rulemaking. 
My office became aware of possible fraud by Merrill; we investigated 
it; we exposed Merrill's practices to public view; we commenced a 
proceeding; and we reached a settlement with Merrill which provided for 
both a monetary penalty and substantive relief. As Attorney General of 
New York, I have a legal duty to enforce the Martin Act--a law that 
predates the federal securities acts--and that has been integral to 
protecting investors for over eighty years.
    Unlike rulemaking, which is the province of the SEC and the 
securities SROs, the settlement we reached with Merrill was a 
resolution of an enforcement proceeding against a firm. It imposed no 
rule on the securities industry as a whole. Indeed, it imposed no 
change on any firm other than the firm investigated, Merrill Lynch. The 
settlement required specific remedial actions to be undertaken by 
Merrill and no one else. It was tailored to deal with the specific 
abuses we had evidence of at Merrill, it was negotiated with Merrill, 
and it is binding on Merrill and Merrill alone.
    It is quite true that after we reached our settlement with Merrill 
I said I hoped the industry as a whole would adopt the reforms Merrill 
was undertaking. That is because I believed then, and believe now, that 
the reforms represented good practices that could well be adopted by 
other firms or imposed by SEC rule. I am gratified that several large 
Wall Street firms apparently agree, and have voluntarily adopted the 
Merrill reforms. I hope other firms follow their lead, and that they do 
even more to address the potential conflicts of interest that exist.
    Critics of state action overlook the absence of federal action that 
made the Merrill investigation and reforms necessary. The analyst 
conflicts of interest we investigated had been widely reported in the 
press for years. But until we published the Merrill Lynch e-mails 
virtually nothing had been done about it--there were no meaningful new 
SEC regulations to address the problem, no legislation to correct 
abuses, and no serious enforcement actions against those who defrauded 
the public. During the period of this federal enforcement vacuum, 
untold millions of individual investors lost vast sums of money.
    Congressman Baker held hearings on the issue of analyst conflicts 
of interest but those hearings utterly failed to uncover the damning 
evidence revealed by our investigation. Indeed, those hearings failed 
to include testimony from industry insiders--even though those are the 
individuals with the most extensive knowledge of the conflicts--and his 
hearings produced no proposals for reform, even though such reforms 
were desperately needed.
    The NASD proposed new regulations on analysts, which were accepted 
by the SEC at its June 8th meeting, but those regulations are simply 
inadequate. Indeed if those rules had been in effect, the abuses we 
discovered at Merrill Lynch all would have been perfectly within the 
bounds of federal regulations. With respect to analyst compensation, 
the only restriction imposed by the new regulations is a ban on 
compensating an analyst on a per transaction basis--i.e., a flat fee 
per transaction or a percentage of the investment banking fee from each 
transaction. All other methodologies and procedures to compensate 
analysts for generating investment banking revenue, including those 
ended at Merrill by the settlement, are permitted to continue. The new 
regulations' disclosure requirements are also inadequate in several 
respects. They totally fail to address clearer disclosure upon 
termination of coverage, a serious abuse we found at Merrill, and also 
fail to require firms to disclose whether analysts authoring research 
reports solicited investment banking business in the past year, 
something we feel strongly investors should be told.
    In considering the attacks made by critics of state action, one 
must consider the alternatives they support. A case in point is HR 
3763, a bill that originated in Chairman Oxley's and Representative 
Baker's committee, which on the issue of analyst conflicts requires 
absolutely no action from anyone. Its sole directive is to the SEC to 
study and report back to Congress on any final rules a self-regulatory 
organization may in the future deliver to the SEC. It is difficult to 
conceive of a more passive--or inadequate--response to the problem.
    The Merrill investigation and settlement has spawned another 
movement, that is very dangerous to investors. I am referring here to 
the behind-the-scenes effort to pass legislation that would eviscerate 
the ability of the states to effectively prosecute securities fraud.
    The threat is very real. Representative Baker--in a letter to all 
of the nation's attorneys general--has threatened that he would 
``introduce legislation which would supercede'' state efforts in this 
area. Two weeks ago, an amendment to the Sarbanes bill was circulated. 
It would have stripped state prosecutors of their power to obtain 
substantive relief from analysts who have conflicts of interest.
    This is no time to curtail the powers of state regulators to pursue 
securities fraud. Continued state enforcement is essential if 
individual investors are to receive the protection they need and 
deserve. The state security regulators are the ``cops on the beat'' who 
insure that the investing public is protected from fraud--whether that 
fraud is perpetrated by a small bucket shop or by one of the biggest 
investment institutions in the world.
    For years, many in Congress have aggressively promoted the concept 
of increased federalism--a belief that the Federal Government should 
scale back its involvement in our nation's affairs. I opposed that 
effort when it began and I still oppose it now.
    However, I believe that the Congress and the Federal Government 
cannot have it both ways. If Congress and the Executive Branch decide 
to curtail federal oversight of areas such as securities, they must 
recognize it is the responsibility of state securities regulators such 
as myself to step in to protect the investing public.
    Several Members of Congress and some leaders of the financial 
industry have said that what truly is needed is a uniform national 
standard. Let me say very clearly here: I agree. It would be best for 
the SEC to use its power to impose nationwide rules to regulate 
analysts to prevent the sort of abuses we discovered in the Merrill 
Lynch case. But so far that has not happened, and when and if it does, 
the enforcement of those regulations and actions to curtail abuses will 
be of paramount importance. It will be incumbent on federal and state 
regulators to continue our efforts to vigorously pursue enforcement 
actions and obtain significant relief where such relief is necessary to 
protect the investing public from continued abuses.
    Finally, I want to be very clear what this case is about. Wall 
Street spends millions of dollars each year to convince individual 
investors to put their life savings in the hands of the large 
investment houses and their brokers. What they have not told investors 
is that their investment advice has been compromised by a desire to win 
investment banking clients. Regular people--not Wall Street 
professionals--have lost a collective fortune by relying on the tainted 
advice of the biggest and most trusted names in the world of finance. 
Don't take it from me. Listen to the words of one investment analyst of 
Merrill Lynch who wrote, ``We are losing people's money and I don't 
like it. John and Mary Smith are losing their retirement because we 
don't want . . . [an investment banking client--the cfo of goto.com] to 
be mad at us.'' I don't like it either, and neither should anyone who 
has the power and responsibility to regulate or prosecute this 
industry.
    As I said at the beginning of my testimony, one of my primary goals 
is to restore the confidence of the investing public in Wall Street. 
Unfortunately, as a result of the abuses that have occurred, the 
American people simply do not believe the advice that they are being 
given by the Wall Street firms. We need to change that perception, and 
here are the reforms that need to be implemented:
    First, we need to rebuild the wall between research analysts and 
investment bankers, to eliminate pressure from the investment bankers 
for more favorable research reports. This must include careful thought 
to the precise aspects of every interaction with investment banking 
clients that analysts are permitted to participate in.
    Second, we need to ensure that analyst compensation is not based on 
investment banking revenue, so that analysts are considering the 
interests of the investing public, and not their own wallets.
    Third, we need to provide greater disclosure to the public. For 
example, investors should be told how frequently a firm issues ``buy'' 
or ``sell'' recommendations on stocks in particular sectors; all 
research reports should reveal whether the investment banking firm has 
received compensation from the subject company; and firms must state 
when and why they have discontinued research coverage of a company.
    Finally, every firm should have an independent committee that 
reviews all research recommendations, to confirm that the research 
recommendations are based upon sound, objective analysis.
    Implementation of these four fundamental reforms will give 
confidence to the Mr. and Mrs. Smith mentioned in the Merrill Lynch e-
mail that the recommendations provided by Wall Street firms are 
objective, honest, and can be relied upon as they decide how to invest 
their life savings.
    Again, I thank you for giving me this opportunity to address you 
today on these important issues. If you have any questions I would be 
happy to answer them.

    Senator Dorgan. Attorney General Spitzer, thank you very 
much. We have been joined by the Ranking Member of the Full 
Committee and the Ranking Member of the Subcommittee, as well 
as Senator Edwards. Let me call on Senator McCain for an 
opening statement.

                STATEMENT OF HON. JOHN McCAIN, 
                   U.S. SENATOR FROM ARIZONA

    Senator McCain. Thank you. I will be brief. Thank you, Mr. 
Spitzer. Mr. Chairman, I was just informed by staff that 
Congressman Baker called over and said he was never formally 
asked to testify. We can rectify that, I am sure, in the 
future.
    Mr. Spitzer, I applaud what you have done. The only 
encounter I ever had with Attorney General Spitzer was an 
effort to clean up boxing, so far, at which we have been 
significant failures, but I still appreciate your effort 
enormously. Anybody who says that you should not have done what 
you did does not have the interest of the investors all over 
the country as their primary motive. I do not believe that we 
would be finding out the things we are finding out today in 
light of a $3.8 billion misstatement on the part of WorldCom. I 
think Enron was only $1.-something billion. So Mr. Spitzer, I 
applaud your efforts, and I believe a majority of the United 
States Senate would oppose any endeavor to curtail your efforts 
on behalf of the average citizens of this country. Mr. Spitzer, 
I hope you will do more, and I wish you would put somebody in 
jail. I will tell you, Mr. Spitzer, until somebody goes to jail 
I am not sure that these people are going to get the message. I 
hope that the next time, and obviously there will be a next 
time, that criminal charges are referred, because I do not 
think that a $100 million fee is that big. I mean, it is a 
pretty big deal in most places in America, but I am not sure 
how big a deal it is with Merrill Lynch.
    So Congressmen and Senators are free to write letters to 
anybody they want to, and I applaud that right, but I believe a 
majority of the United States Senate would oppose curtailing 
your investigatory activities, which I think are carried out on 
behalf not only of the people of New York but the people of 
Arizona and every other state in America.
    Why did you decide not to refer criminal charges?
    Mr. Spitzer. Senator, let me explain it this way. The 
objective number one for me was to reform the industry and to 
articulate a new set of rules that desperately needed to be 
articulated so that others who have the power to mandate 
industry-wide reform could do so.
    As we proceeded with the Merrill Lynch investigation, I 
have stated this publicly, we could have indicted and convicted 
Merrill Lynch. That would have destroyed 60,000 jobs. It would 
have destroyed an entity, but it would not have led to the sort 
of reforms that we believe are necessary to protect the 
American public.
    Senator McCain. Is not there some individual 
responsibility?
    Mr. Spitzer. Absolutely, Senator, and there are individuals 
who still face the possibility of criminal charges, not from my 
office but from other offices, and indeed, let me explain this 
in the context of timing. I believed it was critical for Wall 
Street, the investment world to see what the parameters were of 
the Merrill Lynch deal to be awakened quickly to the realities 
of what was there, and to protect the investing public, and we 
took a first step at that.
    I have spoken to the leadership on Wall Street and said to 
them, it is now incumbent upon you to step into this breach, 
because as I said in my opening statement, we have had an 
absolute void at the SEC. There has been absolutely no 
meaningful----
    Senator McCain. An absolute void, and the fox is guarding 
the hen house.
    Mr. Spitzer. And that is why I said to the industry, 
gentlemen and ladies, it is up to you now to work with me and 
with others who have the interest of the investing public at 
heart.
    Senator McCain. What do you think of what the SEC has 
proposed so far?
    Mr. Spitzer. Inadequate, and I have said that privately and 
publicly, and I have made it very clear to the SEC that 
although I am proud to be in a partnership with them to 
continue to investigate the underlying abuses, they are indeed 
the primary regulator of this industry. Their actions so far 
have been inadequate for a year now. It has been a year now, 
Senator, that this has been brewing. We have seen nothing 
meaningful from them.
    Senator McCain. For the record, and soon, would you provide 
this Committee and me with your recommendations as to what they 
should be doing?
    Mr. Spitzer. Yes, sir, I will do that.
    Senator McCain. I appreciate the generosity of the Chairman 
here. I was supposed to be making an opening statement, but I 
think all Americans are terribly disturbed, particularly in 
light of today's news. People's life savings are being wiped 
out today as we speak. The last time I looked, the market was 
down 140 points. By the way, we do have a banking expert here 
to my right who will probably be able to ask much more coherent 
and temperate questions than I am asking.
    I thank you, Mr. Chairman.
    Senator Dorgan. Senator McCain, thank you. Let me ask 
Senator Fitzgerald for an opening statement, then Senator 
Edwards, and then we will get to the questions. As always, 
Senator McCain got right to the bull's eye of the target.
    Senator McCain. I thank you for your forbearance, Mr. 
Chairman.
    Senator Dorgan. Senator Fitzgerald. Before you start, let 
me just make this point. When we announced this hearing, 
Senator McCain, Congressman Baker's staff called and asked 
about the opportunity to testify. I told our staff to call them 
back and say he was invited to testify. They then said he was 
unavailable, so that is the way that worked. I do not want to 
misrepresent it, but they did inquire. I said, ``you are 
welcome, we would love to have you,'' and then they indicated 
he was not able to, so just for the record.

            STATEMENT OF HON. PETER G. FITZGERALD, 
                   U.S. SENATOR FROM ILLINOIS

    Senator Fitzgerald. Thank you, Mr. Chairman, and Mr. 
Attorney General, thank you for being here, and I want to 
compliment the Chairman for the series of hearings we did. I 
think it was back in December when we first had a bunch of 
employees from Enron testify right where you are today, and 
these were the folks who lost most or all of their life savings 
in their Enron 401(k) account. At that time I asked all of 
those employees if they had seen any of the research reports 
coming out on Enron stock from some of the analysts and the 
Wall Street investment banking houses, and every member at that 
panel raised their hand, and I said, did you rely on that 
research, did you think that was good, independent, objective 
advice, and they said, oh, yes. That is why we kept holding 
onto our stock, buying more of it in some cases.
    This Committee later looked into what the analysts had been 
doing with respect to Enron. We found that there were 17 
analysts following Enron stock, and up through September of 
last year, 16 of them had a buy or strong buy recommendation on 
the stock, and of those, half kept a buy recommendation on 
Enron right up to the time they filed bankruptcy on December 2, 
and there have been empirical studies that have looked into 
this before.
    As you know, the prior Chairman of the SEC, Arthur Levitt, 
was very interested in this issue, and I think he attempted a 
reform but either got bludgeoned back by Congress or the 
investment banks or both, but there was a study of stock 
analyst recommendations from 1996 through 2000 conducted by 
Dartmouth Professor Kent Womack that found that 71 percent of 
all analysts' recommendations were buy or strong buy, while 
less than 2 percent were sell or strong sell recommendations. 
It is very clear that there is an overwhelmingly optimistic 
bias on the part of analysts, and when you combine that with 
concerns about the influence of the enormous investment banking 
fees that are often generated by the clients that are being 
analyzed, you really have the worry about the independence of 
analysts' judgment.
    Now, I have myself concluded that analysts' reports are 
merely advertisements in most cases for the firms being 
analyzed. They are paying for that advertising via their 
investment banking fees. That is what was going on in the case 
of Enron. They paid hundreds of millions of dollars to Wall 
Street investment banks, and I think there are two ways we can 
deal with it.
    We could seek to stamp out the conflicts of interest, and I 
applaud you for your efforts with respect to the Merrill Lynch 
settlement, or we could simply require disclosure of those 
conflicts of interest, and I think with disclosure of those 
conflicts of interest, most average investors would then have a 
better idea that when they are reading one of these analyst 
reports it really does not have much more credibility, in most 
cases, than an advertisement for diapers, or cereal, or 
something they see on TV.
    I introduced a bill that would require disclosure of all 
the investment banking fees, any positions that companies, the 
investment houses, have in the company being analyzed. I think 
that would help in clearing up people's understanding that they 
may have an agenda, but on the other hand, to stamp out the 
conflicts entirely, or to have complete disclosure of them, is 
very, very difficult when you are dealing with sell-side 
analysts, so I will be interested in your perspective on how we 
should go about handling this situation.
    I do commend you for what you have done in New York, and I 
will have some more questions when we get to the question and 
answer session.
    Senator Dorgan. Senator Fitzgerald, thank you very much. 
Next, we will call on Senator Edwards.

                STATEMENT OF HON. JOHN EDWARDS, 
                U.S. SENATOR FROM NORTH CAROLINA

    Senator Edwards. Good morning, Mr. Attorney General, very 
good to see you again, and thank you for what you are doing on 
behalf of the people of North Carolina, because I think you are 
protecting investors not only in the State of New York but all 
over this country, including people I represent in North 
Carolina.
    As others have said, this hearing could not be more timely, 
given the news on WorldCom. This I think has been focused on 
businesses and investors and employees, but the reality is, as 
the Washington Post reported today, it is also about the 
economy as a whole, because there is no question that what is 
happening with these various firms is having a real impact on 
slowing down the recovery that all of us need, and the key, I 
think, to restoring investor confidence, which I think is a 
huge component of what we are trying to accomplish here, is to 
have aggressive watch-dogs like you, and the truth of the 
matter is that while the federal regulators have been sitting 
on their hands and fiddling around, you have actually been 
doing something, so thank you for what you are doing.
    To those who would say that what you are doing should be 
stopped, they are wrong. What you are doing is important, and 
instead of trying to stand in your way, what we ought to be 
doing is applauding you for what you are doing and pushing you 
forward.
    I want to change subjects, though, just briefly. There has 
been a lot of focus on the investment firms, which you have 
been focused on, on the accounting firms, on the actions of the 
top-level executives at these various companies. I also think 
there is another component that has gotten little attention 
thus far, which is the role of the lawyers in these various 
problems.
    I have many years of experience as a lawyer, as I know you 
do, and you are the top lawyer in the State of New York, but 
the truth of the matter is, a lot of these things could not 
have happened without some lawyer either allowing it to happen, 
or giving an opinion that it was okay, and one of the problems 
that I think happens is, the lawyers develop relationships with 
the people they deal with on a day-to-day basis, the CEOs. You 
know, they go to lunch with them, they play golf with them, 
they are their friends, but that is not who the lawyers work 
for.
    They work for the corporation. They work for the investors. 
They work for the shareholders, and it is my belief that they 
have, we, as lawyers, have a responsibility to those 
shareholders first of all. If they see something about to 
happen that is wrong/illegal, they have a responsibility to say 
it and to stop it.
    Number two, if it goes forward over their objection, I 
think they also have a responsibility to go up the chain, to go 
to the chairman of the board, to go to the board of directors, 
because oftentimes they are in a position to actually stop this 
stuff, as you well know, and I have written a letter to Harvey 
Pitt asking him whether he agrees with this, and whether this 
is something we can do something about. For years, this sort of 
regulation occurred, but unfortunately it stopped over the 
course of the last decade or so, and it is my belief that we 
need to reinstate it at the national level.
    I have also written a letter to the ABA, and unfortunately 
the ABA, even though they agree with the substance of what I 
have just said, is taking somewhat of a hands-off approach to 
this, which I think is wrong. I think we have to be willing to 
police our own profession, and I just wanted to get--Senator 
Corzine and I are working on a bill to do something about this 
issue, because I think it is another place where we can have a 
really meaningful and positive impact in restoring investor 
confidence, and I do not want to ask you questions now, but let 
me just ask you briefly, is that something you would agree 
with?
    Mr. Spitzer. Absolutely, Senator, and I will be brief in my 
answer. I know this is not the Q&A.
    I referred to Enron as the perfect storm of corporate 
governance failure, by which I mean, you not only had a failure 
on the part of the board, the audit committee, the outside 
auditors, the peer review, which is an area I think has gotten 
insufficient attention, but also, as per your point, the 
outside lawyers.
    I think the outside lawyers and the lawyers who work within 
a company have an ethical obligation to report those actions, 
those steps that they believe are wrong, violate law, and as 
you suggest, because their fiduciary duty goes to the 
shareholders, not to the CEO, not to the executive, it goes to 
the shareholders, they have to report up the chain to the board 
when their advice is not followed on ethical matters.
    Senator Edwards. Thank you for your leadership, Mr. 
Attorney General. I look forward to working with you, and thank 
you, Mr. Chairman.
    Senator Dorgan. Senator Nelson.

                STATEMENT OF HON. BILL NELSON, 
                   U.S. SENATOR FROM FLORIDA

    Senator Nelson. Mr. Chairman, I was somewhat jolted into 
reality in a conversation with the Chairman of the Banking 
Committee last evening, the very distinguished Senator from 
Maryland, Senator Sarbanes. When asking him about the reform 
legislation, which is the part that Senator Carnahan and I have 
added to that particular bill on corporate reform, and on 
accounting reform, Senator Sarbanes said that there was an all-
out effort, and they may succeed in defeating his bill. If this 
environment that we have just witnessed of corporate greed and 
skullduggery and accounting firms being in bed with the 
corporate managers, if this environment cannot create the 
political environment in which we can move legislation, that is 
a sad commentary, and I hope that further exposing to the clear 
light of day what you are doing in this hearing will help give 
us the momentum to try to be able to be successful in passing 
legislation for corporate reform.
    Thank you, Mr. Chairman.
    Senator Dorgan. Senator Nelson, thank you very much.
    Mr. Spitzer, again thank you for being here, and thank you 
for your testimony. I want to ask you about the Securities and 
Exchange Commission just a bit.
    The Securities and Exchange Commission was appropriated 
$514 million last year. The President's budget request suggests 
a cut to $466 million this year, a rather strange 
recommendation at this point in time, of course, but I said 
when I started that the SEC ought to hang its head in shame, 
because this has gone on around them. It is as if there is this 
carnival of greed and they have a front-row seat, and they are 
eating popcorn, and nothing is happening there.
    Can you tell me--and again, in your investigation, you 
investigated one piece of this. You are not investigating the 
things I referred to in the newspaper this morning that deal 
with restatements and so on, but tell me about the Securities 
and Exchange Commission and your contacts with them. What were 
they doing? Were they active in this area?
    Mr. Spitzer. I will try to be deft but make my point 
persuasively, and I will try to be deft because I have a 
partnership with the SEC and look forward to working with them 
as we march forward. Having said that, I have been sorely 
disappointed in what we have seen from the SEC over the past 
year. In an environment, as Senator Nelson said, when the 
public and all investors are crying out for leadership we have 
not seen it.
    It is not merely a matter of the budget. I hate to say this 
publicly, because some may get comfort from it. We have only 15 
lawyers in my Investor Protection Bureau, although I am 
constantly asked for more by the Bureau Chief, and we have 
managed rather easily, I should say, to reveal the evidence 
that verified an underlying theory that had been floating out 
there for years, and so it is not that the SEC lacks resources.
    I think they need more resources so they can be more 
affirmative and more aggressive, but it is a matter of will, it 
is a matter of desire, it is a matter of aggressiveness, it is 
a matter of leadership, and I think it is very clear that after 
a year this SEC is not where it should be.
    Senator Dorgan. Well, in your judgment, what has failed? Is 
it, you say a lack of will at the top of the SEC? For how long, 
and is there a culture here at the SEC that says, well, we have 
got $\1/2\ billion so let us decide what to do with it, let us 
sit around and do nothing?
    Mr. Spitzer. Senator, I do not wish to personalize this 
with respect to Chairman Pitt. Having said that, there are many 
professionals at the SEC who wish to be vigorous. I think that 
I will without recounting the details of my first meeting with 
the SEC, I would say that when I first sat down with senior 
lawyers at the SEC and proposed some of the ideas that I 
thought they could embody, since they have rulemaking authority 
that would begin to address the analysts' problems, they were 
dismissive of the ideas.
    The SEC and the SIA were the same. The SEC and the 
Securities Industries Association saw eye-to-eye. It was 
absolutely a failure on the part of the SEC to be inquisitive, 
to be aggressive, to understand that as the evidence was 
unfolding the much-vaunted self-regulatory world that had been 
relied upon was failing the public, and I think that is what is 
clear, whether it is Senator Edward's comments about lawyers, 
where self-regulation there also has been insufficient, or more 
palpably, as the American public has seen on the front page of 
every newspaper and every business page for the past year, in 
the context of our financial reporting systems, there has been 
a failure of self-governance, and hence, it was obligatory upon 
the SEC to step in, and they have not.
    Senator Dorgan. Mr. Spitzer, Senator McCain made the point 
that a lot of folks out there have just lost their shirts, lost 
their life savings. You turn on television, and if you have 
cable television you have 100 channels, and you go through the 
channels and you see all kinds of programs these days with 
investor analysts talking about this stock or that stock. They 
seem authoritative, they sound informed, and they are making 
recommendations here and there, but what you have discovered is 
that in many cases these recommendations are not objective at 
all. In some cases, recommendations are made by security 
analysts or stock analysts who privately are telling their 
firm, ``this is a dog, this stock is worthless,'' and yet they 
are saying to the public, ``buy this stock, buy this stock,'' 
and it has to do with money, does it not?
    Now, let me ask the question. Some say that there ought to 
be some kind of federal standard governing independence of 
investor analysis, or investor analysts. Even if we develop a 
federal standard, something, incidentally, I support, that does 
not mean that there is not going to be a role for Attorneys 
General in enforcing state and federal laws, is that not 
correct?
    Mr. Spitzer. Absolutely, Senator. I could not agree with 
you more. I said in my testimony and I said it for months, I am 
in favor of the SEC articulating a standard. They are the 
rulemaking entity that is supposed to define the behavior in 
the securities environment. I have been encouraging them to do 
so, to do it aggressively. Once they do so, there still will be 
a need for state enforcement.
    I have the Martin Act, which has generalized antifraud 
provisions. It will be obligatory and important for the 
investing public that we continue to enforce those provisions 
as we do from the smallest Ponzi scheme and bucket shop up to 
the Merrill Lynch inquiry. Those two work together.
    Senator Dorgan. Mr. Spitzer, what led you to the 
investigation? The reason I ask that question is that today in 
the Wall Street Journal--I suspect it is coincidence that it 
appears today. It is a two-page advertisement by Merrill Lynch 
with a picture of the president and CEO and chairman and CEO, 
and it says, ``lately you have been hearing a lot about Merrill 
Lynch, now you are going to hear from us,'' and it describes 
the reforms and so on.
    Look this is not, to me, about this company. It is about 
the people inside this company and other companies that have 
not been honest with analysts or with the American public, and 
as a result people have lost a fortune. Tell me what led you to 
this investigation? Were there whistleblowers some place? Where 
did you find the hints and the information to go forward?
    Mr. Spitzer. There were, Senator, over time there were 
people who came forward and spoke to us, but the instigation 
for this was very simple, and this is what is, I think, most 
unfortunate about it. Everybody on Wall Street knew. In the 
past year I have spoken to hundreds of investment bankers. 
Everybody agrees with the premise of our investigation. 
Everybody agrees that there was a fundamental tension and 
conflict, and yet nobody was doing anything about it. It was 
because of the void in enforcement that I felt there was an 
obligation to protect the investor.
    We stepped in precisely because every investment banker, 
every analyst understood what was going on. Mr. and Mrs. Smith 
were losing their shirts and nobody was doing anything.
    Senator Dorgan. Is there a connection, in your judgment--
this is my last question, and it kind of goes far afield in 
terms of what you have done--with the Enron hearings? We saw a 
string from the law firms, high-paid, big law firms that were 
enablers, to accounting firms that were enablers, to CEOs who 
in this turbocharged economy think you ought to make hundreds 
of millions of dollars and perhaps even get hundreds of 
millions of dollars as you exit, to stock analysts whose 
connection to the firm and to the investment bank that they 
serve relates to the fees, and therefore the requirement that 
they give good reports on the company. Is there a thread that 
connects all of this with respect to a culture, do you think?
    Mr. Spitzer. Senator, I think it is a harder question to 
answer, but I do think there is a thread there, and there has 
been I think a crisis of accountability that has gripped Wall 
Street, perhaps other sectors of our society as well, but there 
has been a more generalized dissipation of standards, a 
dissipation of the recognition on Wall Street to abide by the 
ethics that the investment bankers and lawyers and accountants 
understand. Not a failure of understanding. There is a failure 
of will in terms of their willingness to abide by their 
standards.
    Senator Dorgan. Just one final point. Do you have other 
cases underway?
    Mr. Spitzer. Unfortunately we do, and unfortunately, as I 
have said, the evidence at other houses replicates what we have 
seen at Merrill, and I say unfortunately because I wish this 
were isolated, but it is not, and that is a problem.
    Senator Dorgan. Senator McCain.
    Senator McCain. Mr. Spitzer, what is it that motivated you 
to begin your investigation?
    Mr. Spitzer. Senator, we have in New York a statute, the 
Martin Act, that has been on the books since 1921, it predates 
the federal securities laws, that obligates the State Attorneys 
General to enforce the antifraud provisions of the statute to 
ensure integrity on Wall Street. We have had historically 
through Attorneys General of both parties, I am proud to say, 
aggressive enforcement with respect to fraud on Wall Street.
    Most often the cases do not receive the notoriety of our 
investigation of Merrill, of course, because they relate to 
Ponzi schemes, bucket shops, fraud that does not go to the core 
of what has gone on, but our Merrill Lynch investigation is the 
same kind of inquiry that we conduct day-in and day-out, where 
we get evidence, or have a theory of wrongdoing on Wall Street, 
where investors are the losers, and we then pursue it.
    Senator McCain. Did you work with Mr. Morganthal?
    Mr. Spitzer. Yes, sir. I am proud to say I was in his 
office as an Assistant DA for 6 years, and I am glad you raised 
him, because I think the BCCI inquiry is another example of--it 
was the largest bank fraud in history--another example where 
state prosecutors stepped in to make an important case.
    Senator McCain. The agreement you reached with Merrill 
Lynch includes an enforcement provision which allows the firm 
to appoint its own monitor, subject to your approval.
    Mr. Spitzer. Yes, sir.
    Senator McCain. When will this appointment occur?
    Mr. Spitzer. It will occur shortly, and I have every 
confidence that Merrill now understands the problem and will 
act appropriately, if only out of a sense of self-preservation.
    Senator McCain. Well, I want to ask you one question that 
is pretty tough, and that is, under its present leadership, do 
you believe the SEC can be effective?
    Mr. Spitzer. I believe that Chairman Pitt understands the 
problems. I look forward to the evidence that the SEC is 
willing to take the steps that are needed. I have not seen that 
evidence yet. I have seen them proffer proposed rules with 
respect to accounting, with respect to analysts, that are 
insufficient, that do not reflect an understanding of the 
vacuum that exists and, quite frankly, Senator, in a year in 
which there has been a crisis of corporate governance unlike 
any we have ever seen we have seen a failure of leadership at 
the SEC.
    Senator McCain. The hour grows late. I thank you, Mr. 
Spitzer, and I congratulate you for your singular public 
service.
    Mr. Spitzer. Thank you, sir.
    Senator Dorgan. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Spitzer, one of the things I did in preparation for 
this hearing is, I went out and picked up all the financial 
magazines, the money magazines, Kiplinger's and the like, and 
they are just filled with articles about this, and particularly 
the need for more independence at the various firms, and as I 
go through these my sense is that even now, after your good 
work, the firms still do not get it. They do not get it in 
terms of how serious these conflicts are.
    For example, in Money Magazine of this month, where there 
was considerable discussion about the need for firewalls that 
would separate, for example, investment banking from research, 
the Merrill CEO told Money Magazine that research plays a 
critical role in the capital-raising process.
    Now, when I hear a statement like that, that suggests again 
that they still do not see how important these firewalls are 
that separate out these various kinds of functions. Tell me 
what your sense is. Is this message now finally starting to 
sink in, because to see these kinds of quotes after all of this 
attention suggests to me there is still a long way to go.
    Mr. Spitzer. Senator, I agree with you there is a long way 
to go. I think there are different camps within the investment 
banking world, and I think that we saw from Hank Paulson, the 
chairman of Goldman, a very important speech, now 2 weeks ago, 
in which he addressed these issues. I have spoken with many of 
the leaders in the investment banking world, the business 
community, who understand what is at stake, who understand the 
revenues that are needed. They understand the magnitude of what 
is at issue here.
    I think that the precise parsing of where the analysts, and 
as I said in my testimony, how the analysts interact with each 
aspect of the investment banking function of the firms and the 
houses that are full-service investment houses need to be 
parsed very carefully, and that is where we need leadership 
from the SEC.
    Early on in our inquiry, I floated publicly the notion that 
theoretically one could remove the research function entirely 
from the investment banking side, the capital formation side, 
because they serve different customers, one the retail public 
that was buying, the other the capital formation side with 
investment banking fees. It was an idea that garnered 
absolutely no support. It is not a concept I can impose 
unilaterally. It is not a concept that can be the product of a 
settlement with one company. It is a concept that could result 
only from an SEC directive, or legislation, and as a 
consequence, I think that is why, as I said in my testimony, 
this issue of how the analysts interact with investment banking 
needs to be carefully thought through, carefully parsed. That 
has not yet happened sufficiently.
    Senator Wyden. Is it your sense that there are no rules on 
conflicts of interest, or is it a problem that the rules are 
not being enforced?
    Mr. Spitzer. The rules are not being enforced. There are 
platitudinous statements in most of the manuals that are issued 
to analysts by the investment houses. Merrill Lynch had some 
wonderful language in its firm manual, but there was absolutely 
no effort to enforce. As I have said, there was absolutely no 
evidence of compliance ever raising a hand, compliance sending 
a letter to the chairman, to the director of research, to 
anybody, to signal that there was a problem, and this was in a 
context where the abuses were brazen and not subtle, a context 
where, for instance, an analyst would send a report to an 
outside company to get the company's approval before it was 
issued. That is inconceivable, and yet compliance never did 
anything.
    Senator Wyden. Let me ask you about this matter of buy and 
sell recommendations. John Coffey of the Columbia Law School 
makes the point that in 1990 analysts issued six buy 
recommendations for every sell, and by the year 2000 the ratio 
was nearly 100 to 1. You get the sense as you look at this that 
for some analysts--and again, I want to make clear I think 
there are many, many honest people in this field, but for some 
analysts it seems that the word sell is a four-letter word, and 
I would like to have you give us your sense about whether you 
examined whether the percentage with respect to these issues 
varied greatly on whether or not a company was a client in the 
analyst's firm for banking purposes.
    Obviously, to have this information on something resembling 
a firm-by-firm basis would be helpful. Did you look at that?
    Mr. Spitzer. Yes, Senator. As a matter of fact, we have 
obligated Merrill as part of our settlement to disclose that 
very information to investors. What we have required is that 
each analyst statement include not only an array within the 
sector of buy-sell recommendations that Merrill has issued, but 
also then a second chart that says, with respect to those 
companies that are clients of Merrill Lynch, what is the 
distribution of buy-sell recommendations, and that will permit 
us, and we have begun to do this, to examine any skew, any 
differentiation there may be between the distribution of buy-
sells across a sector where people are not clients, and then 
buy-sell recommendations when you do have a client 
relationship, and the evidence so far is that there is a skew, 
so we have been focusing precisely on that issue.
    Senator Wyden. If nothing was done, what do you think would 
happen in 5 years? Would we just be back to business as usual, 
because again, as I talk to someone on Wall Street, and I want 
to stress that I think there are many honest people there, I 
get the sense that people think conflicts are just inevitable.
    They say, you know, we are going to have this attention 
now, and Spitzer is out there digging up our e-mails, and they 
are running around in Washington all lathered up about this, 
but conflicts are always going to be with us. We are always 
going to have these, and I am interested in your judgment about 
what would happen 5 years from now if this is just allowed to 
go by the boards after a few more hearings.
    Mr. Spitzer. I think you are correct that--whether it is 5 
years, 4 years, or 10 years I, of course, do not know, but your 
point that there will be a cycle that will bring us back to 
this problem is absolutely correct, I think, which is precisely 
why we need vigilance on the part of the SEC, on the part of 
the state regulators to ensure that the attention that now has 
properly shone the light on the abuses, that that attention 
continues.
    If this is spasmodic, if this is not a continuing effort to 
ensure that those on Wall Street abide by the ethical rules 
that they understand, then we will see a dissipation of 
standards once again, and we have seen this historically. There 
was a period where insider trading cases were made about 10 
years ago. For a period, people on the street believed that the 
ethic changed, but now here we are a number of years later, and 
again we are seeing the same sorts of problems, so I think you 
are correct, Senator, we need continuing attention to this 
issue.
    Senator Wyden. My time is up, Mr. Chairman. I just wanted 
to wrap up with one point. This morning's story about WorldCom 
10, 15 years ago would be a big deal at the typical country 
club in America, because that is where you would have so many 
people concerned, and they would be anxious about their 
stockholdings. Today's story, though, is of tremendous interest 
to millions of working families, because the stock market is no 
longer just the province of the wealthy, and I think there is 
no more important issue in this Congress at this point, and no 
more important domestic issue in this Congress than making sure 
that working families see that the rules are not rigged against 
them, and that is what is important about continuing these 
hearings.
    I look forward to working with you, and the willingness of 
Senator McCain and Senator Fitzgerald to constantly come to 
these hearings and to make sure that these issues with respect 
to corporate governance are going to be bipartisan, Senator 
McCain, Senator Fitzgerald, I think you do a great service by 
being so extensively involved, and I look forward to working 
with you and them.
    Senator Dorgan. Senator Wyden, thank you very much. Senator 
Fitzgerald.
    Senator Fitzgerald. Mr. Spitzer, I wanted to ask you some 
questions about the Martin Act. It is my understanding the 
Martin law is kind of a strict liability statute, and you said 
you have had it on the books since 1921, that it only requires 
evidence of a conflict of interest that hurt investors, but it 
does not require proof of criminal intent. Is that correct?
    Mr. Spitzer. It is correct, Senator, that to establish 
certain types of violations, that it is not necessary to 
establish intent, that is correct.
    Senator Fitzgerald. In the case of your use of the Martin 
law against Merrill Lynch, was proof of criminal intent 
required?
    Mr. Spitzer. Well, we did not reach that point, and I think 
that--let me say this, since I have said this before. We could 
have established intent had we needed to.
    Senator Fitzgerald. But it sounds to me that that statute 
is stronger than any statutory tool that the SEC may have at 
its disposal, is that not correct, because the SEC would have 
to show criminal intent?
    Mr. Spitzer. I believe it is correct, Senator, that for the 
SEC to enforce most of its provisions, other than bookkeeping 
provisions, certainly in the criminal context the SEC would 
have to establish intent, that is correct. I should indicate, 
it is only in the context of misdemeanors, the criminal 
context, that the Martin Act does not require a demonstration 
of intent.
    Senator Fitzgerald. Say that again.
    Mr. Spitzer. In other words, if you want to indict somebody 
for a felony as opposed to charge him or her with a 
misdemeanor, then it is obligatory that you demonstrate intent 
under the Martin Act.
    Senator Fitzgerald. Okay, and that comports with what I 
learned in law school. You have to have criminal intent for a 
felony.
    Mr. Spitzer. We usually believe that.
    Senator Dorgan. Senator Fitzgerald, would you yield on that 
point just for a moment, so I can understand this? You are not 
saying, however, that the SEC lacks the authority to issue some 
kind of cease-and-desist orders if they see practices in a 
company by which security analysts are providing information 
that is at odds with information the company has because there 
is a conflict. You are not saying they do not have the 
authority to be active and involved and engaged, right?
    Senator Fitzgerald. By no means am I saying that.
    Senator Dorgan. I think that is important, because you were 
asking, I think, Senator Fitzgerald, what authority does the 
SEC have, or what do they not have. My view has been that they 
have had the authority to do certain things but largely have 
been----
    Senator Fitzgerald. Well, what could the SEC do in the case 
of analysts giving overly optimistic research reports that 
misled investors? Say they could not establish, they could not 
show criminal intent, what could the SEC do?
    Mr. Spitzer. Senator, there is absolutely nothing we have 
done that the SEC could not have done, absolutely nothing.
    Senator Fitzgerald. So it is not the difference in the 
Martin law.
    Mr. Spitzer. No, sir. I think many people have focused on 
this, and it is an intriguing, perhaps, issue for a law school 
law review article, but I think in terms of its practical 
import as we have pursued this investigation, there is 
absolutely nothing we did the SEC could not have done under the 
myriad of statutory powers they have.
    Senator Fitzgerald. Now, both the National Association of 
Securities Dealers, the NASD, and the SEC have proposed rules 
to force disclosure of some conflicts such as whether a firm or 
its affiliate owned 1 percent of more of the examined company's 
securities, whether the firm had a banking relationship with 
the issuer over the past 12 months. I notice that you did not 
require specific disclosure along these lines in the agreement 
that you made with Merrill Lynch. Was there a particular reason 
for that, and is it your opinion that making information of 
this type available to potential investors is important?
    Mr. Spitzer. We actually did require that disclosure. We 
did require disclosure of an investment banking relationship 
that generated any revenues in the past 12 months, because we 
thought that was an absolutely critical piece.
    Senator Fitzgerald. How about ownership?
    Mr. Spitzer. Ownership, I do not believe we got to the 
issue of ownership, because I think that was already covered 
elsewhere, but let me say this. We even tried to be more 
expansive than that, because it is the pitch, and this is why 
there is so much work to be done. It is really at the point 
where the solicitation is being made that there is the moment 
of greatest vulnerability.
    It is even prior to the existence of the investment banking 
relationship, when the analyst and the investment bankers are 
going to the prospective client, where the real nefarious deals 
are cut, where the statements are made either explicitly or 
implicitly, if you bring your business to us, we will give you 
a strong buy, and I have heard from CEOs and analysts from both 
sides of this.
    Senator Fitzgerald. So it is really hard to cover that 
situation with disclosure, is it not?
    Mr. Spitzer. It is hard to craft it properly, and we have 
been struggling on how one might do it, but it can be done, 
because it gets into the area of where there is an ongoing 
effort to solicit business, which is, of course, then an area 
where there is some interaction.
    Senator Fitzgerald. Well, do you think that our government 
should try to cover all those potential conflicts with 
disclosures, or should we try to educate the public that hey, 
these are just advertisements, like as you see on TV? People 
are conditioned to know that an ad that they see on TV, they do 
not necessarily believe that it is true, but I believe the way 
analysts' reports come out, people think that they are credible 
and objective.
    Mr. Spitzer. Senator, I suppose--first of all I have to 
say, I was intrigued by your metaphor, your comparison of 
diapers to analysts' reports. I thought, there is probably some 
work we could do with that metaphor, but I am not sure we 
should pursue it too much here, but I think there is a utility 
to having the public rely upon analysts' reports, so I do not 
want to be so dismissive that we say that the capital formation 
purpose that results from dissemination of information to the 
public should be discarded and we should remove these and 
relieve these.
    Senator Fitzgerald. But can we ever require disclosure of 
all the potential conflicts? Don't you think that is really 
hard? For example, Citibank, they loaned $1.5 billion to Enron. 
I am not sure that the disclosures that the NASD and the SEC 
want to require would have required Citibank to disclose the 
indebtedness owed to them, because it is not an ownership 
interest, they were a creditor. Citibank actually wound up 
losing nothing, even though they had lent $1.5 billion to Enron 
because they sold securities to the general public, or maybe in 
a private placement, that had the effect of hedging their 
position. They did not have to pay back the securities if Enron 
did not pay back its debt to Enron. They ended up losing 
nothing.
    Mr. Spitzer. Senator, I agree with you that the complexity 
of the web of interrelationships among the full service 
entities and their client, Citigroup, perhaps being the largest 
of them, makes it difficult to figure out how to do it, but we 
must try, because if we throw up our hands in despair and say 
there is no possibility, there is no mechanism, then we will be 
dooming the capital markets to the increasing decline of 
participation by the American public.
    And as Senator Wyden said, and has observed several times, 
the increasing participation by the American public in capital 
formation is critical. It has been one of the great successes 
of our economy over the past 15 years, and I am concerned that 
if we do not make every reasoned effort to ensure disclosure, 
to ensure that the conflicts--you drew a dichotomy, I am not 
sure it is real, between disclosure versus eliminating the 
conflict.
    I think we can do both. I think we can attack this from 
several angles. If we do not address this problem from each of 
these perspectives, then I think the public confidence will 
continue to dissipate, and we will see the public exiting the 
capital markets.
    Senator Fitzgerald. I know my time is up. Can I do one or 
two followups here? Just, if you really extend that far, we 
cannot limit our disclosure requirements to analysts. There 
were apparently members of the news media that appear to have 
been on Enron's payroll, some of whom were out writing puff 
pieces in various publications, pumping Enron. They would not 
be subject to these regulations. People are conditioned to 
believe that everything they read in the newspaper is 
independent and objective, but there are, in fact, no 
disclosure requirements for members in the news media. It gets 
very hard to stamp all that out. I just want to make that 
comment.
    One other thing is, there is a whole industry of buy-side 
analysts who do emphasize that they are representing just the 
buyers, that they do not work for investment banks, that are 
trying to sell stock for issuers, and you can pay them for 
their research. A lot of the big institutional investors like 
TIAA-CREF will buy some of this research. The problem is that 
research costs money. It is more objective.
    Our system in this country is that the investment banking 
fees pay for research at the investment banking houses, but 
then it is just so intermingled with conflicts that I wonder 
how we can ever really change it.
    Mr. Spitzer. Senator, let me pick up on one of the things 
you said. I agree with you, there are the other houses, Sanford 
Bernstein, others--I do not mean to promote any one--which are 
merely--are not involved in the sell side, they are merely buy-
side, and they are advertising these days. If you turn on the 
TV, you will see advertising that focuses on the fact that they 
do not participate on the sell side, and therefore their 
research should have more credibility.
    You are correct, unfortunately it has been TIA-CREF, the 
major pension funds, the sophisticated investors who have been 
able historically to draw these distinctions to tap into that 
research. It has been the small investors, the Mr. and Mrs. 
Smith referred to in the e-mails, who have been brought into 
the retail network of the sell-side houses, the Merrill Lynch, 
Salomon Smith Barney retail networks that are out there who 
have been, then, the recipients of this research, and hence I 
would argue the victims of the conflicts and the tainted 
advice.
    Senator Fitzgerald. Thank you very much.
    Mr. Spitzer. Thank you, sir.
    Senator Dorgan. Senator Fitzgerald, thank you very much.
    Senator Nelson.
    Senator Nelson. Mr. Chairman, I want to thank you and 
Senator McCain for just like a pit bull hanging onto this, 
because it is a responsibility. It is a unique constitutional 
responsibility that we have in the Senate, when something is 
out of kilter, when something is wrong, when something is out 
of balance, as it clearly was in the decade of the nineties, 
and it starts coming to light, that we bore in and we keep 
boring.
    I appreciate the witness. I am curious, when you found out 
about the Merrill Lynch analysts who were promoting the 
technology stock based upon decisions on the investment banking 
side instead of on the research side, how did you get tipped to 
this?
    Mr. Spitzer. Well, Senator, it was an unfortunately easy 
investigation to conduct. We served a few subpoenas. Merrill 
Lynch, to its credit, did not destroy any documents. They 
turned over all of their material, and it was there clear as 
day. We did not have at that moment anybody who directed us to 
a particular stock or a particular transaction. It was a matter 
of good, diligent work by the lawyers in my bureau, and I am 
enormously proud of them.
    I say it was unfortunately easy, because it shows how 
brazen this behavior was.
    Senator Nelson. Why would Merrill Lynch agree in a 
settlement not to admit guilt?
    Mr. Spitzer. Well, Senator, there is the entire issue of 
the restitution. They paid $100 million as a penalty, or fine. 
They are subject, and there have been a significant number of 
class action and individual lawsuits filed on behalf of 
individual investors who are seeking restitution.
    I have no individual opinion about the magnitude of the 
settlements or verdicts that will result from those 
litigations, but analysts, if we can rely upon them, have 
suggested that could range over a billion to $2 billion, and so 
they did not want to make a statement that would then, from a 
lawyer's perspective, be an admission of liability that would 
necessarily lead to that payment. They wanted to put the 
individual plaintiffs to the proof, and that is what I think 
will happen in the hundreds if not thousands of lawsuits that 
are now pending.
    Senator Nelson. Well, thank you for you work. I appreciate 
it. In my former life as the elected State Insurance 
Commissioner, I had to go after a number of big companies, and 
if you do not go with--as we say in the south, put your head 
down and go forward with an intention that you are going to 
prevail you will get thrown off-course by the dilatory tactics 
and the nuanced answers and the incredible resources that are 
at a number of these companies, and we just need to ferret it 
out and get people on the straight and narrow, and get people 
heading in the right direction as to what they are supposed to 
be, which is protecting their customers and their stockholders.
    Let me summarize here portions of the bill that Senator 
Carnahan and I have filed, and which have been incorporated in 
the Banking Committee bill, the Banking Committee bill to which 
I referred earlier that I was shocked last night when Senator 
Sarbanes thought it is going to be very difficult to pass this 
bill. It sounds like motherhood and apple pie to me, but for 
the record, I wish you would comment on portions of this bill 
prohibiting auditors from providing any nonaudit services to 
their audit clients, the separation of the auditing function 
from the consulting function. That is in our bill and in the 
banking bill as well.
    Mr. Spitzer. I am firmly in support of that. What I have 
referred to, I apologize, until now the Sarbanes bill. I will 
now call it the Sarbanes-Nelson-Carnahan bill.
    [Laughter.]
    Senator Nelson. No, around here you give all kinds of 
deference to the senior Senators. You bow and scrape to the 
chairmen of committees, the Ranking Members of committees, and 
I do that with great deference. It is the Sarbanes bill.
    [Laughter.]
    Mr. Spitzer. Yes, sir. I think the Sarbanes bill is an 
absolutely essential step. I think it is a wonderful beginning 
at clarifying not only in the context of accountants, which is 
not the area we have investigated, but I am familiar with those 
provisions, but also in the contexts of analysts and other 
areas where Congress should be moving.
    I have spoken to Senator Sarbanes, and am fully supportive 
of his bill.
    Senator Nelson. All right. A comment about closing the 
revolving door, where accountants that have been performing the 
audit function and all of a sudden get hired in by the company.
    Mr. Spitzer. I think that is highly problematic. Just as we 
have revolving door concerns in government, because of the 
conflicts that emerge and the concerns about the independence 
of decisionmaking that results, likewise we have to have that 
concern in that context as well.
    Senator Nelson. Mr. Chairman, oh boy, is the revolving door 
a problem that I see, for example, in the regulation of the 
insurance industry, for most of the insurance commissioners in 
the country are appointed instead of being elected, and as such 
they are appointed out of the insurance industry. They are 
appointed Insurance Commissioner by the governor, or whatever 
the appointing authority in the state is, and usually they are 
less than a year in office, and the revolving door continues, 
and they go right back out, back into the industry that they 
are supposed to be regulating.
    All right, here is another component. Requiring the 
rotation of auditors every 7 years, and what the Sarbanes bill 
did was require the leading auditor partner to be rotated every 
5 years.
    Mr. Spitzer. I think that makes perfect sense, and I have 
spoken to not only Senator Sarbanes to this and his staff, but 
also to Arthur Levitt, the prior Chair of the SEC, with whom I 
have had a number of conversations about the issues we are 
discussing this morning, and I think that is a very important 
proposal.
    Senator Nelson. Another component is that the board of 
directors must disclose with every filing any director 
relationships, such as familial, professional, or financial, to 
the company. The banking bill did not go quite that far. It did 
require enhanced disclosure, particularly of loans from the 
companies to directors and transactions between the management 
and the principal stockholders. What do you think about that?
    Mr. Spitzer. Absolutely essential, and I would also add 
that I think that Dick Grasso's and the New York Stock 
Exchange's recommendations about board independence have been 
critically important, and I think were a powerful and useful 
reaffirmation of how independence should be defined, and how we 
need a much more sophisticated interaction between independent 
board members and CEOs.
    Senator Nelson. All right, here is another interesting 
component, that the audit and compensation committee members 
must be independent directors instead of inside directors. The 
banking bill did not go that far. They did it for--the audit 
committee would have to be an independent director. It did not 
address the compensation committees.
    Mr. Spitzer. I think we need to do more in the area of 
compensation. I think one of the things we saw during the 
Roaring Nineties was the explosion of option packages that, 
while one can theoretically argue in favor of options as an 
incentive device for CEOs, they grew so wildly disproportionate 
to the return to shareholders that one wonders what was going 
on, and there were also options that were, heads I win, tails 
you lose, from a shareholder's perspective, so I think a 
critical reevaluation of compensation decisionmaking is also 
necessary as Dick Grasso argued, and as the Sarbanes bill and 
as your proposal called for.
    Senator Nelson. Boy, we sure learned that in the Enron 
case, and then there is the sense of the Senate that the 
commission should take a tough enforcement approach. The actual 
committee bill ends up having, the commission has the authority 
to take legal, administrative, or disciplinary action. It does 
not specifically encourage the tough enforcement approach.
    Mr. Spitzer. Well, Senator, as I have said, I think we 
would all benefit from a strengthening of the resolve at the 
SEC.
    Senator Nelson. Well, Mr. Chairman, thank you for indulging 
me as I got the expert testimony of our expert witness, which 
is all the more testimony that corroborates why a bill that has 
been produced by Senator Sarbanes ought not to be heavy 
lifting. I mean, we ought to pass this, and yet the hard 
reality is, it is going to be difficult to do it. With my 
Chairman's help, we are certainly going to try to help the 
other Chairman, Senator Sarbanes.
    Senator Dorgan. Senator Nelson, thank you. Those were 
interesting observations, and I agree with you with respect to 
the Sarbanes bill. Let me make a couple of additional comments 
and ask a couple of additional questions, Mr. Spitzer, and then 
we will adjourn the hearing.
    The point that was made by my colleague, Senator 
Fitzgerald, is an important one. I think this is complex; it is 
difficult to root out all conflicts, there is no question about 
that. The issue of advertising, for example, consumers beware. 
Advertising that is patently deceptive is illegal, and we have 
a Federal Trade Commission that is supposed to be taking action 
against it.
    If someone is advertising a product that they in their 
internal memorandum are saying this product does not work, but 
we are out here on TV advertising that it works to cure 
hiccoughs or the gout or acne, but internally they are saying 
it does not work, that is perpetrating a fraud on the public.
    The same is true with respect to securities analysts 
working for a firm who are receiving fees from their investment 
banking activities, who are internally saying this stock is a 
dog, it is not worth anything, but who are on television or in 
print saying, ``We recommend as a matter of course, our firm 
recommends that this stock has high earnings potential, has 
high upside potential, we recommend you buy it.'' That also is 
perpetrating a fraud, and so I wanted to make the point that I 
think, while this is a difficult area, it is an important area 
to be involved in.
    I want to go back to testimony last December that was 
received by our Subcommittee by Scott Cleland, the CEO of The 
Precursor Group, some of the most interesting testimony we have 
received. This was last December. I want to read to you what he 
says. The Precursor Group is an independent research broker-
dealer which provides investment research to institutional 
investors. That is essentially what they are doing, so they are 
in a different position than perpetrating sales, but here is 
what he says.
    ``Systemic conflicts of interest are more pervasive and 
corrosive than either Congress, regulators, investors, or the 
press appreciate. Conflicts of interest are eroding the 
integrity and resilience of our capital markets because they 
undermine the objectivity, integrity, and accountability of the 
watch dogs and the early warning systems that markets depend on 
to prevent Enron-type situations from escalating into 
disasters.
    Millions of trusting American investors have lost big in 
the markets in recent years in part because the system has 
become so conflict-ridden that the system no longer effectively 
serves investor interests but primarily serves company 
interests. It appears that the oversight mood has now 
shifted,'' and ``more than ever,'' he says, ``we need the 
internal controls capital markets rely on--auditors, research 
analysts, and boards of directors--to function with integrity 
to ensure the protections of investors' financial security.''
    When Mr. Cleland testified, I thought it was pretty 
remarkable testimony. With 6-months age it appears to be even 
more prescient, and I wanted to make that point.
    Let me also say again that accountability and 
responsibility does not just apply to poor people in America. 
We have seen a decade or two here in Congress where people 
point fingers at something that has happened that is ugly on 
the side of someone who did not have anything, who was abusing 
the system. Well, we ought to point fingers at that, but it 
does not just apply to poor people when you talk about 
accountability and responsibility. It also applies to people at 
the top, and there was an insider trading issue that has 
arisen.
    I mean, we are so surrounded by issues of corporate 
governance and swashbuckling behavior in these financial areas 
that it is hard to know where to start. I was reading the other 
day about an inside trading scandal--I shall not mention the 
participants in this, but it is under active investigation--but 
this is a case where a large investor is on a private jet to a 
foreign land to take a vacation, stops for fuel some place, and 
calls the broker back in New York.
    Well, you know my point. People take a look at that and 
say, well, is this how the system works, and the answer is no, 
it does not work for everybody that way. The broad bulk of 
people in this country who invest and have a 401(k) think that 
everything is on the up-and-up. Everything is honest. 
Everything is something they can rely on.
    I think it is important to say that there are wonderful 
companies out there, wonderful CEO's that run these companies 
that produce great products, do a great service to our country 
and to the stockholders and shareholders, and we should not 
tarnish all of them with these hearings. By the same token, 
there are some that are greedy, that take advantage of people, 
that are committing criminal acts, that are replete with 
conflicts of interest, and we have a responsibility, all of us, 
to do something about it.
    I want to make one point clear at this hearing. There ought 
not be a conflict between federal and state regulators. We have 
enough work for both to do, and both ought to work in harmony 
and together. I said when I started I feel terrible that I 
think our regulators at the federal level have let the American 
people down, and to some extent the Congress as well, but we 
spend a lot of money creating regulatory systems and funding 
agencies, and it is very hard to see that they have been 
aggressive or interested or active in what is going on.
    As the souped up, turbocharged economy surged forward and 
we began to read about the excesses, we have some of these 
agencies that are on the sidelines, and I regret that. I think 
that is shameful. Let me just ask two additional questions, and 
then we will let you go.
    In the standards you have suggested, you talk about a wall 
between the analysts and the investment bank side. Can you 
describe how could one construct that wall? What are the 
developments that would lead you to create that?
    Mr. Spitzer. There are several issues that one has to think 
about in constructing that wall. As I said, it is a subtle 
issue that is difficult and has to be parsed, but first and 
foremost is compensation. We have promoted and have encouraged 
Merrill and the other firms with whom we have been talking to 
devise a compensation system for the analyst that disengages 
analysts from investment banking, that absolutely prohibits any 
factor in the compensation of analysts from being dependent on 
deal flow, from the ability of an analyst to get a client in 
the door, or any favorable treatment of that client. That is 
the rigid, absolute rule that must be followed.
    We have also had discussions with the investment banks 
about the necessity of ensuring that investment bankers do not 
in any way, shape, or form call or excerpt pressure upon the 
analysts in any subtle or overt way to change or alter an 
evaluation that the analyst might render because the client has 
perhaps a conflicting interest, and we also, of course, have 
had lengthy conversations about the degree to which the analyst 
can in any way, or should interact with the potential client or 
an ongoing client in an effort to solicit business from the 
outside entity. That is an area where I think, quite frankly, I 
wish we could do more.
    What we did with Merrill was a first shot at articulating 
that boundary line. There is discussion, I believe, amongst 
some of those who were thoughtful in this area about 
prohibiting analysts from in any way participating in what they 
call the pitch, the effort to generate new clients. I think 
that would be a very important and positive step forward. It 
was not something that we could unilaterally do, but I think it 
would be an important step forward.
    Senator Dorgan. And finally, in the investigations that you 
have been doing, does the culture you describe, the development 
of the conflicts that have occurred over time, extend to the 
top of these companies, in your judgment? Where does the 
knowledge of this practice reach in a corporation, in your 
judgment?
    Mr. Spitzer. That is a hard question to answer in a 
sweeping manner. Part of the problem is that the documentary 
evidence does not always establish that information flows to 
the very top, but as I have said, I have spoken to hundreds, 
literally hundreds of investment bankers, from CEOs down to 
line analysts who are straight out of college or B school, and 
at every point, every individual, man or woman, has 
acknowledged an understanding of this problem, and so yes, I 
think there was an understanding to the very top that this was 
a problem that was festering, but it was a problem that led to 
enormous fee-generations, and as a consequence there was a 
failure of will to address it in the ways that leadership 
understood that they should have been pursuing.
    Senator Dorgan. Mr. Spitzer, let me say for the record that 
we also invited the Securities Industry Association to testify 
today, but those who would testify on their behalf were not 
available today so they declined. I think, had the schedule 
been such that we were able to match yours and theirs, they 
would have testified. Let me again go back to the question of 
Congressman Baker.
    It is not my intention at all to cast aspersions here. He 
certainly has a right to his opinion. He is a thoughtful 
legislator. I would disagree with the publicly stated opinions 
of his with respect to what has happened in New York, but his 
office did call and inquire of the Subcommittee of the 
opportunity to testify. We then called back and indicated we 
would invite him to do so, and then apparently his schedule did 
not allow him to do that, but I wanted to make clear for the 
record that was the case.
    Let me again say I think your work is very helpful. I, for 
one, appreciate the work you do. Having served in a state 
capital for a good number of years, I think much of what goes 
on in state government is refreshing and interesting, and you 
were able to take effective action where in some cases federal 
agencies with far greater resources than you had available to 
you either refused to or failed to. I do not know which at this 
point, but I commend you for your work, and we will have 
additional hearings on this general subject.
    Attorney General Spitzer, thank you for being here. This 
hearing is adjourned.
    [Whereupon, at 11:10 a.m., the Subcommittee adjourned.]
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