Salomon to Pay $5 Million to Settle Grubman Allegations

Salomon Smith Barney agreed Monday to pay a $5-million fine to settle civil charges by the National Assn. of Securities Dealers that its former analyst Jack Grubman touted a telecom stock despite signs that the company was in severe financial trouble.

The NASD also brought a similar complaint against Grubman and his assistant, analyst Christine Gochuico. Grubman and Gochuico are contesting the allegations and could face stiff penalties if found guilty in an NASD civil hearing, including fines or a permanent bar from the industry.

Salomon and the two analysts were accused of breaking several NASD rules, including those requiring high standards of business behavior and barring misleading statements to investors. However, they were not accused of potentially more serious infractions of fraud or intent to deceive investors.

Salomon, a unit of Citigroup Inc., agreed to pay the fine without admitting or denying wrongdoing.

The NASD alleged that Grubman went out of his way to talk up the prospects of Winstar Communications Inc., despite having no basis for his optimism. For example, Grubman steadfastly maintained that Winstar’s stock would rise to $50, even as it sank to 14 cents a share, the NASD alleged. When others on Wall Street questioned Winstar’s prospects, Grubman shot back with reports praising the company while “belittling and attacking” Winstar’s critics, the NASD said.

The $5-million penalty was the third-largest ever levied by the NASD. But it was only a fraction of the $24 million in investment banking fees that Salomon earned from Winstar.

The fine “is a drop in the bucket” for a financial firm the size of Citigroup, said Jacob Frenkel, a former Securities and Exchange Commission official, and suggests the firm may already have set aside a much larger amount to cover liability in other legal actions.

Still, the action by the NASD represents a major crackdown by regulators in their two-year scrutiny of Wall Street stock analysts, and may herald further charges against Salomon and other firms.

Grubman once was among the most prominent analysts on Wall Street, earning $20 million a year. He was credited during the 1990s bull market with going beyond the traditional analyst role of simply handicapping stocks to becoming a deal maker who helped to broker lucrative investment-banking work.

But as the market began to tumble, regulators launched investigations into whether Grubman and other analysts misled investors by tailoring research to favor corporate clients. The NASD noted in its complaint that Winstar did significant investment-banking business with Salomon.

Grubman resigned from the firm last month.

New York-based Winstar, which provided telecom services to corporations, was never profitable and eventually filed for bankruptcy protection in April 2001. Winstar announced Aug. 5 that it was slashing 44% of its work force.

Part of the evidence against Grubman and Gochuico are e-mails they wrote in which they appeared to express doubts about Winstar’s prospects even while they recommended the stock to investors.

In one, Gochuico wrote that “$50 per share is shall we say--extremely aggressive.” In a May 2001 e-mail, Grubman noted, “If anything, the record shows we support our banking clients too well and too long.”

“He was more than bullish,” said Mary Schapiro, NASD head of regulatory policy and oversight. “They had no reasonable basis for the $50 price target. If you look at the private e-mails, they squarely contradict the public pronouncements about the stock.”

This year, Merrill Lynch & Co. paid a $100-million fine after a probe by New York Atty. Gen. Eliot Spitzer revealed a series of e-mails in which analysts derided stocks among themselves even while pitching them to investors.

According to the NASD, Gochuico also privately counseled some favored investors to sell Winstar shares at prices far below $50. In one instance cited by the NASD, she told an investor to buy the stock at about $13 a share and to sell in the low $20s.

The complaint also paints a picture of a close relationship between the analysts and the company. In some cases, they “sought approval” from Winstar before issuing reports, the NASD charged.

The NASD stressed that the settlement announced Monday is narrow in scope and that the group would continue its far broader investigation into Salomon. In addition to probing allegations of analyst conflicts of interests, the NASD is examining whether Salomon dished out shares in initial public stock offerings to corporate executives at below-market prices to secure work.

Spitzer’s office also is conducting a probe of Salomon.

Throughout the bull market, analysts routinely issued extremely upbeat recommendations and sky-high price targets on stocks. Monday’s action may signal that regulators are turning up the heat on what they perceive as unwarranted optimism on the part of Wall Street analysts.

“This case scratches the surface of the allegations of analysts issuing misleading research,” Frenkel said.

Salomon, which is aggressively trying to reach settlements with regulators, said paying the fine put one of the probes to rest.

The settlement “is consistent with our determination to do all that we can to resolve the issues facing [the firm],” Salomon said.

Attorneys for Grubman and Gochuico defended their clients, who deny any wrongdoing.

Lee Richards, Grubman’s lawyer, said his client’s views were consistent with “the overwhelming majority of other analysts” and represented his “honestly held views.”

Grubman sought to downgrade Winstar in early April 2001, Richards said, but was barred from doing so by Salomon’s compliance department. Still, the stock had lost most of its value by then.

Gochuico’s lawyer, Robert Romano, said the NASD complaint “grossly mischaracterizes” her actions and that she is an “honest professional.”

The e-mails written by Gochuico are consistent with her public recommendations, Romano said.

For example, the e-mail telling the investor to sell Winstar stock in the low $20s was written to her sister, who was looking for a short-term investment, not the 12 to 18 months that Salomon predicted it would take for the stock to reach $50, Romano said.

“A little bit of context here is going to go a long way,” he said.

Citigroup’s stock rose 74 cents to $27.57 on the New York Stock Exchange on Monday.

Times staff writer E. Scott Reckard contributed to this report. Reckard reported from Orange County.