Confessions of a Wall Street Analyst Part 15

Less than a week later, on January 28, 2002, Global Crossing declared bankruptcy, wiping out a market value of $54 billion at its peak just two years earlier. It wasn't a complete surprise to me or to anyone by this point-the stock had been trading for pennies and its enormous $10 billion debt load was clearly not going to be serviced-but it was sad nonetheless.

Sad for investors, of course, since any of them who got in after 2000 lost their s.h.i.+rts, while Gary Winnick and his rotating band of CEOs sold stock worth in the hundreds of millions. Gary alone cashed in over $700 million over the course of four years, second only to Phil Anschutz-who pocketed $1.9 billion on Qwest-as the industry's champion roulette player.1 But the bankruptcy filing was particularly tragic in that the promise of this new world had been exposed as nothing more than hype. And even those of us who had questioned the hype had not questioned it enough. It was this century's equivalent of the railroad industry boom and bust in the late 1880s. Customers might use all of those undersea cables one day. But not anytime soon. But the bankruptcy filing was particularly tragic in that the promise of this new world had been exposed as nothing more than hype. And even those of us who had questioned the hype had not questioned it enough. It was this century's equivalent of the railroad industry boom and bust in the late 1880s. Customers might use all of those undersea cables one day. But not anytime soon.

Global's collapse came in the shadow of Enron's sudden meltdown the previous December, which had taken the entire financial world by surprise-the auditors, the regulators, and the Street. Now everyone was scrambling to figure out who had left the barn door open and how. Suddenly, swaps, which had been used by many of the companies in trouble, became public enemy number one. Both the FBI and the SEC opened probes into Global's numbers. It wasn't going to help recoup that $54 billion, though. I was pretty sure of that.

It was pathetic-both to watch and to be a part of. At the beginning of March 2002, I held CSFB's annual telecom conference, this time in Orlando at the Portofino Bay Hotel. Rather than meeting at the heart of the financial world, we instead opted for distraction, taking everyone to Universal's Islands of Adventure. One night, we reserved the Marvel Super Hero Island for the exclusive use of conference attendees. Maybe, we hoped, one of those superheroes would save us from the wreckage of our industry.

As I strapped myself into the Incredible Hulk Roller Coaster, I couldn't help thinking that I preferred the real thing to the virtual virtual roller coaster we'd all been riding for the past few years. In a real roller coaster, there was gravity; what went up came back down, and we ended the ride where we'd started. On the telecom roller coaster, we'd kept climbing further than anyone believed possible-and then we'd plummeted headlong into a chasm. roller coaster we'd all been riding for the past few years. In a real roller coaster, there was gravity; what went up came back down, and we ended the ride where we'd started. On the telecom roller coaster, we'd kept climbing further than anyone believed possible-and then we'd plummeted headlong into a chasm.

Still, as tame as the Universal ride seemed in comparison, it was treacherous in its own way. Megan Kulick, my former a.s.sociate, who had left Merrill to work for a hedge fund and was now a client of mine, was there. She rode the coaster so many times that she ended up puking her guts out. If that wasn't a sign of the times, I didn't know what was.

Although the $1.1 million budget was less than half the prior year's, we didn't skimp on the goodies. In fact, considering what was going on in the sector, it's amazing how luxe the event was. We were a Wall Street investment bank, after all. We hired Kevin Zraly, the internationally acclaimed wine writer and founder of the Windows on the World Wine School, to host a special wine tasting one evening.

The mood was sh.e.l.l-shocked, resigned, and frustrated. That is, except for the value investors, who, like vultures, picked through the skimpy meat left on the bones of some of these companies and debated whether there was anything worth keeping.

The next week, on March 11, WorldCom announced that the SEC had opened an investigation into its accounting practices. This was not exactly a shock, given that every poster child for the go-go 1990s had crashed, many were under suspicion for aggressive accounting, and WorldCom's stock was now trading at $9 a share, an astounding drop from its high of $64.50. My rating remained Hold, as it had been for the past year and a half.

In a highly unusual move, WorldCom not only publicized the investigation; it also published it in full on its Web site, listing all 24 of the SEC's queries. The SEC request sought information regarding virtually every element of the way WorldCom recognized revenue and detailed information about how it accounted for its merger reserves. It also asked for material explaining how information was provided to Wall Street a.n.a.lysts and how a.n.a.lyst forecasts were tracked. To me, this last one suggested the inquiry was leading straight to that cozy relations.h.i.+p between the company and Jack Grubman. Could this finally be it?

The investigators also asked a lot of questions about an enormous loan of nearly $400 million that the company had made to Bernie Ebbers. By this point, we all believed that Bernie hadn't sold any shares of WorldCom stock, instead opting to use it as collateral to buy other a.s.sets ranging from a timber company to one of the largest ranches in Canada. As WorldCom's stock declined in 2000 and 2001, Bernie had faced margin calls from Bank of America, which had loaned him money against his then-valuable stock and now, as the stock declined even further, required more collateral.

Basically, Bernie was a very rich man-but only on paper. He'd bet every last chip on WorldCom, unlike Gary Winnick, Phil Anschutz, Joe Nacchio, and many other telecom executives, who sold when times were good. I was shocked, however, to learn that the board had apparently approved lending him such vast sums of money and that, in addition to the other banks, Citigroup, the parent company of Salomon Smith Barney, had facilitated this obscene leveraging of his a.s.sets much earlier, beginning back in 1999.2 At that time, WorldCom's board had faced two very unpalatable choices: one, let Bernie sell ma.s.sive amounts of stock into the open market, which most definitely would push the stock down further and convince the doubters that even Bernie had lost faith; or two, bail him out. So the board did exactly that. It paid off his Bank of America loan and replaced it with a nearly $400 million loan from the company.

Such corporate "generosity" was highly unprecedented. I had heard about some of the smaller loans in early 2001, but by the beginning of 2002, when the news broke that he was actually $400 million in the hole, I realized how deathly serious the situation was. The guy had been averaging over $12 million a year in salary and bonus and owned, at WorldCom's peak, stock worth over $1.4 billion. Wasn't it just two years ago that he'd exhorted everyone at my conference to play Who Wants to Be a Millionaire Who Wants to Be a Millionaire by buying his stock? by buying his stock?

I also was taken aback by Bernie's apparent stupidity. Rather than selling some shares and diversifying his holdings, he had doubled up, and more, on his WorldCom bet. This poor schmo had quite literally bet the ranch on WorldCom shares continuing to climb and had also locked himself into illiquid a.s.sets, so he had no downside protection if the market, or WorldCom, crashed.

Yet another flurry of negative press stories followed, from broad pieces decrying the collapse of the telecom industry to a New York Times New York Times piece on executives in trouble, featuring the indignity of poor Bernie having had to sell his 118-foot yacht, piece on executives in trouble, featuring the indignity of poor Bernie having had to sell his 118-foot yacht, Aquasition. Aquasition.3 Bernie lost a yacht. Tens of thousands of his employees were going to lose everything. And, if Bernie defaulted, WorldCom shareholders would pay the price for his and his board's bad decisions. All he'd have to do would be to declare bankruptcy. Then he could start over-not as a mogul, of course, but probably not delivering milk either. Bernie lost a yacht. Tens of thousands of his employees were going to lose everything. And, if Bernie defaulted, WorldCom shareholders would pay the price for his and his board's bad decisions. All he'd have to do would be to declare bankruptcy. Then he could start over-not as a mogul, of course, but probably not delivering milk either.

The day after the SEC inquiry was announced, Salomon Smith Barney's chief strategist, Tobias Levkovich, removed WorldCom from SSB's "Focus List" of stocks to buy. Yes, it had been on that list throughout all of the earnings misses and warnings. And why not? Its top a.n.a.lyst, Jack Grubman, still had it as a "1" or Buy. But now even Levkovich, no telecom expert, thought it was time to bail, citing the uncertain outcome of the SEC inquiry.

Sensing more and more vulnerability on the part of the investment banks, New York State attorney general Eliot Spitzer turned up the heat on his probes of the conflicts of interest between research and banking. He made public some of the e-mails written by Merrill Internet stock a.n.a.lyst Henry Blodget, referring to a stock Blodget had recommended with a Buy rating as a "dog," and others he referred to as "POS," for "pieces of s.h.i.+t." He also announced that he was expanding his probe to other banks. Spitzer didn't name names, but we all knew he probably meant CSFB, Morgan Stanley, and Salomon Smith Barney. And indeed, on April 29, Business Week Business Week reported that Jack Grubman had become a target of Spitzer's ongoing investigation of a.n.a.lysts, along with SSB. reported that Jack Grubman had become a target of Spitzer's ongoing investigation of a.n.a.lysts, along with SSB.4 To try to steal some of the regulators' thunder, banks such as Merrill and CSFB hustled to announce their own reforms, including prohibiting a.n.a.lysts' compensation from being tied to specific investment banking deals, though they did not offer to stop funding research departments with money from their investment banking departments. It was amazing to see these firms scramble after denying for so long that there was anything questionable about the way they did business.

On April 19, 2002, WorldCom again warned of an earnings shortfall, forecasting financial targets that were much worse than expected. With the Bernie loan debacle and the SEC investigation, it was enough to make me decide that the company's survival was in real question. So three days later, quite belatedly I admit, I sounded the death knell, lowering my rating from Hold to Sell-the second Sell of my career and the first in many years. I cut my target price dramatically, from $9 to $2. I wrote: "...[The] only exit is takeout by [a Baby Bell] but we believe [the Bells] are highly unlikely to take on $30B of debt, negative revenue growth and inevitable loss of share and pricing power."

I wasn't the only person to lower the boom on WorldCom shares, although I was one of the few to go to a Sell. Goldman and JP Morgan also downgraded the stock. And, finally, so did Jack Grubman, who was already having a pretty scary week with the announcement of Spitzer's probe. He dropped his rating two notches from a Buy, or "1," to a Neutral, or "3," citing the SEC investigation and the debt problems.

His report, t.i.tled "WCOM: Dramatic Change in EBITDA Guid. [sic] Too Much to Ignore," was telling even in its t.i.tle. G.o.d knows he'd ignored all the other bad news coming out of the company for the previous few years-but I guess this was really too much, even for him.5 Surprisingly, Jack still had followers: WorldCom's stock fell by a third on the news, from $5.98 to $4.01 per share. Surprisingly, Jack still had followers: WorldCom's stock fell by a third on the news, from $5.98 to $4.01 per share.

On April 25, WorldCom reported terrible earnings per share and revenue growth. And then, on April 30, the once-unthinkable news broke that Bernie Ebbers-Jack's starmaker-was out, having resigned under pressure from the board. Not only was he getting the boot for WorldCom's horrendous performance, but his financial difficulties had compounded with each downward tick of the stock to the point that he was virtually insolvent. I guess the board finally concluded that it's hard to carry out your fiduciary duties to the shareholders when you owe them $400 million yourself. Maybe the board should have thought about that before they loaned him the money. John Sidgmore, the former CEO of MFS subsidiary UUNet, who had joined WorldCom's board after it snapped up his company, became the acting CEO.

Jack, meanwhile, had replaced the younger and blonder Henry Blodget as the public face of the bear market. The April issue of Money Money magazine, a publication that had glorified the stock market, put him on its cover. Its t.i.tle: "Is Jack Grubman the Worst a.n.a.lyst Ever?" Street people didn't read magazine, a publication that had glorified the stock market, put him on its cover. Its t.i.tle: "Is Jack Grubman the Worst a.n.a.lyst Ever?" Street people didn't read Money Money for the most part-it was aimed at the individual investor-but this copy was dog-eared by the time it had made the rounds of our offices. It essentially blamed Jack for the entire telecom bubble. "People hung on his every utterance," it said. "When he spoke, stocks moved." for the most part-it was aimed at the individual investor-but this copy was dog-eared by the time it had made the rounds of our offices. It essentially blamed Jack for the entire telecom bubble. "People hung on his every utterance," it said. "When he spoke, stocks moved."

Jack wasn't the only telecom hero to suffer an abrupt reversal. A month earlier, in March, Qwest had also come into the crosshairs of the SEC, which was investigating its accounting, focusing particularly on its use of swaps to bolster revenues. The stock was now trading at around $9, down from a high of $66 just two years earlier, with its employees' pension funds virtually wiped out. Joe Nacchio, however, had cashed in stock options worth $74.6 million in 2001 alone and, just five months earlier, had even had his contract renewed until 2005.

But suddenly, Qwest's long-supportive board had a change of heart. Nacchio, too, had to go. Phil Anschutz, Qwest's chairman, did the dirty work. On June 14, he got on his private jet and flew to a private airport in New Jersey to break the news in person to Joe, who met him there.6 Ever the salesman, Joe tried to convince Phil otherwise, but his charm had worn thin. And though the board could have made the case that he was being fired for cause due to the accounting investigations, in which case he wouldn't be eligible for any severance, it let him leave with a $12 million payout plus a $3 million consulting contract for two years. Joe left rich in dollars but not reputation, his grand strategy disgraced and discredited. He had done what I thought no man ever could: he had come close to destroying a Baby Bell, a cash cow if ever there was one. Ever the salesman, Joe tried to convince Phil otherwise, but his charm had worn thin. And though the board could have made the case that he was being fired for cause due to the accounting investigations, in which case he wouldn't be eligible for any severance, it let him leave with a $12 million payout plus a $3 million consulting contract for two years. Joe left rich in dollars but not reputation, his grand strategy disgraced and discredited. He had done what I thought no man ever could: he had come close to destroying a Baby Bell, a cash cow if ever there was one.

But he either couldn't or wouldn't acknowledge that he had any responsibility in the debacle. Drake Tempest, Qwest's general counsel, organized a good-bye dinner for Joe and most of his top staff in a private room at an Italian restaurant in downtown Denver. According to one person who was there, Joe made an emotional speech lamenting the unfairness of life. He insisted that he'd tried to do what was right for the company and the employees. He then quoted some biblical pa.s.sages about being betrayed and getting revenge, telling everyone that he was not going away. Apparently, he saw Phil Anschutz as his Judas.

A few weeks later, the U.S. Department of Justice opened a formal investigation into Qwest's conduct. Five midlevel executives have been indicted so far, two of whom have pleaded guilty. Not until March 15, 2005, after nearly three long years had pa.s.sed, did the law touch Joe. The SEC filed civil charges against him as well as two of his former CFOs, Robin Szeliga and Robert Woodruff, former COO Afs.h.i.+n Mohebbi, and three other executives, alleging that they orchestrated a "ma.s.sive financial fraud."7 The SEC complaint cited Qwest's "culture of fear" and alleged that "Qwest relied so heavily on the immediate revenue recognition from one-time IRU and equipment sales transactions to meet the aggressive revenue and growth targets that Qwest management and employees referred to the practice as a 'drug,' an 'addiction,' 'heroin,' and 'cocaine on steroids.' Moreover, Qwest's reliance on so-called IRU 'swap' transactions to meet revenue targets led some in the company to refer sarcastically to those transactions as 's.l.u.ts' (short for Simultaneous Legally Unrelated Transactions)."8 On June 5, 2005, Robin Szeliga agreed to plead guilty to insider trading and cooperate in the ongoing investigations. Nacchio's trial is expected to begin in early 2006. Maybe I'll sit in.

WorldCon The telecom and overall market implosions were in full force. Investors had been wiped out, employees were being laid off weekly at most of the major telecom companies, and we walked around in a state of numbness. What else could go wrong? In mid-June, I became convinced that WorldCom was not even likely to survive the summer, based on its downward-spiraling numbers. Ido and I tried to come up with a valuation for the company based on our best guess of the real numbers.

The target price we came up with was, amazingly, zero, though the shares were trading at almost a dollar. That reflected the fact that the company's ma.s.sive amount of debt, roughly $30 billion, exceeded our estimate of the value of its a.s.sets. In effect, after paying off bondholders, there would be no value left for shareholders and bankruptcy was imminent.

We wrote a report highlighting the zero target price and reiterating our Sell rating. CNBC's Maria Bartiromo, known on the Street as the "Money Honey," ridiculed our target price, as if a zero valuation was preposterous. Right around the same time, in a report dated June 21 but distributed the following Monday, June 24, Jack cut his rating on WorldCom again, to Underperform, or "4," from Neutral. The stock was trading at $1.22 per share on June 21 and closed at 91 cents on the 24th.

Just after Jack's downgrade, I flew out to Kansas City to speak at a strategy meeting for Sprint executives. WorldCom was in free fall, but the outlook for other long distance companies wasn't appreciably better. WorldCom's efficiencies and synergies had been, up until now, the envy of executives at Sprint and AT&T. Even as WorldCom faltered, executives at AT&T and Sprint remained completely obsessed with understanding how WorldCom managed to get its costs so much lower than their own. So the Sprint folks asked me to come explain how and why WorldCom consistently reported vastly lower cost ratios and thus better profit margins than Sprint. They hoped my words would help to crank up the energy level and get their executives fired up to compete, WorldCom style.

We were all about to find out exactly what that meant. The night before my presentation, I went out to dinner at a steak and brew pub with Steve Fletcher, a former colleague from MCI who was now vice president of strategic planning at Sprint. We hadn't known each other very well at MCI, but we did know a lot of folks in common. We ordered beers and reminisced about MCI when it was still a sc.r.a.ppy startup.

We had just started to talk about our kids when my BlackBerry started vibrating insistently. I couldn't stop myself from stealing a glance at the screen. Rude, I know, but in this business everyone understood. You just never knew what was about to happen.

But this one I could never have antic.i.p.ated. I glimpsed the headline and choked on my beer.

"Oh, my G.o.d," I gasped. "You're not going to believe this."

I held my BlackBerry up to Steve's eye level. I saw his pupils dilate as he read the headline that I'd just seen: "WorldCom Restates $3.8 Billion; CFO Sullivan Out." WorldCom was announcing that it had overstated its financial results by almost 70 percent over the past 18 months.

"Holy s.h.i.+t!" he blurted, probably just one of thousands of "Holy s.h.i.+t's" being uttered at that exact moment all over the globe. "What the h.e.l.l is going on here?"

We had all experienced so many disappointments and reversals over the last few years that I thought I had lost the ability to be shocked by anything. But this one really threw me. I knew that Global and Qwest seemed to have pushed the envelope on a lot of stuff, and that the collapse of Enron had put every chief executive on the defensive, but this was utterly beyond the scope of what I could fathom.

First was the enormity of the numbers: $3.8 billion in missing operating cash flow? In a company whose total operating cash flow was reported at $9.3 billion last year? It was a number so large that it embarra.s.sed everyone who had anything to do with this company. It meant that the company's profits for at least the previous year, perhaps longer, had been zilch. Why hadn't Andersen, the auditing firm, noticed almost $4 billion in errors? Why hadn't the bankers who were always ready to help WorldCom sell another slug of stock or debt seen anything? What about internal executives? The board of directors? The SEC? And, of course, the a.n.a.lysts? As dazed as I was by the news, it wouldn't be long until WorldCom's investors were wis.h.i.+ng the restatement were only $3.8 billion.

Then there was the Scott Sullivan factor. Scott? The straightlaced, monotonal numbers guy who always had total recall of every component of WorldCom's balance sheet and income statement? It had been an impressive quality. Too impressive, perhaps.

Steve and I stared at each other. We instantly knew that this was the end of both a company and an era. All of this navel-gazing and soul-searching on the part of so many companies trying to replicate the WorldCom magic had been for naught. All this strategizing and firing and hiring and relocating and repricing to try to catch up to a company that had been a complete sham was instead a cruel joke. In reality, there was no way to outdo WorldCom with fiber-optic wires, computer software, and clever marketing. All you really needed was a CFO with a pencil and an eraser.

We talked in rapid-fire bursts, the way people do when something terrible happens. I felt numb inside. Sure I had a Sell on the stock, and sure I'd been considerably more cautious than my compet.i.tors for the past two years, but I'd had no inkling that there could be something so sinister going on. Why not? And why didn't anyone else? What about Jack? I wondered. Did he know? Or did Scott dupe him as well? That would be one amazing irony-the insider led astray by his inside connection. As with so many of the questions that had arisen in the past year, I had no answers.

The next morning, I showed up for my presentation to Sprint's executives with no idea of what to say. I made it through the speech on autopilot, sarcastically commenting that I had been planning to tell everyone how they could become more like WorldCom. My mind was back in that dingy office in Jackson, Mississippi, where Bernie had showed me his handwritten notes on acquisitions.

I thought, too, about my former colleagues at MCI. Those who had stayed on through the WorldCom acquisition had probably lost their life savings by now. And then, of course, there were the investors, large and small, who gambled big on the stock and lost, but had been playing the whole time with a deck stacked against them. One thing was not debatable: Mark Bruneau, the consultant who had called WorldCom the "poster child for buying real things with fake money" in that April 2000 Fortune Fortune article, had been more accurate than he ever could have imagined. article, had been more accurate than he ever could have imagined.

Hearings from h.e.l.l The publicity-shy Sullivan immediately found his name splashed across the front page of every newspaper in the country and many around the world. But he was not the only one to feel the heat of a furious public. The next morning, CNBC reporter Mike Huckman conducted an old-fas.h.i.+oned stakeout in front of Jack Grubman's post Upper East Side town house near the Metropolitan Museum of Art. When Jack emerged only to see the cameras rolling, he visibly blanched and tried to keep walking, but Huckman kept up the pace-and unleashed a torrent of aggressive questions.

Jack came off looking s.h.i.+fty. "Look, could you-first of all, this is a huge invasion of privacy," he said, trying to outpace the reporter. Huckman asked if Jack had known anything about WorldCom's disaster in advance. "n.o.body saw this coming," he said. "I'm no different from anyone else on Wall Street." His shoulders were hunched, his body language defensive. But he still couldn't keep his d.a.m.n mouth shut!

"I mean, what [sic] are you hara.s.sing like this?" Jack whined, his voice even squeakier than usual.

"I'm not hara.s.sing you," said Huckman. "I'm just asking you questions about the company that you cover. Do you think WorldCom can survive?"

"Look," he sputtered. "I have no, I have no comment. I'm as shocked about this as everyone else."

The video clip zipped around the Street quicker than a Roger Clemens fastball. Jack looked so pathetic that I actually felt bad for him for a moment. Shouldn't he be allowed to walk freely in his own neighborhood? Then I caught myself and thought about what many now viewed as an endless stream of hype and deception that had spilled from his lips over the past decade.

The next day, the House Financial Services Committee subpoenaed Jack, Bernie, Scott, and Melvin d.i.c.k, the Andersen accountant in charge of the WorldCom audit, requiring them to appear at a televised hearing about the downfall of the company.

The thought of having to walk in Jack's shoes for a city block nearly made my heart stop. What if the committee asked me to testify too? Even if they wanted me as a counterexample to Jack, which didn't seem likely given the witch-hunt atmosphere, I had no interest in standing next to these questionable characters in front of a bunch of bloodthirsty politicians. Certainly the reputation of a.n.a.lysts was so soiled by now that I'd be a victim of guilt by a.s.sociation. Plus, I realized, there were plenty of embarra.s.sing questions that they could ask me, such as why it had taken me so long to go to a Sell rating on WorldCom or why I had been bullish on Qwest for so long. So mixed in with my anger at Bernie, Scott, and Jack and my gratification that they were finally being called to account was quite a bit of worry that-in the public perception anyhow-I would be viewed as one of them.

The House hearings on WorldCom began on July 8, 2002. I stayed home that day so that I could watch them. It was, for anyone in my business, the ultimate reality television show. All four of them looked as if they'd aged about 20 years in the last one. Mel d.i.c.k looked bewildered. Bernie's cowboy jauntiness now looked stiff; Scott's oncecrisp, precise demeanor was now tense and clipped; and Jack looked as if he'd spent the previous night on a barstool. He'd never done a lot of television and you could see why.

Scott, who would be arrested three weeks later along with his controller, David Myers, took the Fifth Amendment and just sat there, listening mutely as the committee members railed against WorldCom's restatement of what was now believed to be over $7 billion. This number was so huge as to be almost incomprehensible. Things didn't get easier to comprehend when the number jumped up to $11 billion by April 3, 2003, replacing Enron as the largest corporate fraud in history.

Bernie, dressed in a blue suit with a red-striped tie, read a prepared statement. He would speak, he said, "...when all the activities at WorldCom are fully aired and when I get the opportunity...to explain my actions in a setting that will not compromise my ability to defend myself...I believe that no one will conclude that I engaged in any criminal or fraudulent conduct during my tenure at WorldCom. Until that time, however, I must respectfully decline to answer the questions of this committee on the basis of my Fifth Amendment privilege."

Next came Mel d.i.c.k, the former Andersen accountant and now CEO of an apparel company. He pa.s.sed the buck. "The fundamental premise of financial reporting is that financial statements of a company, in this case WorldCom, are the responsibility of a company's management, not its outside auditors," he said.

Finally, it was Jack's turn. And as always, he talked. Dressed in a navy suit, white s.h.i.+rt, and blue tie, his dark hair thinning, his angular face stretched thin, he looked like a mouse-a mouse caught in a trap.

"Let me say I am saddened by why we are here," he said. "I am saddened that people lost money, I am saddened that people lost jobs. I am saddened that a major company is enmeshed in a major scandal, but I want to commend you and everybody on this committee for acting quickly to try to find out what went wrong here," he said. "WorldCom fit my long-held, honestly held investment thesis that newer, more nimbler [sic] companies would create value.... I am aware that there is speculation that I had advance knowledge of this fraud. That speculation is categorically false."

Whatever the politicians thought of that statement, they didn't go easy on Jack. They grilled him on WorldCom, repeatedly probing whether his ratings were driven by Salomon Smith Barney's banking interests. And then they threw him a curve ball, asking him about "special IPO [shares] to executives of WorldCom."

What they were asking about was the phenomenon of IPO spinning, in which investment banks gave corporate executives shares in companies about to go public, allegedly in return for those executives sending business to those investment banks. In effect, spinning was a quid pro quo, or a payoff: in return for a company's choosing a certain bank, its top executives would get a special bonus of a few thousand shares of stock in companies that bank was about to take public. This way, the executives would get the almost guaranteed quick profit that accompanied hot IPOs. Apparently, Salomon Smith Barney had been pretty expert at this game. I had only heard about spinning by reading it in the paper, but I quickly realized it must have been going on all around me for quite some time.

I suddenly flashed back to a strange conversation with Clark McLeod, CEO of McLeodUSA Communications, in late 1997. McLeodUSA was a startup local phone company headquartered in Iowa and covered by my colleague Mark Kastan. McLeod himself was a former schoolteacher who'd taken a flier on telecom, much as Bernie had, and had scored big before the you-know-what hit the fan.

Clark had never called me before, so I was surprised to hear his voice. I figured he either wanted to hear my views on the sector and his company's place in it or had a complaint about Mark's research. But he had something else on his mind. He asked me, instead, if I could get him some shares in the upcoming Teligent IPO.

Teligent was another startup local phone company, run by Alex Mandl, the former president of AT&T. It planned to use the less expensive wireless technology instead of fiber to carry the local portion of calls for business customers. Salomon and my firm at the time, Merrill, were the lead bankers for its IPO and thus determined which investors received shares the day of the offering.

It took me a while to realize that he was asking me to get him on the "friends and family" list of people who received shares in advance of an IPO. Usually, the only people who got pre-IPO shares were executives and employees of the company and a very small list of people whom the executives designated-hence the "friends and family" term. With the IPO market as hot as it was, anyone with these shares would probably see a significant firstday pop in the stock and, if they sold into the market, could make some serious dough very quickly.

I didn't know what to tell this guy. I didn't understand why he thought I had anything to do with handing out IPO shares, and it made me very uncomfortable. "Do you have a Merrill broker?" I asked. "That's probably your best bet."

"No," he said, "But I can get shares in IPOs from Salomon and I wondered if there was anything you could do for me."

I sputtered that I'd try to help him and got off the phone, both perplexed and a bit worried. What was Salomon doing now? I called up a guy I knew on Merrill's syndicate desk, which is in charge of allocating IPO shares, and told him the story.

"There's not much we can do," he said. "We don't do that." Whatever "that" was, I didn't really want to know more about it. I left it with him and washed my hands of the whole thing. Merrill Lynch was never named in the investigations that followed. But now, in 2002, this technique, which had somehow gotten the name "spinning," was all over the news.

I suddenly understood what I had been too naive to comprehend before: someone at Salomon, possibly Jack, was able to exert "special" insider influence in yet another way-by making sure his nearest and dearest telecom execs got IPO shares. But it wasn't just Salomon. It would later be alleged that Frank Quattrone of CSFB, my firm, was one of the most blatant users of this innovative approach to customer service. Combined with the earlier scandal, in which inflated commissions were charged for hot IPO shares, Frank was in serious, serious trouble. He'd had his contract renegotiated the previous year by John Mack to one that no longer gave him a big piece of the action (not that there was any action anymore), and word had it that he was in very hot legal water. I thought to myself once again what a good move it had been to have negotiated a chain of command that went nowhere near him.

But at this moment it was Jack who was on the congressional hot seat, and when asked whether he knew about Salomon's spinning of IPO shares to telecom executives, he suddenly looked as if he had swallowed a few chili peppers. Rather than deflecting the question, Jack, as always, opened his mouth.

"I'm trying to think if I can answer that specifically yes or no," he stammered, trying to have it both ways as usual. "I just don't recall because that's not something I would be involved with. So I can't recall. I'm not saying no; I'm not saying yes. I just can't recall."9 The answer made him look even slimier, if that were possible. The answer made him look even slimier, if that were possible.

I watched, riveted by the testimony, with an odd mixture of relief and dread. Finally, finally, Jack was getting his. I wanted to feel victorious, but instead I felt nervous. I wondered if there was any chance that I'd end up testifying before millions of people too. The previous weeks had taught me that public opinion can turn on a dime.

Just look at Jack. He had been a hero for so many years, and now the whole world a.s.sumed he was a total crook. In fact, the press seemed convinced that he knew about and had perhaps had a part in orchestrating WorldCom's ma.s.sive fraud. Clients later e-mailed me that Jack had come off terribly, managing to appear both squirrelly and uncaring about the amounts of money lost.

But no one asked Jack about inside information, which I saw as the key to his success. I was glad the hammer was finally coming down on Jack, but I thought the investigators were missing a lot too. The problem was not that Jack had had a hand in WorldCom's fraud, because it was unlikely he had. The problem was that IPO shares were getting spun, certain investors got insider information, and the rest of the investing public was playing in a rigged game and didn't even know it.

BY THIS TIME my marketing had come to a halt, and my research had slowed down a lot too. Partly it was because I was spending so much time chewing over the WorldCom disaster and trying to figure out why everyone (including me) had missed such a colossal fraud. Had we simply been duped, or had we been the best-paid people on the planet to have done the worst job? my marketing had come to a halt, and my research had slowed down a lot too. Partly it was because I was spending so much time chewing over the WorldCom disaster and trying to figure out why everyone (including me) had missed such a colossal fraud. Had we simply been duped, or had we been the best-paid people on the planet to have done the worst job?

Partly it was because several of my stocks had essentially ceased to exist. But mostly it was because I was done. The a.n.a.lyst role had s.h.i.+fted from anonymous wonk to glamorous networker and rainmaker to pathetic pariah, and I just wanted to make it to my early retirement date. I had only a few more months to go.

On July 21, 2002, WorldCom filed for bankruptcy. People had been totally horrified by the size and scope of Enron's bankruptcy the previous December-the largest ever in American financial history, eliminating $70 billion dollars of shareholder value-until WorldCom took over the top spot just months later. It was an utterly ignominious end to the fairy tale that had begun with a milkman turned gym teacher and a bunch of scribbles on a napkin. Scott Sullivan was probably facing indictment, and so was Bernie-who, unlike many CEOs in trouble, was facing financial ruin as well.

The fraud, it turned out, had occurred mostly in the way line costs were accounted for. Line costs were those costs WorldCom paid to local phone carriers for originating and completing phone calls (the so-called last mile) and were WorldCom's single largest expense. Apparently, Scott Sullivan and whoever else knew about it had decided to capitalize line costs, which meant spreading the costs over ten or more years instead of over one year, which juiced earnings and just so happened to be totally inconsistent with accounting rules. The idea of messing with such a large and important part of a company's business was so audacious that it never occurred to most people that someone would try to do such a thing. It was the elephant in the room, the fraud too huge to fathom. Any auditor should have seen it a mile away. But somehow, neither Andersen-nor anyone else-ever did.

WorldCom had gone bust with Bernie Ebbers, its former CEO, still owing it an unbelievable $400 million. He was still on the hook, even with the company's bankruptcy filing, and had five years to pay back his debts. He owned 17 million nearly worthless shares of WorldCom, along with a yacht-building business, a soybean farm, a timber business, a stake in a refrigerated trucking company, and the Canadian ranch.10 These were not the sorts of a.s.sets that could be easily liquidated to raise cash. These were not the sorts of a.s.sets that could be easily liquidated to raise cash.

In the meantime, Eliot Spitzer continued to turn over rocks in the hope of finding something on which to nail Jack Grubman. Juicy little tidbits leaked out every so often to Charles Gasparino, a reporter at The Wall Street Journal, The Wall Street Journal, and a few other reporters. Jack was as famous as he'd ever been-but now for all the wrong reasons. He made the cover of the August 5, 2002, and a few other reporters. Jack was as famous as he'd ever been-but now for all the wrong reasons. He made the cover of the August 5, 2002, Business Week. Business Week. The headline: "Inside the Telecom Game: How Salomon's Jack Grubman wheeled and dealed with WorldCom, Qwest, Global Crossing, and others." The headline: "Inside the Telecom Game: How Salomon's Jack Grubman wheeled and dealed with WorldCom, Qwest, Global Crossing, and others."11 The story essentially blamed Jack for the collapse of the entire industry. The mania was still present, just reversed: if the market had once believed Jack was responsible for the rise in Telecom Wonderland, now he was just as culpable for its fall. Even I thought that was going too far. The story essentially blamed Jack for the collapse of the entire industry. The mania was still present, just reversed: if the market had once believed Jack was responsible for the rise in Telecom Wonderland, now he was just as culpable for its fall. Even I thought that was going too far.

Jack's regular morning run didn't guarantee him any relief either. One August morning, he literally ran into Spitzer himself in Central Park, who, in an uncharacteristic display of goodwill, jogged up alongside him and shook his hand. Jack, trying to blame the system, said, "Conflicts are inherent on Wall Street."12 Spitzer agreed. That's true, I thought while reading the press reports of the impromptu meeting, but the real issue was how individuals chose to handle them. Spitzer agreed. That's true, I thought while reading the press reports of the impromptu meeting, but the real issue was how individuals chose to handle them.

By the middle of August, it was clear that Jack's support from the top of Salomon Smith Barney and, its owner, Citigroup, had evaporated as quickly as WorldCom's market value. Press reports suggested that Sandy Weill had watched Grubman's congressional testimony and was peeved.13 On August 15, Jack announced his resignation from Salomon Smith Barney, though not before he had received a $32 million severance package consisting of stock, options, forgiveness of a loan, a consulting contract, and an agreement by Citi to pay his legal expenses, which were likely to run in the millions. In exchange, he would sign a confidentiality agreement-thus, Citi apparently hoped, keeping whatever skeletons remained in its closet carefully hidden away. On August 15, Jack announced his resignation from Salomon Smith Barney, though not before he had received a $32 million severance package consisting of stock, options, forgiveness of a loan, a consulting contract, and an agreement by Citi to pay his legal expenses, which were likely to run in the millions. In exchange, he would sign a confidentiality agreement-thus, Citi apparently hoped, keeping whatever skeletons remained in its closet carefully hidden away.

"The relentless series of negative statements about my work, all of which I believe unfairly single me out, has begun to undermine my efforts to a.n.a.lyze telecommunications companies," he wrote in his good-bye letter sent to colleagues and clients.14 I finally felt a sense of closure. Even Sandy Weill, Jack's biggest benefactor and beneficiary, as it would turn out, had ditched the guy. The role Jack had redefined had come back to bite him-hard. I finally felt a sense of closure. Even Sandy Weill, Jack's biggest benefactor and beneficiary, as it would turn out, had ditched the guy. The role Jack had redefined had come back to bite him-hard.

"What's a Level 3?"

I watched the decline of my industry and the collapse of the reputations of some of my compet.i.tors and colleagues with a jumble of bewilderment, frustration, mortification, schadenfreude, and, perhaps most significant, relief that I wasn't going to be dragged into this mess. At least, that's what I was hoping.

But on September 30, 2002, when I got a call from a CSFB attorney named Jennifer Huffman, I couldn't help but feel my heart sink.

Spitzer was, by this point, investigating all of the major investment banks. The various regulatory agencies, from NASD to the NYSE to numerous state attorneys general, had each been a.s.signed to investigate research practices at various banks. Huffman told me that NASD and the Ma.s.sachusetts attorney general were working on CSFB and that its investigators had sent a list of 24 CSFB research a.n.a.lysts who might be interviewed, one of whom was me. She said the investigation covered such things as IPO spinning and biased, potentially fraudulent, research-the same issues that Spitzer had brought out in the open in his investigations of Merrill Lynch with Henry Blodget and Salomon Smith Barney with Jack Grubman.

Indeed, on that same day, Spitzer filed suit against five telecom executives, charging them with making $28 million in illegal IPO gains-Joe Nacchio, Metromedia Fiber Network chairman Stephen Garofalo, Qwest chairman Phil Anschutz, Bernie Ebbers, and Clark McLeod, my IPO-seeking buddy from McLeodUSA. All of them had used Salomon as their banker. And they'd all allegedly been personally rewarded for doing so by being granted pre-IPO shares in hot SSB-underwritten stocks. The suit sought fines of $28 million as well as the return of over $1.6 billion obtained through sales of shares in their own companies. Ebbers, Anschutz, Nacchio, and Garofalo settled the charges, paying $6.3 million in aggregate, far less than their alleged IPO profits. They neither admitted nor denied guilt. The case against McLeod remains open.

CSFB would pay all my legal expenses related to the investigation, CSFB's Huffman said, using the top New York law firm Davis, Polk & Wardwell, but I could choose an additional lawyer to personally represent me if I wished. I jumped at the chance, figuring two heads were always better than one and that I should be ready just in case CSFB wanted me to answer questions in a way that made me uncomfortable. So Huffman set me up with another lawyer, David Fein of Wiggin and Dana, a New York University Law School graduate who had been a prosecutor with the U.S. Attorney's Office in Manhattan and a.s.sociate counsel in the Clinton White House. David's job was to find out what, if anything, in my background presented a potential problem, and to prep me for a meeting with Davis Polk's lawyers, who, along with David, would be preparing me for a possible meeting with the NASD.

The goal, I soon learned, was to answer truthfully, but succinctly. In other words, they wanted me to give yes or no answers without speculating or hypothesizing. In effect, they wanted me to avoid giving any of the kind of a.n.a.lytical or predictive answers I had been providing for the past 14 years. CSFB sent five enormous boxes containing my e-mails and research reports for David to review. I also received copies and spent several days reading over them myself. NASD also asked for my trading records and my CSFB personnel file.

On October 7, David and two of his a.s.sociates grilled me for three hours, aggressively jabbing me with a nonstop series of questions. They included the following: -Describe your CSFB employment contract. Does it provide for you to be paid for banking successes? It didn't, of course-though it easily could have, had I accepted that contract proposal that gave me a piece of the investment banking department's profits. It didn't, of course-though it easily could have, had I accepted that contract proposal that gave me a piece of the investment banking department's profits.-When you moved from Merrill Lynch to CSFB, did any clients or business move with you? I explained that all the sell-side a.n.a.lysts have the same buy-side clients, so the answer was that of course all the clients moved with me. What he meant, of course, was did any banking clients switch to CSFB when I did. The answer was no. I explained that all the sell-side a.n.a.lysts have the same buy-side clients, so the answer was that of course all the clients moved with me. What he meant, of course, was did any banking clients switch to CSFB when I did. The answer was no.-Did Bernie Ebbers attend your conferences? Yep, he did, but not after I downgraded his stock. Yep, he did, but not after I downgraded his stock.-How many Holds Holds and and Sells Sells did you have? And what did those terms mean to you? did you have? And what did those terms mean to you? I went through the Holds over the years and the Sell on WorldCom and the Sell many years earlier on Ameritech. I explained what those ratings meant and how I usually didn't waste effort on stocks that I saw as unattractive or that didn't fit into my fairly traditional definition of telecom services. I went through the Holds over the years and the Sell on WorldCom and the Sell many years earlier on Ameritech. I explained what those ratings meant and how I usually didn't waste effort on stocks that I saw as unattractive or that didn't fit into my fairly traditional definition of telecom services.-Did you ever publish an opinion on a stock that was inconsistent with your a.n.a.lytical conclusions on that stock? No, I replied. No, I replied.

The lawyers were satisfied with my answers, it seemed. They also really liked my contract because it didn't tie my pay to banking. So, once again, did I.

Three days later, we had a similar session at Davis Polk, where I was interrogated even more aggressively in preparation for what might lie ahead. At this meeting, my attorney, David Fein, told me that the NASD had asked for copies of all my e-mails between July 1999 and July 2001 and that Eliot Spitzer's office would get copies of them as well. It's terrifying to think of someone else going through every thing you've put in writing for the past few years in the hope of finding a smoking gun. I couldn't help but feel violated, even though I understood why they needed to do it. But I wasn't very concerned. I told David I didn't have any incriminating e-mails and I was happy to help. I had thought they asked all of the right questions, with the exception of the biggie: inside information. No one, apparently, was pursuing this topic.

So I was pretty surprised a week or so later when the phone rang and it was David.

"What's a Level 3?" he asked nonchalantly.

It turned out that the paralegals at Davis Polk had been a.s.signed to read all of my e-mails, looking for anything incriminating, such as a situation where I privately criticized a stock while recommending it in my reports. They found an e-mail I wrote to Frank Quattrone, dated October 10, 2000, that read: "Enough. I gave on Level 3 and that's it."

From a paralegal's perspective, this sure sounded juicy. Wasn't there a numeric stock rating system at CSFB where "1" equals Strong Buy, "2" equals Buy, and "3" equals Hold? It sure sounded as if I had caved by rating some stock a Buy or Strong Buy when I believed it should be a (level) "3."

What actually had happened, I explained, was that after CSFB merged with Donaldson Lufkin & Jenrette in 2000, DLJ's Internet a.n.a.lyst, who had previously covered Level 3, the Internet/telecommunications company, and another startup local telecom company, Metromedia Fiber Network (MFN), wanted to continue covering both of them.

Frank Quattrone was in the highly unusual position of being a banker who had the technology research team report directly to him. So he e-mailed me and asked if I would be willing to transfer coverage to the new guy. I was more than happy to give up Level 3, since I wasn't going to cover it anyway, but told Frank that it made no sense for MFN to be covered by anyone but Mark Kastan. Hence my e-mail.