Background on WTC7 Tenant Salomon Brothers and Related Financial Scandals

When Citigroup Met WorldCom
By GRETCHEN MORGENSON and TIMOTHY L. O'BRIEN
Published: May 16, 2004

It was early 1997, and the assistant to James L. Dimon, Smith Barney's chief executive, had thus summoned one of the bank's analysts to an impromptu meeting in an executive dining room.

When he arrived, the analyst recalled, he found two colleagues and several investment bankers earnestly explaining their views to Bernard J. Ebbers, the self-assured founder of WorldCom, the telephone company that was then a favorite of Wall Street. The telecommunications industry had been deregulated a year earlier, Internet use was soaring and Mr. Ebbers, a former nightclub bouncer and high school basketball coach, was widely regarded as a pioneer who would reap huge rewards from the rapidly transforming communications landscape.

Mr. Dimon soon joined the meeting, the analyst said, as did another legendary deal maker, Sanford I. Weill, the chief executive of Smith Barney's parent, the Travelers Corporation. Over the next year, Mr. Weill would engineer the creation of the world's largest bank, Citigroup, itself a product of the 1990's passion for financial deregulation.

Why the assemblage of so much Wall Street firepower that day? According to the analyst, who later left Smith Barney and who asked that his name not be used, there was a simple reason: to pay homage to Mr. Ebbers.

''This was not an intellectual exchange of ideas,'' he recalled. ''The banker was holding his chair. The guy who was head of mergers and acquisitions was running to get him some water. The word 'brilliant' was used seven or eight times.''

Some seven years later, Citigroup's shareholders may be ruing the day that the financial services conglomerate built by Mr. Weill set its sights on Mr. Ebbers and WorldCom.

Last week, Citigroup agreed to pay $2.65 billion to settle a class-action lawsuit filed by investors who lost money in WorldCom, which filed for bankruptcy protection two years ago. It is the second-largest class-action settlement in history, after Cendant's, and the largest ever paid by a bank.

Clearly, the bank's courtship of Mr. Ebbers, who was indicted last March on charges of securities fraud and conspiracy, is turning out to be costly. More suits against Citigroup over its dealings with WorldCom are still outstanding, so a final accounting of that relationship is not now possible. And investigators are still examining possible abuses throughout the financial world -- at banks, insurers and mutual fund companies.

In settling the class-action case, Citigroup denied any wrongdoing and said it would vigorously contest remaining suits. ''Mr. Weill had no business involvement with WorldCom or Bernie Ebbers,'' said a Citigroup spokeswoman. She added that the bank had embarked on a ''new day'' after overhauling its research and investment banking activities to prevent conflicts that have bedeviled the company. Certainly, an investor who bought shares of Citigroup just after the 1998 merger that created it would be doing very well. The stock has returned more than 86 percent, versus 8.7 percent for the Standard & Poor's 500-stock index.

But the deeply symbiotic relationship between the bank and the telecom giant is worth re-examining because it illustrates the risks to investors that have resulted from the broad deregulation of the 1990's. ''Deregulation became a kind of religion -- it was supposed to enable people to get better products or services more competitively,'' said Felix G. Rohatyn, the financier. ''But it doesn't mean wiping out all the protection of the consumers in order to respond to some kind of a dogma.''

No bank has taken advantage of deregulation more astutely, or with greater consequences, than Citigroup. Under its umbrella is a brokerage unit, an insurance company and major commercial, consumer and investment banks. It is every bit the financial services supermarket promised by its creators, and one that produces formidable profits.

But its relationship with WorldCom demonstrates that Citigroup's disparate activities, often monitored loosely, resulted in transactions that benefited Mr. Ebbers, WorldCom and Citigroup officials in the short term but ultimately hurt many of the bank's clients and shareholders.

MR. EBBERS, who ran WorldCom as a personal fief, was in a position to provide two important things to Citigroup: immense fees for its help in conducting various investment banking and trading operations, and a product -- stocks and bonds -- for the bank to sell to its clients. As a result, he was given access to every service a financial superstore could provide: share allocations in highly-sought-after initial public offerings that generated millions in profits, personal loans backed by collateral whose value was allowed to fall well below normally acceptable limits, and commercial loans that enabled him to dabble in unrelated businesses.

Even more troubling, Citigroup's transactions with Mr. Ebbers indicate that the bank's interests were so entwined with his that it had a powerful motivation to prop up WorldCom's stock price once it began its downward spiral.

Richard Thornburgh, the former attorney general appointed by the bankruptcy court to examine WorldCom's history, filed the final version of his analysis in January. It concluded that Citigroup ''gave extraordinary financial favors and assistance to Mr. Ebbers, which were intended to and did influence Mr. Ebbers to award WorldCom investment banking business'' to the firm.

As a result, the report stated, ''the examiner believes that WorldCom could pursue claims against Mr. Ebbers for breaches of his fiduciary duties of loyalty and good faith to WorldCom and against Citigroup Capital Markets, successor to Salomon Smith Barney, for aiding and abetting such breaches.''

Among the examiner's observations was this: WorldCom, which emerged from bankruptcy protection last month and is now known as MCI, could sue Citigroup to get back the $106 million in investment banking fees that it paid from 1996 to 2002.

Of those with a role in the WorldCom saga, Jack B. Grubman, a former leading analyst of the telecom industry at Citigroup, has drawn the most attention. But it is clear from court documents and interviews with financiers that he was far from the only one at Citigroup courting Mr. Ebbers.

''I have to believe it was a team effort at Citi because WorldCom was such an important fee-generating relationship,'' said Michael Holland, an independent money manager who worked for Salomon Brothers from 1989 to 1992. ''Anyone who could have helped, from the top of Citi on down, would have.''

Besides Mr. Grubman, Eduardo Mestre, Citigroup's head of investment banking, pursued WorldCom ardently, as did Mr. Mestre's chief telecom banker, Thomas King. To keep Mr. Grubman from bolting to a rival firm, Mr. Weill paid him handsomely and closely monitored his involvement with the telecom industry.

One veteran Wall Street telecom banker said that Citigroup and WorldCom ''were effectively inseparable,'' and ''it always seemed like some combination of Jack, Eduardo and Tom King when Citigroup was involved with WorldCom.''

Citigroup declined to make its executives available for comment, citing continuing litigation. The Thornburgh report, however, provides a troubling portrait of the company's relationship with WorldCom.

According to the report, financial favors to Mr. Ebbers began with enormous allocations of initial public offerings, which typically soared in value once the shares started trading. The first was an allocation from Salomon of 200,000 shares of Mc-LeodUSA, a telecommunications start-up, in June 1996. Over the next four years, Mr. Ebbers received more than a million initial offering shares in various companies. His profits totaled $12 million.

Why would an investment banking company want to give Mr. Ebbers such shares? Mr. Grubman and Mr. Mestre had unsuccessfully sought business from WorldCom since 1994. Until the McLeod allocation in 1996, Mr. Ebbers had done no brokerage business through Salomon. But just two months after the McLeod deal, Salomon got its first WorldCom assignment as financial adviser on the acquisition of another telecom business, MFS Communications. That transaction, according to the Thornburgh report, was a good example of Salomon's concept of synergy.

IN early August 1996, shortly after WorldCom met with executives from MFS, Mr. Ebbers phoned Mr. Grubman to talk about the deal, according to the Thornburgh report. At the time, Mr. Grubman was publicly considered an independent analyst whose efforts were supposed to be clearly separated from Salomon's investment banking operation. Mr. Grubman, the report said, immediately called Mr. Mestre, who in turn alerted other Salomon bankers.

At Mr. Ebbers's behest, Mr. Grubman set up a meeting a week later with WorldCom's chief financial officer, Scott D. Sullivan, and Salomon bankers. One banker told Mr. Thornburgh that several surprises greeted her when she arrived in Mr. Grubman's office for that meeting.

First, the report said, Mr. Ebbers and Mr. Sullivan were there with Mr. Grubman. The Salomon banker ''was informed that WorldCom would seek to acquire MFS,'' it said. ''She then recalled Mr. Ebbers 'bantering' with Mr. Grubman about whether Salomon would be hired by WorldCom for the transaction,'' it added. ''Her reaction was that it was 'strange' and 'unusual' to have this kind of meeting in an analyst's office.''

Dispensing insider information about pending mergers is a crime, and the banker ''recalled being thankful that the meeting occurred after the market had closed at 4 p.m.'' The banker also remembered a meeting later that day in Mr. Mestre's office, where Mr. Ebbers and Mr. Sullivan discussed the terms under which WorldCom would retain Salomon's services.

From that point on, Salomon, which later merged with Smith Barney before being swept into the Citigroup conglomeration, was WorldCom's primary investment banker.

WorldCom fit neatly with Mr. Grubman's model for the future of telecommunications. Put simply, he believed that the industry should favor corporate customers over consumers, data transmission over voice services and innovative communications networks over older, established systems. For a time, Wall Street appeared to heed his predictions. ''When Grubman said something it was go along or be left behind,'' said an investment banker involved in telecommunications deals at the time. ''The reality is that he was brutally wrong in his dogma.''

The error of Mr. Grubman's vision, and of the telecom start-ups it nurtured, did not become apparent until years later.

THE day that Citicorp and Travelers announced the merger that formed Citigroup in April 1998, Mr. Weill, sitting in Citicorp's headquarters, rocked back and forth excitedly in his seat, marveling aloud each time an assistant updated him on his stock's escalating price. A year later, Congress struck down Glass-Steagall, the Depression-era law that separated plain-vanilla lending from speculative investment banking. Mr. Weill had lobbied heavily for the repeal, which was hastened by the Citigroup merger.

In short order, Mr. Weill went on to recast Citigroup in his own image: financially adroit, aggressive, cost conscious, profit oriented and enthralled with deal making. By spring 2000, he had vanquished his rivals and was Citigroup's sole chief executive, and he had handpicked most of the bank's senior executives. One of his lieutenants, Charles O. Prince, succeeded him as chief executive late last year, although Mr. Weill has remained chairman -- leading some corporate governance experts to complain that Mr. Weill is still influencing Citigroup's affairs.

A Wall Street banker who tried and failed to win WorldCom's business said it would be a ''huge understatement'' to say Mr. Ebbers ''lorded his relationship with Citigroup over other banks.'' He said Mr. Ebbers routinely chastised analysts who were not as favorably disposed as Mr. Grubman toward WorldCom and told their firms that they would not receive any of his business until their analysts adopted a rosier viewpoint.

Citigroup made sure to take care of Mr. Ebbers. As early as 1999, a Salomon Smith Barney broker assisted in arranging a $60 million loan from Citibank to help refinance Mr. Ebbers's ranch in Canada, according to the Thornburgh report. And in February 2000, Travelers Insurance, a Citigroup unit, lent $499 million to Joshua Timberland, a company owned by Mr. Ebbers, to buy 460,000 acres of timber property. Because the loan was highly risky, Travelers received a 2.5 percent equity stake in Joshua. That the bank was a partner with Mr. Ebbers was not publicly disclosed in WorldCom filings. Citigroup's spokeswoman declined to comment about the status of this loan and equity stake.

Marc Weill, Mr. Weill's son, who served on the bank's influential management committee and oversaw Citigroup's investment portfolio, was heavily involved in approving the Travelers loan to Joshua, according to a person who has examined the transaction. Marc Weill, who resigned from the bank several months later while undergoing treatment for a drug addiction, could not be reached for comment.

Salomon, meanwhile, continued to advise WorldCom on major acquisitions. The most significant was WorldCom's $30 billion takeover effort, started in October 1997, for the long-distance provider MCI. Mr. Ebbers had put together the deal with the support of Mr. Grubman and Mr. Mestre. According to a person who spoke with several people involved in the transaction, one of Mr. Grubman's assistants performed a detailed financial analysis of the takeover before it was announced -- a task normally performed by investment bankers, not analysts -- to encourage Mr. Ebbers's bid.

According to the Thornburgh report, Salomon received $32.5 million in advisory fees for the MCI deal and $15.8 million for being the lead underwriter on a related debt offering the next year. Other debt deals continued to draw Citigroup and WorldCom together. The Thornburgh report said that in 2001, as the bank jockeyed for the lead position on a $12 billion bond offering from WorldCom, Salomon bankers asked Mr. Grubman to contact Mr. Ebbers directly to promote the firm. Citigroup secured the deal, but had to share it with J.P. Morgan & Company.

WELL before that, however, the fortunes of WorldCom and Mr. Ebbers had begun to deteriorate. After peaking in June 1999 at around $62, the shares were trading in the mid-$40's in July 2000. In the fall of 2000, after regulators blocked WorldCom's bid to buy Sprint, another big long-distance carrier, investors started to worry that WorldCom's growth era was over. By that summer, Mr. Ebbers's net worth had dropped to $658 million from $1 billion. His margin debt was around $380 million and included loans from Bank of America, Paine Webber, Morgan Keegan and Citibank -- all backed by WorldCom shares. If those shares fell below a specified value, Mr. Ebbers was required to post additional collateral, or the lender could sell the WorldCom stock and pay down the loan.

Mr. Ebbers faced multiple calls for additional collateral as WorldCom shares continued to decline. In September 2000, he received a $10 million cash bonus and borrowed $50 million from WorldCom to meet some of his margin calls.

But that was not enough. So Mr. Ebbers turned to Salomon for help.

In the opinion of the bankruptcy examiner, what followed was ''extraordinary and unprecedented financial assistance.'' First, the report said, Salomon Smith Barney persuaded Citibank not to sell any of the stock that Mr. Ebbers had pledged to back the loan. Salomon also guaranteed Citibank that the bank would suffer no losses on a $53 million loan to Mr. Ebbers; Citibank agreed to accept an unsecured exposure of up to $10 million on the loan before it would sell Mr. Ebbers's shares. Finally, Salomon offered to take over a $49 million loan to Mr. Ebbers that was held by another firm -- an offer that Mr. Ebbers never acted on, according to the Thornburgh report.

''The assistance was not casually provided,'' the report said. In fact, it said, the help required the involvement of one of Mr. Weill's key deputies, Michael Carpenter, as well as Mr. Mestre, Mr. Grubman and many others inside the Citigroup financial services supermarket, including the co-heads of the firm's global equities unit, the vice chairman of the global private client group, the director of private-client sales and several other senior credit and risk managers. Advocating the takeover of the Paine Webber loan in an Oct. 23, 2000, e-mail message, David Trautenberg, a Salomon broker, put it simply: ''This individual is associated with the No. 1 fee-generating client of the bank as well as institutional fixed income/equities. In addition, retail does have WorldCom's stock-option exercise program.''

It was clear, the report said, that Salomon Smith Barney ''provided personal financial assistance to Mr. Ebbers as a means of enhancing the probability that S.S.B. would keep a preferred position in receipt of WorldCom business, including investment banking and stock-option business, and also as a means of avoiding sales of Mr. Ebbers's stock, which would adversely affect WorldCom's stock price.''

In other words, Citigroup had an interest in propping up WorldCom stock. But soon, its relationship with WorldCom extended well beyond the investment bank. When Mr. Grubman was at his most influential, Citigroup's brokerage unit controlled 13 percent of trading in WorldCom stock, a hugely profitable business. On Sept. 30, 2000, Smith Barney Asset Management held more than 45 million WorldCom shares for its clients. And with Salomon guaranteeing Mr. Ebbers's personal loan and WorldCom shares guaranteeing the Travelers loan, Citigroup's interest in the WorldCom stock price became even keener.

Salomon's bankers at the time were trying to persuade WorldCom to start two tracking stocks. The purpose, Thornburgh's report concluded, ''was to attempt to boost the value of WorldCom stock.'' Salomon was paid $3.5 million in fees on the tracking stocks, and Mr. Grubman remained a cheerleader for WorldCom.

EVEN those efforts could not keep WorldCom shares from dropping. On Jan. 26, 2001, WorldCom shares were around $20, putting Mr. Ebbers in a precarious financial position. That day, he met with representatives from Citibank and Salomon Smith Barney. A memo summarizing the meeting, written by the executive handling Mr. Ebbers's Citibank loan, said: ''Our efforts to 'weather the storm' with Ebbers during WCOM's price volatility have apparently paid off, as he is looking to expand our relationship'' to make Citibank the lead bank for WorldCom's corporate banking.

That same day, Mr. Grubman wrote a glowing report on WorldCom, calling its shares his ''top pick.''

In May 2001, WorldCom gave Salomon the coveted role as co-lead manager, with J.P. Morgan, of its $12 billion bond offering, the third largest in history. Salomon earned $20.3 million on the deal. Documents turned over in the class-action lawsuit just settled by Citigroup show that WorldCom had promised Salomon the co-lead role provided that Citigroup committed at least $800 million to a revolving credit line WorldCom was trying to refinance. Citibank committed $710 million before the bond deal, but in the credit memo, an official at the bank said that, given the bond sale, WorldCom was unlikely to use the credit line. In fact, however, Citibank wound up as a creditor in the WorldCom bankruptcy.

The favors to Mr. Ebbers continued throughout 2001 and 2002, the Thornburgh report said. As WorldCom stock kept falling, Citigroup repeatedly eased conditions on Mr. Ebbers's margin loan. On Feb. 28, 2002, his financial adviser asked that Salomon release the lien it held on Mr. Ebbers's condominium in Vail, Colo., allowing the sale proceeds of $1.12 million to go to Mr. Ebbers rather than to pay down his loan. The request was granted.

Mr. Ebbers did pay off some of his margin loan throughout 2001 and 2002. By the time he resigned in late April 2002, the balance on his loan guaranteed by Salomon was $10 million. On May 3, 2002, Salomon sold the WorldCom shares backing the loan, taking a loss of $1.7 million.

WITH WorldCom headed for bankruptcy, the reckoning had begun. Mr. Grubman left Citigroup in August 2002, paid a $15 million fine to regulators and was barred from the securities industry for life. Mr. Carpenter was reassigned. Mr. King and Mr. Mestre moved on to new duties at the bank. And, of course, there was the $2.65 billion the bank paid last week to settle the class-action suit.

Mr. Weill stepped aside as chief executive on Oct. 1, 2003.

''The repeal of Glass-Steagall has enabled the giant financial conglomerates like Citigroup to become involved in a great variety of different businesses which often raise serious conflicts of interest,'' said Lewis D. Lowenfels, an expert in securities law at Tolins & Lowenfels in New York. ''Those involved have to be particularly sensitive to these potential conflicts and have the controls in place to avoid them.''

During the bull market, Wall Street had little sensitivity to the conflicts of interest inherent in integrated operations. Subsequent investigations have produced billions in fines and a heightened awareness of the potential problems.

All told, Citigroup has reserved $6.7 billion for settlements and fines related to financial abuses since 2002. In addition to $325 million to resolve analyst conflicts, the firm was fined $1 million by the New York Stock Exchange for failing to supervise WorldCom's stock option program. The exchange said Citigroup had failed to properly counsel WorldCom employees about the risks of holding WorldCom stock or borrowing money to exercise options.

But as long as financial services firms are permitted to conduct a variety of intersecting businesses, there appears to be potential for conflicts. ''There were good reasons for separating these types of operations,'' said Gary Lutin, an investment banker at Lutin & Company in New York. ''If you are the C.E.O. of a company that has a commercial bank, investment bank, brokerage firm and insurance company, how can you say, 'Don't do anything to benefit each other'? It would be against nature to say, 'Let's not cooperate or derive any benefit from being under the same roof.'''

http://www.nytimes.com/2004/05/16/business/when-citigroup-met-worldcom.h...