The politics of enforcement: Eliot Spitzer, state-federal relations, and the redesign of financial regulation

Publius: The Journal of Federalism

Volumn 35, Issue 3, 2005, Pages 449-466

  O'Brien, Justin ^a  

^a QUEEN'S UNIVERSITY BELFAST   (United Kingdom)

Author keywords

[No Author keywords available]

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EID: 26644448707     PISSN: 00485950     EISSN: None     Source Type: Journal    
DOI: 10.1093/publius/pji019     Document Type: Review

References (88)

1. Charles Gasparino, Blood on the Street (New York: Free Press, 2005);
2. Justin O'Brien, Wall Street on Trial (Chichester, UK: John Wiley & Sons, 2003);
3. Roger Lowenstein, The Origins of the Crash (New York: Penguin Press, 2004);
4. John K. Galbraith, The Economics of Innocent Fraud (London: Allen Lane 2004);
5. Nomi Prins, Other People's Money (New York: New Press, 2004).
6. The role of SAGs as policy entrepreneurs has become a vital vein of study in the power of state actors to shape regulatory policy. For example, see Colin Provost, "State Attorneys General, Entrepreneurship, and Consumer Protection in the New Federalism," Publius: The Journal of Federalism 33 (Spring 2003): 37-53;
7. Joseph Zimmerman, "Interstate Cooperation: The Role of States Attorney General," Publius: The Journal of Federalism 28 (Winter 1998): 71-89;
8. Rorie Spill, Michael Licari, and Leonard Ray, "Taking On Tobacco: Policy Entrepreneurship and Tobacco Litigation," Political Research Quarterly 54 (September 2001): 605-622;
9. Lynn Mather, "The Politics of Litigation by State Attorneys General," Law and Policy 25 (September 2003): 425-428;
10. Thomas Schmeling, "Stag Hunting with the State AG: Anti-Tobacco Litigation and the Emergence of Cooperation among State Attorneys General," Law and Policy 25 (September 2003): 429-454.
11. The widening investigation into American International Group is a crucial example of this dynamic. Spitzer's call through the Martin Act for information relating to the use of contingent commissions has sprawled outwards to include not just the Securities and Exchange Commission and the Department of Justice but also regulators in a range of countries, including the United Kingdom, Australia, and the Republic of Ireland, which has become one of the leading global centers in the insurance industry. See Timothy L. O'Brien, "Investigation of Insurance Puts Buffett in a Spotlight," New York Times, 28 March 2005, p. C1.
12. Brian Gerber and Paul Teske, "Regulatory Policymaking in the American States: A Review of Theories and Evidence," Political Research Quarterly 53 (December 2000): 849-886, 851.
13. Eliot Spitzer, New York SAG, interview with the author, New York City, 10 December 2004.
14. Ellen Kelleher, David Wighton, and Adrian Michaels, "AIG Chief Ousted amid Probe," Financial Times, 15 March 2005, p. 1;
15. Jenny Anderson, "In Clash of Titans, Chief of AIG Met His Match," New York Times, 15 March 2005, pp. C1, C9.
16. For an interim assessment of the derivative risks involved in "finite reinsurance" and its use as a mechanism primarily to boost earnings rather than to displace risk, see O'Brien, "Investigation of Insurance," p. C1.
17. For a scathing critique condemning Spitzer's methods as "rough justice if it is justice at all," see Editorial, " . . . and Something Else," Wall Street Journal, 16 March 2005, p. A24.
18. "SEC Focus on AIG as Greenberg Goes," Financial Times, 15 March 2005, p. M26. Greenberg relinquished all posts pertaining to AIG on 28 March 2005. He had been scheduled to give a deposition to the New York attorney general three days later.
19. Full text online at http://oag.state.ny.us/press/2005/jan/ marsh_agreement.pdf; accessed 2July 2005.
20. Monica Langley and Theo Francis, "Insurers Reel from Spitzer's Strike," Wall Street Journal, 18 October 2004, p. A1.
21. Spitzer, interview.
22. NYSAG, "Statement by Attorney General Eliot Spitzer regarding the AIG Investigation," 4 April 2005.
23. Many investment banking figures interviewed by the author viewed Spitzer with a mixture of irritation and admiration. The specific reference to Robespierre was made by a senior executive from a firm not directly targeted by Spitzer. An acerbic commentator came to a similar conclusion; see Jack Willoughby, "He's No TR," Barron's Online, 7 February 2005 (Internet Explorer version). Other observers are more ambivalent; see Gasparino, Blood on the Street, p. 311.
24. For largely positive profiles, see Adi Ignatius, "Wall Street's Top Cop," Time Magazine, 22 December 2002 (Internet Explorer version);
25. James Traub, "The Attorney General Goes to War," New York Times Magazine, 16 June 2002 (Internet Explorer version);
26. John Cassidy, "The Investigation: How Eliot Spitzer Humbled Wall Street," New Yorker, 7 April 2003.
27. " . . . and Something Else," Wall Street Journal, 16 March 2005, p. A24.
28. Zimmerman, "Interstate Cooperation," 72.
29. The quotation comes from a seminal article, written by the sociologist Edward Ross in 1907, that provided the first sustained critique of white-collar crime. See Edward Ross, "The Criminaloid," Atlantic Monthly, January 1907, pp. 44-50. David Browne, the managing director of the boutique investment firm Tweedy Browne, scathingly refers to Spitzer as a contemporary muckraker. In an interview conducted in Hamilton, Ontario, on 20 January 2005, he decried Spitzer as "a political egomaniac." Browne was instrumental in orchestrating the demise of the press magnate Conrad Black in what emerged as one of the most egregious corporate governance failures in the current crisis.
30. AIG's involvement in earnings management was the subject of cease and desist orders from the Securities and Exchange Commission long before the current regulatory investigation. In 2003 AIG paid a fine of $10 million to settle charges that it had inflated the earnings of Brightpoint. See Securities and Exchange Commission, SEC Charges American International Group and Others in Brightpoint Securities Fraud, 11 September 2003. When AIG announced in March 2005 that it was restating its accounts, it did so because of a recognition that the earnings management extended to the corporation itself.
31. See Ian McDonald, Theo Francis, and Deborah Solomon, "AIG Admits 'Improper Accounting,'" Wall Street Journal, 31 March 2005, p. A1.
32. Spitzer, interview.
33. Editorial, "Eliot Spitzer for Attorney General," New York Times, 29 October 1998, p. A30. Condemning what it termed his "campaign trickery," the editorial argued that "in normal circumstances, Mr. Spitzer's evasions would have made it impossible to endorse him for the state's top legal position. . . . Mr. Spitzer, for all his dishonesty on campaign funding, does offer the prospect of an attorney general who will not be hobbled by ideology." Spitzer's electoral strategy has once again come into clear focus with the revelation that the internet search company Google was paid to provide a link from AIG to his gubernatorial campaign.
34. See Christopher Grimes, "Google Link Puts Spitzer in the Line of Fire," Financial Times, 7 April 2005 (Internet Explorer version).
35. Spitzer had not been elected when the multistate tobacco litigation was designed. Before his investigations on Wall Street, his most effective litigation involved suing power plants in the Midwest for causing the pollutants that fall as acid rain on New York. See "Spitzer Files Law Suits against Out of State Power Plants," 29 November 1999; http://www.oag.state.ny.us/ press/1999/nov/nov29a_99.html. Two major utilities settled in November and December 2001. Spitzer had also secured a major settlement for environmental cleanups in New York State in December 1999.
36. See "State Secures $9 million in Toxic Clean Up," 27 December 1999; http://www.oag.state.ny.us/press/1999/dec/dec27a_99.html.
37. O'Brien, Wall Street on Trial, p. 152;
38. Gasparino, Blood on the Street, pp. 216-217. In an interview, the director of enforcement at the Securities and Exchange Commission, Steve Cutler, argued that "the timeline demonstrates conclusively that this issue was already being addressed by the regulatory authorities" (Washington, DC, 23 May 2003). Spitzer's success was in taking the issue public just as Congress was holding financial hearings into the complicity of financial institutions into the collapse of Enron. By holding Merrill Lynch to account for failures in the wider securities and investment banking industry, the authorities had little choice but to coopt the New York SAG. In Cutler's diplomatic phrasing, up to that point the regulators had been engaging in "the kind of parallel play you associate with toddlers."
39. New York Laws of 1921, chap. 649, New York General Business Law, §352.
40. Spitzer, interview.
41. For a critical assessment of the efficacy of enforced self-regulation as an enforcement tool, see Ian Ayres and John Braithwaite, Responsive Regulation: Transcending the Deregulation Debate (Oxford: Oxford University Press, 1992).
42. O'Brien, Wall Street on Trial, pp. 155-157.
43. O'Brien, Wall Street on Trial, Ibid., 155.
44. See Justin O'Brien, "Ethics Probity and the Changing Governance of Wall Street: Cure or Remission," Public Integrity 7 (Winter 2004): 43-56.
45. O'Brien, Wall Street on Trial, p. 167.
46. Having the case heard does not necessarily guarantee victory. A class action was filed in the Southern District of New York against Merrill Lynch, using the evidence provided by Spitzer's investigation. Judge Milton Pollack ruled he was "utterly unconvinced." He castigated the "plaintiffs [who] would have this court conclude that the federal securities laws were meant to underwrite, subsidize and encourage their rash speculation in joining a free-wheeling casino that lured thousands obsessed with the fantasy of Olympian riches, but which delivered such riches to only a scant handful of lucky winners" (p. 7). For full details of the ruling see Re Merrill Lynch & Co Inc, Research Reports Litigation Securities, SDNY 02 MDL 1484 (30 June 2003). The ruling was upheld on appeal.
47. See Lentell et al v. Merrill Lynch & Co Inc and Henry Blodget, U.S. Federal Court of Appeals 2nd Circuit, 03 7948 (20 January 2005).
48. "Citigroup to Set Aside $4.95 Billion for Litigation," 10 May 2004; www.bloomberg.com. A total of $2.58 billion related to a class action suit over the bank's complicity in the collapse of WorldCom. As with the Merrill Lynch case cited in note 28, much of the evidence implicating the bank was sourced from Spitzer's investigation. It was entered into evidence in the consolidated complaint issued by the New York state comptroller, Alan Hevesi, on behalf of the common retirement fund.
49. For full details see "Consolidated Complaint," Re WorldCom Inc Securities Litigation, SDNY 02 Civ. 3288 DLC (2 December 2003).
50. The day after the former WorldCom chief executive, Bernie Ebbers, was convicted on nine charges of fraud, JP Morgan Chase settled its liabilities for $2 billion. The price for settlement went up 17 percent in the intervening period. With remarkable understatement, JP Morgan's chief executive, William Harrison, released a statement in which he argued that "given recent developments, we made a decision to settle rather than risk the uncertainty of a trial." See "JP Morgan Settles WorldCom Suit for $2bn," Washington Post, 17 March 2005, p. E1.
51. For a discussion of the importance of symbolism in regulatory politics, see Murray Edelman, "Symbols and Political Quiescence," American Political Science Review 54 (September 1960): 695-704.
52. For its application to the current manifestation, see O'Brien, "Ethics, Probity and the Changing Governance of Wall Street."
53. O'Brien, Wall Street on Trial, p. 144.
54. For an assessment of these dynamics in the earlier savings and loans debacle, see Julie Laumann and Paul Teske, "Principals, Agents and Regulatory Federalism in the Savings and Loan Crisis of the 1980s," State Politics and Policy Quarterly 3 (Summer 2003) 139-157.
55. For a trenchant critique arguing the case for increased state competition in order to improve regulatory capacity, see Roberta Romano, The Advantage of Competitive Federalism for Securities Regulation (Washington, DC: AEI Press, 2002).
56. Public Law no. 109-2.
57. David Rogers and Monica Langley, "Bush Set to Sign Landmark Bill on Class Actions," Wall Street Journal, 18 February 2005, p. A1;
58. Stephen Labaton, "Quick, Early Gains Embolden Business Lobby," New York Times, 18 February 2005 (Internet Explorer version).
59. Spitzer, interview.
60. See Susan Rose-Ackerman, Rethinking the Progressive Agenda: The Reform of the American Regulatory State (New York: Free Press, 1992);
61. Joseph Zimmerman, Federal Preemption: The Silent Revolution (Ames: Iowa State University Press, 1991).
62. For a focus on the role of SAGs within this new dispensation, see Provost, "State Attorneys General" and Teske, Regulation in the States, pp. 218-235.
63. Michael Moran, The British Regulatory State (Oxford: Oxford University Press, 2003), p. 16.
64. For a discussion of how debates impact on capacity, see Malcolm Sparrow, The Regulatory Craft (Washington, DC: Brookings Institution, 2000), pp. 18-28.
65. William Lowry, The Dimensions of Federalism (Durham, NC: Duke University Press, 1992).
66. Eliot Spitzer, "The Challenge of the New Federalism" (speech delivered on Law Day, 1 May 2000); www.oag.state.ny.us/press/statements.
67. Spitzer, interview.
68. Conrad Black, Franklin Delano Roosevelt, Champion of Freedom (London: Phoenix Books, 2003).
69. Mark Seliger, "Spitzer's Justice," Vanity Fair, January 2005.
70. Brandeis remains a controversial figure. For contrasting perspectives, see Philippa Strum, Brandeis: Beyond Progressivism (Kansas: University Press of Kansas, 1992)
71. and the profile of Brandeis in Thomas McCraw, Prophets of Regulation (Cambridge, MA: Harvard University Press, 1984), pp. 80-152.
72. Associated Press, "Chamber Chief Attacks Spitzer," Los Angeles Times, 6 January 2005 (Internet Explorer version).
73. Eliot Spitzer, "Business Ethics, Regulation and the 'Ownership Society'" (remarks to the National Press Club, Washington, DC, 31 January 2005), p. 5. Full text at www.oag.state.ny.us/press/statements.
74. Spitzer, interview.
75. Ibid.
76. O'Brien, Wall Street on Trial, p. 171.
77. For an academic critique see Roberta Romano, "The Sarbanes-Oxley Act and the Making of Quack Corporate Governance," Finance Working Paper, European Corporate Governance Institute, Brussels, 2004, p. 52.
78. For an assessment of how federal regulators view the business environment see William Donaldson, speech to Business Roundtable, Washington, DC, 14 October 2004; www.sec.gov/new/speech/spch101404whd.htm.
79. Spitzer, interview.
80. New York State Constitution, Article 5, section 1.4, and Article 19, section 1.
81. Eliot Spitzer, "Statement to Senate Committee on Governmental Affairs Subcommittee on Financial Management, the Budget and International Security," Washington, DC, 16 November 2004, p. 13; www.oag.state.ny.us/ press/statements.
82. Teske, Regulation in the States, p. 7.
83. Istemi Demirag and Justin O'Brien, "Conflicting and Conflating Interests in the Regulation and Governance of the Financial Markets in the United States," Journal of Corporate Citizenship, 15 (Autumn 2004): 111-119.
84. Public Law no. 107-204.
85. Sarbanes-Oxley serves four interlinked purposes. It creates new structures to regulate the audit process and the profession, offers greater protection for whistleblowers, increases the responsibilities and criminal liabilities of corporate boards, and enhances the authority of the Securities and Exchange Commission to police the market. As such, Sarbanes-Oxley imposes new restrictions on the capacity of corporations seeking to raise finance on U.S. capital markets. To secure access to the liquidity offered on the primary exchanges, all corporations, regardless of domicile, must follow the more restrictive provisions of the act. They must also follow stricter listing requirements mandated by the primary exchanges under the guidance of a more assertive Securities and Exchange Commission. For a discussion of the act and how it operates, see Justin O'Brien, ed. Governing the Corporation (Chichester, UK: John Wiley and Sons, 2005).
86. In this he is following the lead of two of the most senior judges in the Delaware Chancery Court. See William Chandler and Leo Strine, "The New Federalism of the American Corporate Governance System: Preliminary Reflections of Two Residents of One Small State," University of Pennsylvania Law Review, 152 (December 2003): 954-1005.
87. See, Laureen Edelman, Christopher Uggen, and Howard Erlanger, "The Endogeneity of Legal Regulation: Grievance Procedures as Rational Myth," American Journal of Sociology, 105 (September 1999): 404-454, 447.
88. Michael Slackman, "Fund-Raiser Provides $3 Million for Spitzer Campaign," New York Times, 10 December 2004 (Internet Explorer version).