uring the market boom, a handful of top executives at telecommunications companies received big allotments of hot new stocks from Salomon Smith Barney, according to a former broker who has filed a lawsuit accusing the firm of unfair business practices. Jack B. Grubman, the firm's star analyst covering these businesses, played a central role in deciding which executives got how many shares, the broker said in an interview this week.
All the executives ran companies that were investment banking clients of Salomon. The executives named in the lawsuit include Bernard J. Ebbers, former chief executive of Worldcom; Joseph P. Nacchio, former chief executive of Qwest Communications International; James Q. Crowe, chief executive of Level 3 Communications; Clark E. McLeod, former chief executive of McLeodUSA, and Stephen A. Garofalo, chairman of Metromedia Fiber Network.
David Chacon, a former broker in a Salomon branch in Los Angeles, filed the suit in Los Angeles Superior Court last year after he complained to management about the practices and was fired in July 2000. His suit claims wrongful termination.
Mr. Chacon, 31, says that favored telecommunications executives received tens of thousands of shares in hot stock offerings underwritten by Salomon, stocks that more than doubled or tripled in value instantly. In his lawsuit, Mr. Chacon contends that the practice allowed Salomon to reward top executives personally for business their companies gave to the firm or could give to it. The practice left his clients at a disadvantage, says Mr. Chacon, whose suit also seeks restitution on their behalf.
Arda Nazerian, a spokeswoman for Salomon Smith Barney, said, "The firm has examined Mr. Chacon's allegations, and we are confident that they are without merit and contain gross factual inaccuracies."
Dispensing hot stock issues to favored clients is not new on Wall Street and may not be illegal if there is no quid pro quo attached to it. The Securities and Exchange Commission looked into practices of steering initial public offerings to favored executives in the late 1990's and took no action.
But Mr. Chacon's suggestion that the firm allotted big shares of hot offerings to a coterie of wealthy individuals while distributing far fewer or none at all to other clients adds ammunition to investors who have complained after the market decline that practices on Wall Street unfairly favor the rich and powerful.
Firms that underwrite stock offerings have great discretion in distributing those shares. Salomon has strict policies forbidding employees from linking a client's brokerage relationship with his or her company's activities, Ms. Nazerian said, and securities offerings are allocated broadly to both institutions and individuals. "Neither the research department nor a specific analyst has responsibility for making allocations of I.P.O.'s," she said.
Congressional investigators looking into the WorldCom accounting fiasco recently questioned Mr. Grubman about stock allocations and have asked the firm to supply additional information, which Salomon says it cannot do because of confidentiality constraints. Asked whether hot stock offerings had gone to top executives at WorldCom, Mr. Grubman said in Congressional testimony last week that he could not recall.
Mr. Grubman and Salomon, a unit of Citigroup, are also under investigation by Eliot L. Spitzer, the New York State attorney general, who wants to know if the analyst advised investors to buy the shares of fledgling telecom companies to generate future investment banking fees to the firm, fees that contributed to his compensation, which he described as $20 million a year.
Using hot stock offerings as a reward for past business or an inducement for future business could violate securities laws, according to Lewis D. Lowenfels, an authority on securities laws at Tolins & Lowenfels in Manhattan. "And if it was done willfully and intentionally, it could possibly become a criminal case," he said. Salomon may have also violated securities law, Mr. Lowenfels added, if it failed to disclose that a significant percentage of an offering was given to a group of individuals whose companies generated investment banking fees for the firm.
According to Mr. Chacon's lawsuit, Mr. Ebbers was allowed to buy several hundred thousand shares of Rhythms Netconnections, a company that was building a network for high-speed data transmission, in its initial public offering of 9.4 million shares at $21 each in April 1999. Lead managers on the deal were Merrill Lynch and Salomon Smith Barney, which says that Mr. Ebbers's allocation was far less.
The day after the offering, Mr. Grubman began coverage of Rhythms with a strong buy recommendation and assigned it a price target of $90. A week later, the stock traded above $111 and closed at $93.125. Mr. Chacon said he did not know the date that Mr. Ebbers sold his shares, but said it was soon after the offering.
Although the stock was a highflier, the company never got off the ground. It filed for bankruptcy just two years after the offering. The company's top management and directors sold shares worth at least $26 million before the fall, however.
Reid H. Weingarten, a partner at Steptoe & Johnson in Washington who is representing Mr. Ebbers, said that in connection with Salomon, "Mr. Ebbers was similarly situated with other telecom executives; he assumed the offerings had been completely vetted with legal counsel, and he never believed the offerings obligated him to do anything at all for Salomon."
A lawyer for Mr. Nacchio, Charles A. Stillman, of Stillman & Friedman in Manhattan, said that the executive had brokerage accounts at many firms and that he met his Salomon broker through someone other than Mr. Grubman. "The suggestion that any allocation to Joe Nacchio related to business done by the company would be disgracefully false," he said.
Neither Mr. Crowe nor Mr. Garofalo returned calls seeking comment. Mr. McLeod could not be reached.
Another former Salomon employee said that it was not uncommon for executives of telecommunications companies to call the firm's syndicate desk, which handles securities offerings, and ask about their allocations.
Mr. Chacon said the Salomon broker designated to handle the executives' accounts was Rick Olson, known in the firm as Jack's broker. Salomon did not make Mr. Olson, a director of private wealth management, available for comment.
Mr. Chacon said that Mr. Olson had handled wealthy clients at Salomon Inc. before the firm's 1997 merger with Smith Barney. He then aligned himself with the firm's investment banking department and coordinated constantly with Mr. Grubman on allocations of initial offerings, Mr. Chacon said.
Allocations that would otherwise go to an office of 40 or 50 brokers went to Mr. Olson's operation. The telecommunications executives who did business with Mr. Olson all ran companies that paid Salomon millions of dollars in fees for merger advice or for selling their securities to investors.
An accountant by training, Mr. Chacon started in the brokerage business in March 1997 at a Smith Barney office in Los Angeles. He generated enough business to be promoted to senior vice president within three years.
Mr. Olson, his colleague, was doing so much business with top executives of companies, especially those in the telecommunications sector, that Mr. Chacon was asked to become his partner in late 1998. Not only was Mr. Chacon a top salesman, but he had worked at telecommunications start-ups in college.
"I wanted to know how to do business with billionaires," Mr. Chacon recalled. "I felt I'd get experience and be able to branch out." He was soon going on sales calls with Mr. Olson, who he said referred to many customers as "the telecom mafia."
After a few offerings, Mr. Chacon said that he saw that the allocations were skewed to the telecommunications executives, and he grew concerned that his other customers were getting none of the hot issues. He says allocations were even given to executives at a stock's initial offering price days after the shares had been trading substantially higher in the open market.
Mr. Chacon says that he began complaining to his immediate superiors: to the branch manager, the regional manager and upward. A memorandum, dated May 2000, that he wrote to Jay Mandelbaum, vice chairman of Salomon, describes improper allocation of hot issues and notes that superiors had told the broker that the allocation of Rhythm Netconnections shares to Mr. Ebbers was done "to encourage him" to give additional banking business to the firm. According to Mr. Chacon, he received no response from Mr. Mandelbaum. He was terminated less than two months later.
The spokeswoman for Salomon said that Mr. Mandelbaum did not receive the memorandum, which Mr. Chacon has presented in his wrongful-termination dispute."Just as we believe he fabricated the memo, there is no record of his ever having raised his alleged concerns to his superiors," Ms. Nazerian said. She added that Mr. Chacon was fired for violating corporate policy.
Jeffrey L. Liddle, a lawyer at Liddle & Robinson in Manhattan, which is representing Mr. Chacon, said that his client was providing a missing piece of the puzzle of what went on in the telecommunications bubble. "If the allegations he has raised result in the ability to establish facts that support them," he said, "we have a serious question here of whether there hasn't been an improper financial payoff for directing investment banking business to Salomon Smith Barney."
Mr. Chacon, who is now a broker at another major Wall Street firm, said that he was disappointed in the firm's response to his concerns. "There is nobody to turn to if you have concerns," Mr. Chacon said. "Even in a professional manner, it cannot be done."