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NEW YORK — Gary Lynch isn’t reciting the settlement agreement in his sleep — not yet, anyway. Still, the general counsel of Credit Suisse First Boston LLC and former U.S. Securities and Exchange Commission enforcement chief says he is never far from the 22-page document. It outlines the bank’s new duties under the deal that CSFB and other Wall Street firms struck with regulators this spring to resolve charges over research analyst conflicts. But ensuring that every part of a sprawling securities shop follows the detailed agreement isn’t easy. Lynch says that when he’s unsure how to answer questions, he’ll turn to a peer at a rival bank for advice. What types of questions is he getting? Lynch won’t say. He’s worried about federal and state regulators, like New York Attorney General Eliot Spitzer, who are still carefully monitoring the banks’ actions. (Southern District Judge William Pauley III hasn’t signed off on the analyst settlement yet; he is expected to do so in 2004.) But one thing Lynch and his deputy, CSFB global head of compliance Stuart Breslow, will discuss is their company’s failure to police its analysts and bankers. “Did you ever see the movie ‘Boiler Room?’” asks Breslow. He’s referring to the 2000 flick about a college-dropout-turned-stockbroker who discovers the seedy side of Wall Street. “Remember the compliance guy eating a banana in the corner [of the trading floor, oblivious to the brokers who were swindling investors in front of him]?” Breslow says CSFB was like that. “Well,” he pauses, “it wasn’t that bad. But it was a very different ethic [back then].” That candor may seem surprising, coming from a Wall Street firm that’s still being battered by regulators and investors angry over the excesses of the late 1990s. But it’s part of a carefully orchestrated campaign by Lynch, Breslow and others at the subsidiary of Swiss financial services giant Credit Suisse Group to disclose past failures and to ensure that CSFB workers comply with the new rules. This corporate catharsis — figuring out what went wrong, and coming clean — is happening now all over Wall Street. The analyst settlement gets a large part of the credit for setting it in motion. In April, CSFB and nine other Wall Street banks, including Salomon Smith Barney Inc. (now Citigroup Global Markets), Goldman Sachs & Co. and Morgan Stanley & Co. Inc., agreed to pay a total of $1.4 billion , from $80 million to $400 million apiece, to get rid of regulatory actions that accused them of issuing biased research and doling out shares of initial public offerings to favorite clients in exchange for underwriting work. The charges came from nine states, the SEC, the National Association of Securities Dealers Inc. and the New York Stock Exchange. For these gigantic financial institutions, (Morgan Stanley alone reported a net income of $3.1 billion in 2002), the monetary penalties are light. But the settlement’s directives, and their impact on the companies’ compliance and legal departments, are real. The settlement requires the securities firms to disclose their potential conflicts of interest; to hire outside vendors to provide independent research; and to completely restructure their research and investment banking divisions, including two separate reporting lines, legal and compliance staffs, and budgeting processes. Even before the settlement was hammered out seven months ago, company lawyers started turning some of these policies into practice. They got a head start in the compliance area, thanks to the USA Patriot Act of 2001, which overhauled money-laundering rules, and the Sarbanes-Oxley corporate governance reform of 2002. But things have sped up since the settlement negotiations started in late 2001. Legal departments have been beefing up compliance staffs, pouring millions of dollars into new technology, and hiring and firing in-house attorneys. In fact, in-house counsel were the ones who failed to keep the banks out of trouble during the late 1990s boom, say Spitzer and others. Now, in the crush of lawsuits and the regulatory probes that followed, it’s their job to sweep up the mess and make sure it never happens again. “This isn’t a question of voluntary change,” says Donald Kempf Jr., a former Kirkland & Ellis partner who’s been Morgan Stanley’s chief legal officer since 1999. “We don’t have an option.” The analyst settlement targets practices that were widespread on Wall Street during the late 1990s. One part of the deal concerns the Chinese wall that was supposed to keep research analysts and investment bankers apart, but crumbled as both sides worked together to attract business. A second practice, “spinning,” involved handing out shares of hot IPOs to top clients, namely company executives and directors, in exchange for high commissions and the promise of future business. In a separate “voluntary initiative” announced at the same time as the stock research settlement this spring, the banks agreed to restrict these IPO giveaways. A third alleged scheme, “laddering,” involves the huge one-day spikes in initial public offerings valuations that were common during the boom. According to regulators and investors, IPO prices soared because they were artificially inflated by Wall Street firms and corporate executives who secretly agreed to buy and sell their IPO shares at certain prices, thereby spurring demand. Federal and state regulatory probes are still looking into this area. Spitzer, who led the regulatory charge on Wall Street, calls it “astonishing” that the industry leaders landed in so much hot water. And when it comes to assigning blame, he looks to the legal departments. “Where were the lawyers?” Spitzer asks. He says he hasn’t found a single instance during his investigations where an in-house lawyer or compliance officer voiced concerns about practices that, in hindsight, were blatantly deceptive. “Were [the in-house lawyers] absent because they did not know this was going on?” he wonders. “Or were they absent because they chose not to do anything?” Spitzer says he doesn’t have the answer. It’s a blistering indictment, but one that many Wall Street lawyers say befits an ambitious politician. It was common knowledge, say current and former Wall Street in-house lawyers, that conflicts between research analysts and investment bankers were a problem — just like everyone knows that derivatives, hedge funds and off-shore banking are risky investments today. Nobody complained until the bubble burst and investors suffered massive losses. Only then were “a number of practices — that had been taken for granted as industry practices — re-examined with different eyes,” says Rachel Robbins, the former general counsel of J.P. Morgan & Co. Inc., who is now general counsel of Citigroup International. “I don’t think it’s fair to say [in-house lawyers] were asleep at the switch or sidelined or not listened to.” Other current and former Wall Street lawyers say they were hampered by vague regulations, technology and senior executives who placed more value on hiring traders, who make money, than adding lawyers, who cost money. To meet the requirements of the analyst settlement and to deal with the barrage of investor lawsuits and regulatory inquiries, Wall Street legal departments have been shuffling the ranks over the past several months. Of the top 10 securities shops, half have seen turnover at the general counsel job in the past two years. Many banks have plucked top talent from regulatory agencies and law firms and put lawyers in key posts in legal or on the business side. In September, Eric Dinallo, who was Spitzer’s right-hand man and the one who masterminded the research analyst probe, started work as Morgan Stanley’s managing director of regulatory affairs, one of about a dozen new senior positions within the law department. Two years ago CSFB snared Lynch, the former SEC enforcement director who brought down junk bond king Michael Milken in the late 1990s, to serve as GC. Across the board, legal departments aren’t bigger. Most securities firms employ about the same number of attorneys they did just a few years ago. Instead, there’s been a “churn” in the types of lawyers hired and fired. At Morgan Stanley, which has about 310 lawyers today, the story isn’t in the overall attorney count but the “huge differentials” in growth, according to GC Kempf. So while there are more litigators and compliance professionals, there are fewer M&A and private equity specialists. “The net number masks significant changes within,” he says. There are a few exceptions: Merrill Lynch has cut 20 percent of its lawyers in the past two years, down to a roster of 270 worldwide. (Merrill declined to comment on law department changes.) Lehman Brothers Holdings Inc., on the other hand, is 33 percent bigger, adding 12 attorneys in three years for a total of 87. The shuffling has been most pronounced at Citigroup Inc., the concern hardest hit by the recent scandals. The attorney roster ballooned to more than 1,500 in 1998 from multiple mergers before dropping to 950 this year. And the company has made a number of high profile appointments in the past several months. Notably, the Citigroup GC job changed hands twice in two years. Co-GCs Joan Guggenheimer and Stephanie Mudick left their posts in early 2003 after the bank brought in Michael Helfer, the former chairman of Washington, D.C.’s Wilmer, Cutler & Pickering, to serve as its newest general counsel. The bank has also made other key appointments in its legal departments. Richard Ketchum, the former president of Nasdaq, joined in May as GC of the company’s global corporate and investment bank, formerly Salomon. Robbins, the former J.P. Morgan GC, became GC of Citigroup International, a division that includes 300 overseas lawyers. But Helfer’s taking the GC spot was dwarfed by the ascension of Charles Prince III, who was Citigroup general counsel before leaving the department to Guggenheimer and Mudick and moving over to operations in 2001. Prince is now gearing up to take the helm from chairman and CEO Sanford Weill. John Coffee, the Columbia Law School professor and securities law expert, says that promoting lawyers to senior business posts isn’t unusual for companies facing legal and regulatory crises. But the magnitude of change at Citigroup, he adds, is out of the ordinary. “No one has gotten into quite the same degree of trouble as Citigroup,” says Coffee. (Citigroup declined to comment.) A second major piece of the Wall Street cleanup centers on beefing up compliance programs. These are the systems and people who function as internal watchdogs, the ones who are supposed to make sure employees aren’t breaking any laws. Historically, the jobs are low-paying and filled by nonlawyers expert in the minutiae of voluminous rules. “The compliance people are low on the totem poll,” says the ex-GC of a top Wall Street bank. “The bankers and the traders on the desk roll right over them.” At CSFB, compliance was a disorganized group whose leader was low on the company’s organizational chart. When Lynch agreed in August 2001 to give up his partnership at Davis Polk & Wardwell and join CSFB, fixing compliance was high on his list of priorities. For good reason: CSFB, at the time, was reeling from a federal inquiry into its IPO commissions, which ended in a $100 million fine and eventually led to the indictment of top banker Frank Quattrone (Quattrone denies the charges; his trial is scheduled to start at the end of the month). Lynch reports directly to CEO John Mack, thereby compressing a reporting line that previously went through the chief operating officer and the chief financial officer. Lynch also oversees the company’s research, and in late 2002 he was given the title of vice chairman. In September 2001, a month before he started at CSFB, Lynch invited Stuart Breslow, then the head of compliance at Morgan Stanley and a former client of Lynch’s, to lunch at Tabla, a trendy Indian restaurant near Lynch’s office. He offered Breslow a job as global head of compliance, a newly created position that would report directly to Lynch. Breslow would also come in as a managing director, another first for compliance. At CSFB, teaming legal and compliance was only the beginning. Breslow has added three more managing directors, building a core team of four that handles compliance worldwide. The overall number of employees in the department has stayed flat at about 205, including paralegals, but turnover has approached 30 percent as Breslow has weeded out underperformers. There are more lawyers on staff, about 40, but nonlawyers are still the majority. While salaries for compliance personnel have reportedly risen 30 percent or more on Wall Street, at CSFB they’re flat or down. Breslow says CSFB used to have such a hard time recruiting compliance personnel that pay levels were already above-market before the salary wars. Breslow is also trying to craft a new mind-set where the banana-eating ethic of “Boiler Room” is verboten. Compliance officials now sit in the center of CSFB’s trading floor, not in the corner. And Breslow has pared the company’s compliance manual from 89 pages of “jumble” to 17, and is revising it further. He tossed the firm’s old orientation video for all new recruits, which he says was too heavy-handed, and replaced it with one that features Breslow and Lynch talking expansively about CSFB ethics. Breslow doesn’t consider these measures superficial. “Is [a video] a compliance initiative? I think so,” says Breslow. “It’s about creating a new culture.” Technology consumes a big chunk of time and money at CSFB and other banks. Richard Walker, the general counsel of Deutsche Bank Americas and the SEC’s chief lawyer in the late 1990s, puts the overall tab for the banks’ technology upgrades, in response to the analyst settlement and regulatory changes of the past two years, at $1 billion. Implementing these changes will require many tweaks to existing technology systems, according to David DeMuro, the head of compliance at Lehman and the president of a legal and compliance group within the Securities Industry Association, an industry trade group. For example, firms must upgrade their systems for tracking their own investments. If they own 1 percent or more of a company that their bank’s research department also follows, the securities firm must publicly disclose that information. The previous rule required a 5 percent stake. “As these percentages get smaller, you have to make sure your data is incredibly accurate,” says Morgan Stanley Executive Director Arthur Riel. He oversees information technology for Morgan Stanley’s legal department. “It’s pretty tough to miss [an ownership stake of] 5 percent. It’s easier to miss 0.5 percent.” At Morgan Stanley, Riel says spending to beef up or develop new software will exceed $115 million this year, with almost $6 million of that going to the law department. Once the “backwater” of Wall Street, Riel says upgrading technology is critical, in part because regulators no longer give banks long lead times to comply with requests. For example, he says, the bank can now turn over e-mails to regulators within 48 hours, instead of six months. “Now [regulators] say, ‘We don’t want any excuses. We want the gap closed now.’” Yet money can’t buy Wall Street fool-proof systems. While the technology available to monitor employees and customers alike is becoming increasingly sophisticated, there are limits. Nobody, for instance, has figured out how to search encrypted e-mails, explains Deutsche Bank’s Walker. But programming a virtual cop to catch phrases like “dead money,” the term one analyst reportedly used to deride in private a stock he was publicly recommending, is going to be difficult, explains a former Wall Street GC. “No system is going to catch that,” says the ex-Wall Street GC. “What that comes down to is the judgment of the individual employees you hire.” That’s the fundamental problem. Wall Street banks can pour millions into new surveillance gadgets and gizmos. They can make new orientation videos. They can unleash more watchdogs. And while the knowledge that someone nearby is watching may deter scofflaws, and better systems might detect crimes before the regulators do, “there will always be felons you can’t catch,” says CSFB’s Breslow. Spitzer takes a darker view of the situation. Part of the problem is Wall Street’s inherent avarice, he says. When the good times start to roll again, Spitzer has no doubt that the greed will return, and the lines will get crossed. “I believe there’s been a change of heart [across Wall Street] for the moment,” he says. “Will it last six months, a year or 10 years? I can’t answer that, but prosecutors don’t worry about going out of business.” Krysten Crawford is a senior reporter for Corporate Counsel magazine, a Recorder affiliate based in New York City.

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