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It is not every day that someone decides to take on all of Wall Street, so when New York state Attorney General Eliot Spitzer announced he was investigating the research practices of Merrill Lynch & Co. and other securities firms, many people wondered how far he could go. The answer, experts say, is pretty much as far as he wants, thanks in large part to New York’s Martin Act, considered the toughest securities law in the country. “As long as the attorney general suspects inappropriate conduct, he is perfectly within the power granted to him by the state Legislature,” said Edward Fleischman, a former commissioner of the Securities and Exchange Commission and now senior counsel at the New York office of Linklaters & Alliance. “There isn’t anyone who could dislodge him.” Spitzer is going after the Wall Street practice of issuing bullish stock reports on companies in an effort to get their investment banking business. Documents he released last month revealed Merrill Lynch analysts privately disparaging companies they were publicly promoting, describing stocks as “junk” and “crap.” One analyst worried that “john and mary smith are losing their retirement because we don’t want todd [the chief executive of a Merrill Lynch investment banking client] to be mad at us.” With the Martin Act, Spitzer is well armed to conduct his probe. The statute grants the attorney general “the broadest and most easily triggered investigative and prosecutorial powers of any securities regulator, state or federal,” according to David J. Kaufmann, an expert on the Martin Act and senior partner at New York’s Kaufmann, Feiner, Yamin, Gildin & Robbins. Prosecutors using the statute do not even have to prove scienter, or that perpetrators willfully or knowingly did something illegal, as required under federal law. Neither do they have to show that any stock was traded. All they need to show is that the defendant committed an intentional act constituting fraud. “It is a remarkably potent statute,” said Kaufmann, a former assistant attorney general in the bureau of investor protection and securities, “far more powerful than any other of its kind.” NO COMPLAINT NEEDED Among the many weapons at Spitzer’s disposal is his right to ask the court to take action against a company without even filing a complaint. Merrill Lynch learned this the hard way last month when it found itself facing a court order forcing it to make immediate reforms to its analyst reports. The order, by New York State Supreme Court Justice Martin Schoenfeld, directed the firm to disclose whether it had or hoped to get investment banking business from the companies covered in its research reports. Merrill Lynch protested the one-sided nature of the proceeding. “We are outraged that we were not given the opportunity to contest these allegations in court,” it said in a statement. The company’s outrage notwithstanding, Spitzer was squarely within his rights under the act. Section 354 of the General Business Law — which is where the Martin Act appears — expressly authorizes the court to order “such preliminary injunction or stay as may appear to such justice to be proper and expedient” upon a request by the attorney general. The injunction certainly seems to have had the effect sought by Spitzer, who said he requested it after settlement talks with Merrill Lynch broke down. Within days, the company, which is represented by Edward J. Yodowitz of Skadden, Arps, Slate, Meagher & Flom, agreed to an interim settlement requiring it to put up a Web site providing disclosure in its stock reports along the lines of the court order, in exchange for Spitzer’s agreeing to lift the injunction. Merrill Lynch chief executive David Komansky also publicly apologized to investors who took the advice of the firm’s analysts, which had been another of Spitzer’s demands. It was a remarkable show of remorse for an executive of a major corporation. The parties are negotiating to reach a full settlement of the investigation. They have set a deadline of May 16. THE SEC SIGNS ON Spitzer’s announcement jolted other Wall Street players out of a seeming slumber. Late last month, the Securities and Exchange Commission, whose own ongoing investigation had yet to uncover anything close to the evident misconduct found by Spitzer, joined his probe, as did a number of state securities regulators. The attorney general’s disclosures put the agency generally considered Wall Street’s “top cop” in an awkward position. “Every regulatory agency wants to be first,” said Alice McInerney, a partner at Kirby McInerney & Squire who served as chief of the attorney general’s investor protection bureau in the early 1990s. “It’s a real feather in [Spitzer's] cap.” Although the SEC itself has not publicly taken issue with Spitzer’s efforts, at least one of its allies has suggested that he should yield to his federal counterpart. In a letter last week, Rep. Richard Baker, R-La., urged the attorney general to cede authority to the SEC, saying he had “grave concerns” that Spitzer’s efforts could lead to the state courts’ setting new rules for stock analysts. “Because of the need for uniformity in our national securities markets, it is essential that the SEC now lead the concluding phase of this inquiry,” Baker wrote. But Spitzer, who has expanded his inquiry to include practically every major brokerage house on Wall Street, has made it clear that he has no intention of stepping aside. In a statement, he said that before he disclosed his probe last month, “it was abundantly clear that no serious fundamental reforms were occurring in the industry to address conflicts of interest in the securities markets.” “Respectfully, the hearings conducted by the Capital Markets subcommittee failed to elicit any of the evidence necessary to bring about such reforms,” he said. “Moreover, no other regulatory body stepped forward to prevent abuse from occurring.” Kaufmann, the former assistant attorney general, said Baker’s letter makes “an old and very tired argument.” “The New York attorney general has always made a habit of stamping out fraud,” he said. “It’s nothing new for the attorney general to beat his colleagues to the punch.” He said that as the home of the world’s premier capital markets, “New York state has a unique interest in assuring that its markets are squeaky clean.” Still, questions as to Spitzer’s motivations linger. “The amount of publicity here in an election year is something that I find unsettling,” said Stanley S. Arkin, senior partner at Arkin Kaplan & Cohen and co-author of a treatise on business crime. “This thing should not be a political football.” Arkin is a columnist for the New York Law Journal. A MODEL FOR OTHER LAWS Enacted in 1921, the Martin Act preceded by more than a dozen years the principal federal securities anti-fraud law, the Securities and Exchange Act of 1934, and served as a model for it and many other state laws that followed. But unlike most other securities laws, which center on registration of brokers and securities, the Martin Act is aimed primarily at enforcement. And unlike others, it does not provide for a private right of action. Its most formidable weapon is criminal penalties, said Kaufmann, who also is a Law Journal columnist. A felony conviction of intent to defraud more than 10 people can result in four years in prison. Misdemeanor offenses can draw up to a year in prison. Spitzer has warned Merrill Lynch that he could file criminal charges against the company if they failed to reach a settlement. Most of the cases brought under the act have been against so-called boiler rooms, brokerage firms such as Stratton Oakmont and A.S. Baron, that used high-pressure cold calling to sell penny stocks they owned. The statute has also been used to prosecute insider trading and pyramid schemes. Since taking office in 1999, Spitzer has dramatically stepped up enforcement activity against Martin Act violators “to heights not seen for close to 15 years,” according to Kaufmann. Until now, he has focused on more traditional cases such as last year’s prosecution of associates of the Gambino organized crime family who engaged in a classic ‘pump and dump’ scheme, pushing worthless stocks to inflate their value, then selling their shares at enormous profits, leaving their victims holding the bag. Ironically, at one point Spitzer was himself accused of violating the Martin Act. During the 1998 race for attorney general, Spitzer’s opponent, then-incumbent Attorney General Dennis Vacco, charged that Spitzer, whose campaign was primarily self-financed through loans secured with Manhattan properties he owned, failed to file disclosure forms as required under a section of the act governing cooperatives and condominiums. Spitzer acknowledged his oversight and promised to correct the problem. Two weeks later, he squeaked by Vacco to victory and has been invoking the muscle of the Martin Act ever since.

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