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To the small investors left holding their battered stocks, perhaps nothing rankles more than the corporate insiders who made a killing on the very same stocks because they knew to cash out before the bust. So it may come as a surprise to learn that some corporate “insiders” also lost their shirts believing the same hype about their company’s stock that was being touted to the general public. That is what happened to several dozen high-ranking WorldCom Corp. executives, all of whom have sued Citigroup subsidiary Salomon Smith Barney, claiming the firm cost them millions of dollars by mishandling their WorldCom stock option accounts. The complaints, filed with the National Association of Securities Dealers, range from around $200,000 to $14 million. Among the complainants is Gary Brandt, former head of WorldCom’s investor relations. The charges being levied are virtually identical: In each instance, customers allege that the Salomon Smith Barney brokers in charge of WorldCom’s stock option plan mishandled their portfolios by encouraging them to take on margin risk, neglecting to “hedge” and failing to warn them of the danger of their “exercise and hold” strategy. “[Philip] Spartis, [Amy] Elias and [a third broker, David] Hobby misrepresented, deceived, and/or concealed from claimants material facts [with the intention of] lulling claimants into a false sense of security that Respondent Smith Barney would properly manage claimants’ accounts and recommend and solicit only suitable investment strategies for claimants,” reads one complaint, filed by Lawrence L. Klayman of Klayman & Toskes in Boca Raton, Fla. Salomon Smith Barney has been settling the cases, against the wishes of Spartis and Elias, who do not want to have the complaints on their U-4 forms, public records on brokers kept by the NASD. Earlier this year, the company fired them, officially for “job abandonment,” although the two said they left the firm after they had already been terminated. (Hobby, who still works at Salomon, did not return a phone call seeking comment on the matter.) Now, Spartis and Elias, who are represented by Jeffrey Liddle, of Liddle & Robinson in Manhattan, have turned around to sue their former employer and several of its executives, including its once high-flying telecommunications analyst, Jack Grubman. They are seeking $100 million each, half as compensation for lost income and injury to their career, and half as punitive damages. In a complaint filed with the New York Stock Exchange on Sept. 19, the two assert that the firm used them as “pawns in a financial chess game,” sacrificed to serve the greater interests of its investment banking group and Grubman. Salomon Smith Barney spokeswoman Susan Thomson said that the firm considers the claim meritless. In a separate statement, Grubman’s lawyer, Lee S. Richards of Richards Spears Kibbe & Orbe, has defended his client’s conduct, saying his analysis was “diligently researched, was based upon what he knew about the companies at the time, and contained his honestly held views about those companies.” According to their complaint, while at Salomon Smith Barney, Spartis and Elias built a $1 billion book of business, much of it from an exclusive arrangement in which they handled all of WorldCom’s options accounts. Initially, as WorldCom stock soared, the two enjoyed enormous success. Spartis, for example, made $3 million in commissions on $651 million in total assets in 1999 and $2.8 million in commissions on $509 million in total assets in 2000. But in late 2000, the party ended. WorldCom’s stock, which peaked in July 1999 at around $65 a share, steadily plummeted, to the point where it no longer trades on the NASD market, having been delisted after the firm filed for bankruptcy in July in the wake of a massive accounting fraud. (On Oct. 7, the second WorldCom executive pleaded guilty to being part of a multibillion-dollar scheme to hide costs on the company’s balance sheet to boost the stock price.) As it turned out, many WorldCom employees had used an “exercise and hold” strategy, in which they exercised their options to buy WorldCom stock — and even borrowing from the firm to buy more — and then held onto it, rather than sell some or all to diversify their holdings. When WorldCom’s share price went down, they found themselves with big margin debt and a hefty bill from the IRS. The claim of Robert J. Grim exemplifies what happened. In March 2000, Grim, a 17-year veteran of WorldCom, exercised nearly 50,000 stock options at the going rate of $42.56 a share, giving him a total market value of over $2 million. An exercise and hold strategy was used, including a loan from Salomon Smith Barney of nearly $800,000 to cover the cost of the options and taxes. By November 2000, when Grim closed his account, the portfolio had lost nearly $1.7 million, or more than 99 percent of the original value of the options. On top of that, he owed the taxes on nearly $1.3 million in ordinary income, or more than $500,000. He is claiming damages of $1.75 million, including the value of his house, which he was forced to sell to satisfy his debt to the IRS. Klayman, who is representing Grim and is a former stockbroker himself, contends that a financial strategy called a “zero cost” collar would have preserved Grim’s nest egg by creating a range of value that the portfolio would have maintained regardless of the direction of the underlying stock price. Because of a widespread belief that WorldCom stock would continue to climb, the cost of this strategy was cheap, Klayman said. “With no cost, you could have protected 100 percent of the downside with 50 percent of the upside.” Spartis and Elias claim they were always careful to advise their clients of investment options, and say they have tape recordings of conversations surreptitiously made by their former employer that prove it. But, they say, some clients were just too enamored of Grubman’s relentless bullishness on WorldCom stock to listen. Indeed, not until April of this year, when details of the accounting fraud first came to light and WorldCom stock was trading around $7 a share, did Grubman downgrade his “buy” rating to “neutral.” When the complaints first started rolling in, the brokers say they were ready to defend themselves. Yet they claim that Salomon Smith Barney, with whom they shared legal counsel, insisted on settling, in an effort to conceal the firm’s scheme to dominate investment banking in the telecom industry, in which Grubman was a key player. Last year, when Spartis and Elias first made their case as a cross-claim against Salomon Smith Barney and Grubman in the lawsuits brought against them, many in the industry considered it a stretch. Klayman, who has not named the brokers directly as defendants, described the cross-claims as a litigation tactic. “Mr. Liddle is trying to muddy up the waters,” he said. “That’s why I don’t sue brokers.” Since then, however, Merrill Lynch has agreed to a $100 million settlement with New York Attorney General Eliot Spitzer for alleged conflicts of interest involving its high-tech analyst, Henry Blodget, and several of the top Wall Street firms have implicitly acknowledged the problem, announcing their intentions to separate banking and research. As for Grubman, complaints have continued to pile up: At last count, his NASD records revealed 45 customer complaints, as well as a regulatory action and investigation pending against him. And events of last week have apparently brought new credibility to Spartis’ and Elias’ allegations. On Sept. 30, Spitzer sued five top telecom executives, claiming they steered business to Salomon Smith Barney in exchange for bullish stock ratings and lucrative shares of initial public offerings. E-mails released by Spitzer in support of his complaint show that a number of retail brokers at the firm show that Spartis and Elias were not the only ones who were taken for a ride. Brokers describe Grubman as an “investment bank whore” and an “overpriced cheerleader,” and complain about the quandary that he and their firm put them in. “[T]o represent himself as an analyst is an egregious act by the management of this firm,” reads one typical comment. “Clearly many of his … table-pounding Buys were directly related to investment banking $ for him and his firm. … Shame on him, shame on the banking division, shame on the senior management of this firm.” “Jack Grubman is not an analyst — he is an investment banker,” reads another. “He sold us a bill of goods on [WorldCom] and [AT&T], and now we’re bleeding red in our clients’ accounts.” It is still early to know whether Spartis and Elias will succeed, but there is little doubt that Spitzer’s lawsuit, which came two weeks after they filed their complaint, can only help their cause. For his part, Klayman said the recent revelations boost his clients’ cases as well. “These brokers were basically shoe salesmen selling shoes,” he said. “It’s up to the firm to make sure its salesmen do the right thing.”

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