Eliot Spitzer

How New York’s attorney general became the most powerful man on Wall Street.

Eliot Spitzer, who is temperamentally unable to stay out of the headlines for more than 72 hours, is back in them again. Last week, the New York state attorney general accused commercial insurance companies of bid-rigging. In response, the stocks of the biggest players implicated, Marsh & McLennan and AIG, have tanked, losing a combined $38 billion in market capitalization. More alarming for the insurers, Spitzer signaled this was just the beginning of an industry-wide investigation. For when he finds a few bad eggs, Eliot Spitzer cleans out the entire coop and changes the way it is run, as Wall Street’s investment banks and mutual funds have learned to their dismay.

In the past two years, in a state filled with big egos—Gov. George Pataki and New York City Mayor Michael Bloomberg on the right, Sens. Hillary Clinton and Charles Schumer on the left—Spitzer has emerged as the most consequential political figure. He may be America’s most powerful politician outside Washington. He has transformed a sleepy office into the nation’s dominant regulator and re-engineer of the financial services industry—all in the name of protecting consumers.

Spitzer isn’t a scalp-taker, as Rudy Giuliani was when he was a prosecutor. Spitzer doesn’t like taking cases to trial. Instead, he has devised a more powerful tactic: He exploits the threat of stock declines and business losses to force industries to change.

How has he been able to do it? A feckless Securities and Exchange Commission has responded haphazardly to five years of scandal, leaving a vacuum for Spitzer to fill. He also works with the fervor of the seriously ambitious politician. Spitzer is just as relentless as Giuliani was when he was a prosecutor. (Should Sen. Schumer decide to run for governor, the 2006 Democratic primary could see a scintillating death match between two nasal Harvard Law graduates with receding hairlines.)

But Spitzer also possesses two crucial, overlooked advantages. Thanks to Progressive-era legislation, he has more powerful prosecutorial tools than any official in the country. And thanks to his family wealth, Spitzer approaches Wall Street not merely as an antagonist but as a sophisticated customer. Unlike practically every government lawyer who tangles with Wall Streeters, Spitzer understands them and their work, because he has known them his whole life. If he’s waging class warfare, it’s against his own class.

Spitzer has the classic New York rich kid résumé. The scion of a family that made a fortune in real estate, Spitzer attended Horace Mann High School, graduated from Princeton (Class of 1981) and Harvard Law School, where he was an editor of the Harvard Law Review. After clerking for a judge, he worked as an assistant district attorney in Manhattan from 1986 to 1992. Spitzer was a young man in a hurry—literally. In the 1990s, I frequently saw him jogging the loop in Central Park, the same circuit favored by investment bankers and stock analysts. In 1994, the 35-year-old first-time candidate ran a disappointing fourth (out of four) in a largely self-financed Democratic primary for attorney general. After biding his time at a white-shoe law firm, he ran again in 1998, again relying on family money. This time he nipped incumbent Republican Dennis Vacco. In 2002, he cruised to re-election by a more than 2-1 margin over token Republican opposition. He quickly turned a backward office into a hotspot for legal talent.

Until the stock market crashed, challenging big Wall Street firms was generally a nonstarter for New York attorneys general. Merrill Lynch, Morgan Stanley, and their brethren were not only large employers, they were large political donors. But once the bull market ended and the conflicts of interests emerged, all bets were off.

Spitzer was ideally situated to take on Wall Street. He had jurisdiction, since most financial firms and many of their customers were based in New York. He had the motive, since plenty of New Yorkers had been hurt in the crash. And, most important, he had the means: in particular, New York state’s Martin Act. The 1921 legislation, as Nicholas Thompson noted in this Legal Affairs piece, gives extraordinary powers and discretion to an attorney general fighting financial fraud. He can “subpoena any document he wants from anyone doing business in the state,” make investigations secret or public at his whim, and “choose between filing civil or criminal charges whenever he wants.” Extraordinarily, Thompson notes, “people called in for questioning during Martin Act investigations do not have a right to counsel or a right against self-incrimination. Combined, the act’s powers exceed those given any regulator in any other state.”

Spitzer had another advantage over his counterparts in other states and at the SEC. Federal agencies are confined to very narrow jurisdictions. The SEC looks into securities issues, the Federal Trade Commission deals with antitrust matters, and the Justice Department prosecutes fraud. But Spitzer functions as a one-stop prosecutorial and regulatory shop. He can indict an executive on securities fraud, seek civil disgorgements, and levy antitrust charges at a company—all in the same investigation and at his own discretion. Punishment, remedy, and structural change.

Spitzer also understood what he was up against. When top executives are indicted, they generally fight. But Spitzer viewed his targets not as criminals who needed to be jailed but as professionals (and firms) with assets, careers, and reputations to protect. So he didn’t simply indict. He issued press releases. First, in 2002, he pursued Merrill Lynch’s investment banking and research practices. When Spitzer published a press release detailing “a shocking betrayal of trust by one of Wall Street’s most trusted names,” Merrill Lynch lost $5 billion in market value in a few days and quickly settled. Getting the rest of the investment banking world to go along was then a relatively easy matter. In the landmark December 2002 research settlement, 10 major firms agreed to cough up $1.4 billion, to sever the links between research and investment banking, to ban the spinning of IPOs, and to commit to purchase independent research for five years. “This agreement will permanently change the way Wall Street operates,” Spitzer said. Punishment, remedy, and structural change.

Next Spitzer went after the mutual fund industry. He began with Edward Stern, a hedge fund manager who had set up late-trading and rapid-trading deals with several mutual funds. (Spitzer knew something about how hedge funds worked—he was an investor in James Cramer’s hedge fund.) Again, Spitzer got his target to cooperate, and he was ultimately able to iron out a series of big-ticket settlements with major mutual fund companies like Janus, MFS, and Strong Capital. In virtually every instance, prominent executives lost their jobs and the firm agreed to pay fines and reduce fees for investors going forward. Punishment, remedy, and structural change.

As the CEOs and directors of Marsh & McLennan and AIG are now learning, the threat of Spitzer isn’t jail time; it’s a tanking stock. The very announcement of a Spitzer investigation is an excuse to sell and an invitation for shareholder lawsuits and proxy campaigns. Which is why we should expect to see these insurance firms replace some senior executives, refund millions in fees, and pledge to mend their ways. Punishment, remedy, and structural change.

Spitzer has the best of both worlds. He’s a public servant who lives more like a Wall Streeter. He resides in Manhattan with his wife and three children but “also maintain[s] a home in Columbia County.” Spitzer inherited most of his wealth, but he’s making the guys he sees at Princeton reunions and parent-teacher conference nights work a lot harder for theirs.