Much of the public reaction to Empire State governor Eliot Spitzer’s alleged involvement with Emperors Club prostitutes has focused on rich irony. After all, in his previous role as New York’s attorney general, Spitzer had prosecuted upscale escort services, in addition to his higher-profile campaigns against Wall Street fraud and corruption. Spitzer cultivated an image of himself as a White Knight — a champion against vices both fiscal and physical. But a close look at his public record reveals a man who has become used to the abuse of power — comfortable with the idea of being a law unto himself. Those whom Eliot Spitzer has sought to ruin publicly to serve his political ends — and there are more than a few — doubtless see no irony, no incongruity, in his having allegedly broken the laws he swore to uphold.
As New York attorney general, Elliot Spitzer charted a course unprecedented in American history — stretching the bounds of ancient laws and the state-federal prosecutorial divide in his crusade against Wall Street. Spitzer flaunted the federal regulatory scheme vested in the Securities and Exchange Commission to prosecute investment firms and corporate executives after the dot-com stock-market bubble burst. Spitzer’s weapon of choice was New York’s 1921 Martin Act, which (under 1955 amendments) gave broad power to prosecute “any device, scheme, or artifice to defraud or for obtaining money or property by means of any false pretense, representation, or promise.”
The Martin Act was one of several state “Blue Sky” laws intended to prevent hucksters from selling fraudulent securities of phantom enterprises that consisted of nothing more than “the blue sky above.” The laws were passed before the federal government started regulating securities markets during the Great Depression, but often remained on the books. New York’s Martin Act largely lay dormant; before Spitzer, it was used mainly to go after Ponzi schemes and “boiler room” stock fraud operations.
Spitzer saw a ladder for his ambition in the open-ended law, which is particularly susceptible to prosecutorial abuse. Unlike the federal securities laws, the Martin Act has no requirement of an intent to defraud, no requirement that anyone relied on the alleged fraud, no requirement that anyone was injured by the fraud, and indeed no requirement that any securities transaction took place. The law affords the attorney general broad subpoena power and the capacity to apply enormous pressure on potential witnesses to “cooperate” while waiving their Fifth Amendment rights against self-incrimination.
As employed by Eliot Spitzer, the Martin Act gave vast powers to tax and to regulate national financial and commercial activity. Spitzer targeted investment banks for alleged conflicts between the companies’ stock analysts and banking divisions. Analysts’ sunny forecasts for now-busted tech companies, Spitzer’s office discovered, were influenced by the client and investment-banking relationships. Because the Martin Act afforded Spitzer the ability to take his investigation public, he went after Merrill Lynch and star analyst Henry Blodget on CNBC; the company’s stock price promptly tanked. Eventually, Spitzer took down over $1.4 billion in settlements from New York’s ten biggest investment firms.
Flush with this success, Spitzer went after the Big Apple’s big businesses with increasing relish. He targeted mutual funds for offering trading advantages to bigger clients. He went after insurance companies for paying brokers “contingent commissions” for bringing in a broader book of business. He charged record companies for paying radio stations to play more of their tunes. He sent threatening letters to mortgage lenders attacking them for setting rates too high for minority subprime lenders — a due diligence that, in hindsight, we may wish had been maintained.
In virtually every case, the public interest in Spitzer’s prosecution was tenuous at best. The godfather of law and economics, Nobel laureate Ronald Coase, famously defended pay-to-play practices in the music industry in his paper “Payola in Radio and Television Broadcasting,” showing that the practice enhanced competition. Similar rationales would support contingent commissions in the insurance industry and what amounted to bulk discounts in the mutual fund business. The sketchy nature of sell-side stock analysis was widely known on Wall Street; while some individuals may have had legitimate claims if they bet the farm on the basis of analyst recommendations, it’s a much bigger stretch to claim that market pricing was manipulated at the behest of hedge fund professionals.
That’s not to say that there were no wrongs that Spitzer investigated. If insurance companies submitted “phantom bids” intended to price-fix the market, as Spitzer alleged, such actions warrant prosecution. Also, in many cases, practices could have been better disclosed.
In some cases, however, Spitzer went after practices that were fully disclosed to sophisticated parties — such as the corporate clients who bought insurance contracts. And we’ll never really know if the alleged phantom-bidding scheme and other Spitzer crusades really warranted prosecution. The punishment that Spitzer could and did unilaterally inflict on corporate share prices through the media meant that the attorney general was able to extract settlements to his liking without ever going to trial. Sometimes, he changed longstanding industry practices by fiat, such as contingent commissions in insurance, and pay-to-play practices in radio. Disturbingly, in many instances, Spitzer’s settlements bore no relation to the wrong alleged: in the mutual fund case involving market timing, the fund companies had to agree to lower their fees, effectively giving the New York attorney general the power to set national price controls.
It’s worth noting that Spitzer wielded the Martin Act with often shocking ruthlessness, typically targeting his political enemies. He reportedly threatened to indict insurance giant AIG unless the board removed chairman Maurice “Hank” Greenberg, who had spent his life building the company. In going after Dick Grasso for his New York Stock Exchange compensation plan that Spitzer deemed immoral, a Spitzer associate allegedly threatened to out the business leader’s extramarital affair — a delicious irony in light of the governor’s present predicament.
And Spitzer saw in the Martin Act the ability to generate carrots, as well as sticks. Spitzer strong-armed several of the corporations he had publicly targeted to seat his political allies on their boards. Included in many of the settlements he demanded were “slush funds” paid out to community groups and other potential supporters of the aspiring governor.
Spizer’s self-serving prosecutorial crusade has had real and deleterious economic effects — it’s far from a private matter. As now-Governor Spitzer has publicly acknowledged, U.S. stock markets have been losing their competitive advantage to overseas markets. Spitzer’s prosecutions, while not the sole cause, share significant blame for foreign companies’ reluctance to list in America. Media accounts of Eliot Spitzer’s current predicament will undoubtedly contrast the situation’s seamy facts with his reputation as a white knight crusader. The real irony is, Spitzer was never a white knight.
– Jim Copland is the director of the Center for Legal Policy at the Manhattan Institute.