Thursday, March 18, 2004 | 9:32 a.m.
BLOOMBERG NEWS
NEW YORK -- The Securities and Exchange Commission is probing whether Citigroup Inc., J.P. Morgan Chase & Co., Bank of America Corp. and Deutsche Bank AG were aware that WorldCom Inc. was riskier than they told investors before a $10 billion bond sale, two people familiar with the matter said.
The regulator is investigating the sale after bondholders said in a lawsuit that Citigroup analyst Jack Grubman and other bankers were aware of the risks and didn't inform the public, said the people, who declined to be identified. The bonds, which the banks helped to sell in May 2001, 14 months before WorldCom went bankrupt, now trade at 35 cents on the dollar.
"Any time the SEC is investigating, you can be pretty sure they've got smoke at least, if not actual fire," said Larry Soderquist, director of the Corporate and Securities Law Institute at Vanderbilt University. "This absolutely raises the stakes for any banks that sold these bonds."
The bondholders, led by New York State Comptroller Alan Hevesi, who represents $118 billion of state pension funds, made their claims in a brief dated March 8 in U.S. District Court in the Southern District Court of New York. The brief, earlier reported by the New York Times and Wall Street Journal, sought to avoid a postponement of proceedings in a long-running suit.
The 24-page brief, accompanied by 363 pages of bank documents, says that internal memos show the banks "had much more access to what was happening within WorldCom than they presently acknowledge."
WorldCom, based in Ashburn, Va., filed for bankruptcy in July 2002 after discovering $3.85 billion in accounting errors. The biggest accounting scandal in U.S. history led to the world's largest corporate collapse and the indictment of WorldCom Chief Executive Officer Bernard Ebbers on fraud charges.
The banks said in legal papers in response to the suit that they acted properly and were unaware of fraud.
Citigroup spokeswoman Christina Pretto, J.P. Morgan spokesman Adam Castellani, Deutsche Bank spokesman Ted Meyer in New York and Bank of America spokeswoman Shirley Norton, in Charlotte, N.C., declined to comment. SEC spokesman John Heine in Washington also declined to comment.
"The SEC will be interested in determining who knew or believed what, and when did they know or believe it," said Joseph Grundfest, a former SEC commissioner who is now a law professor at Stanford University.
In the legal papers, bondholders cited reports by Grubman, 50, then a Citigroup telecommunications analyst. He left Citigroup in August 2002 and agreed in April to pay $15 million and be barred from the securities industry as part of a settlement with Wall Street banks that ended a probe into biased research.
Between 1996 and 2002, Ebbers awarded Citigroup work that generated more than $100 million in investment-banking fees because the firm allocated shares in initial public offerings to him that yielded more than $12 million in profits, according to a report from a court-appointed examiner. Citigroup, which the report said also loaned Ebbers $53 million, has defended its treatment of Ebbers, saying that he was one of the company's best clients.
In a Feb. 8, 2001, report that was circulated to Citigroup clients, Grubman wrote that WorldCom would take in more cash from sales than it paid out for expenses by 2002, a measure known as free cash flow. He recommended that clients buy the stock, then trading at $20.75.
One month later, in a memo intended only for internal use at the bank, Grubman forecast the opposite. In 2002, the memo reads, payouts for expenses would exceed sales receipts by $612 million, compared with $1.95 billion in 2001. By 2003, that figure would be negative $778 million, and a year later, in 2004, it would be minus $556 million.
The analyst maintained his "buy" rating on WorldCom stock until April 22, 2002, when he changed it to "neutral." By then, the stock had tumbled 81 percent to $3.98.
The bondholders said all four banks were aware that WorldCom's finances were risky prior to the bond sale.
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