Funds feel heat from toughest fraudbuster

PERCHED high in his unprepossessing 50th floor office in the heart of Manhattan's financial district Eliot Spitzer, the New York State District Attorney, is surrounded by the enemy in the big Wall Street firms.

This wiry, aquiline son of privilege has turned his elected office into the most feared financial regulator in the world. Before his arrival, it was more associated with representing consumers against power companies and rooting out wrongdoing in local government.

At a time when the Securities & Exchange Commission - America's top business watchdog - is under fire for the sclerotic way it dealt with Enron, Spitzer, aged just 44, is viewed as a wunderkind who is reshaping the financial landscape from Wall Street to the City of London.

Spitzer's great virtue is that he is fearless. He has refused to be intimidated by the Wall Street firms' huge financial power, or to be slowed by the due process and human rights fears that has made Britain's Financial Services Authority a timid regulator.

It is sobering to reflect that it was only in June that he first received a tipoff about corruption in the $7,000bn mutual fund industry, which handles collective investment for tens of millions of ordinary Americans.

By September he was able to bring a first prosecution against the Canary hedge fund. Now he is handling what he describes as a 'torrent' of cases.

In an exclusive interview in his cavernous office, seated on the utilitarian blue upholstered furniture made in New York State prisons, Spitzer argues that agility has been the key to his success.

'The advantage we have is we are small. This office is comparatively thin compared with the SEC. We just have 15 lawyers doing investor protection work. By virtue of our minimal size we can be quick, make rapid decisions, figure out what is worth doing and how to move on our target. We don't get mired in endless investigations which just fill space.'

When Spitzer receives a tip-off or sets his sights on a target, his method is to shower them with subpoenas and see what comes up. There is no polite letter writing and dialogue with firms - the approach the FSA has taken as it has sought to respond to the analytical and research scandal.

He mocks the idea that regulators are held up by civil rights concerns as is often claimed in the UK. 'We also have due process,' he says. 'Unlike you guys we have a written constitution. We serve subpoenas, gather information hard. Put in long hours and get results,' he asserts.

His record in taming corruption on Wall Street has so far been nothing short of miraculous. It was only last year that Spitzer got his teeth into the powerful investment banks over the practice of using their analytical arms to feed clients poor and often incorrect information during the technology boom.

As a result of his crusade against bad practice there have been sweeping changes in the way analysts do their jobs. The largest firms - Merrill Lynch, Morgan Stanley and Citigroup - were forced to pay $1bn in fines and establish separate research houses.

Now he is in the thick of a fruitful assault on mutual funds. It has already caught up with Old Mutual, which is quoted in London. Anglo-US funds group Amvescap is also under Spitzer's microscope.

Gary Pilgrim and Harold Baxter, two founders of Old Mutual's US offshoot Pilgrim Baxter, have been charged by Spitzer and the SEC in a joint complaint with civil fraud and breach of fiduciary duty. When Spitzer first got stuck into the mutual fund industry he had no idea where the probe was leading.

'Despite its claims of being pure, the mutual fund industry has always looked as though there was a certain amount of fat and waste. Whether it was illegal and corrupt we didn't realise. We just pushed at the issues of what the fees should be and thought it was worth thinking about,' he explains.

The breakthrough came with an anonymous informant. 'He came with a story of improper trading. At first it sounded so outlandish we didn't think it could be true,' Spitzer says. He pauses for effect and adds: 'Every piece of it has proven to be true.'

In Spitzer's view 'most invidious' has been the after-hours trading scandal. This allowed privileged insiders, hedge funds and the like, 'to trade after 4pm (when daily mutual fund prices are set) and get yesterday's price knowing what was going to move the market. They can then sell the following morning when the price has gone up'.

There is nothing in Spitzer's background that would likely cast him as one of America's greatest modern prosecutors. His grandparents were immigrants - from the Austro-Hungarian empire on his father's side and from pre-1948 Palestine on his mother's side.

His father grew up in a tenement in New York's predominantly Jewish Lower East Side. The Spitzers moved up the wealth scale when his father turned an engineering training into one of New York's biggest property fortunes.

This allowed him to put Eliot into the best private schools in New York - a start he is giving his own three daughters. From there it was a short hop to the Ivy League with Spitzer taking his first degree at Princeton. He moved directly to Harvard Law School - a training ground for many presidents including Bill Clinton - where he edited the Harvard Law Review and met his wife.

After working for a couple of preeminent private law firms he joined the legendary prosecutor Bob Morgenthau at the Manhattan district attorney's office.

He worked with Morgenthau in tracking down fraud at the Bank of Commerce & Credit International (BCCI). It was a case that eventually led to the Bank of England closing the British-domiciled bank.

Spitzer pays generous tribute to Morgenthau's 40-year reign, describing him 'as the person who defines what being a prosecutor is about. He is a paradigm'.

Despite his immaculate CV, Spitzer's first efforts at winning public office, running on a Democratic ticket, were disappointing. He was portrayed as the son of a wealthy family who was taking the short cut to power using his father's cash. Indeed, his father had to pay off several millions of campaign debts before Spitzer, now in his second term, was elected State Attorney.

The world is now his oyster with no job seen as beyond his reach - including becoming next Governor of New York.

As well as bringing fraudsters in the mutual fund industry to justice, Spitzer is determined to clean up the lower level abuses that affect millions of investors.

He accuses the mutual fund industry of cheating the public for years 'piling fee upon fee' and believes the directors 'are not living up to their fiduciary obligations.

'The end game for me is putting in place some kind of structure to ensure genuine market pressure exerts downward pressure on fees,' Spitzer explains.

His attempt to impose a new deal on the whole industry has not endeared him to the SEC. It is clear that he is contemptuous of the senior organisation.

'They are going through a period of self-criticism at the moment, to see what they could have done differently. There are questions at many levels - the compliance departments, regulators, governance of companies. It is fair to ask how could this have gone on for so long.'

Spitzer has no doubt as to what is at the core of the mutual fund imbroglio. 'It is fraud. No question, a violation of the Martin Act,' - the historic 1921 New York securities law Spitzer has used in bringing wrongdoers to justice.

'The entire sector appears to have tolerated practices which simply cannot be countenanced,' he insists.

No one should be in any doubt that Spitzer will deliver on his aim of forcing through the biggest changes to stock market savings for decades.