Inside the $750 Billion Telecom Heist

Broadbandits, Part Three

August 27, 2003
By Om Malik, Broadbandits, Chapter Nine

The biggest bubble in the history of the modern business world was not the dot-com bubble, but the telecom bubble. What seemed like an endless demand for bigger and faster information networks created a buildup of excessive proportions and a glut of capacity, the result being 600,000 jobs eventually evaporating into thin air. All this from an industry that at one point had a value of $2 trillion. The robber barons of the information age - The Broadbandits - were shortsighted and greedy, and their financial management left the telecom industry in a shambles. Visionary entrepreneurs lost their reputations and average joes lost their savings. Some essentially good ideas bit the dust. It was a case of the right thing at the right time with all the wrong people. This is a story of a handful of men, a few dozen companies, insane optimism, and a culture that worshipped at the altar of greed. - Broadbandits, prologue

The House (of Cards) That Jack Built

Merrill Lynch's dot-com huckster Henry Blodgett and Morgan Stanley's Mary "Queen of the Net" Meeker may have gotten all the headlines, but it was the behind-the-scenes operator, Jack Grubman, a Salomon Smith Barney telecom analyst, who was the real power broker, the consigliore, as his colleagues called him.

Grubman personified the winner-take-all culture of the nineties. He was in bed with not one but several competing broadbandits. It was as if Grubman was starring in his own version of The Bachelor, only he picked all of the bachelorettes, not just one. On the one hand, he was a quasipersonal adviser to WorldCom's Bernie Ebbers, while on the other hand, he helped recruit Qwest's CEO Joe Nacchio.

This modern-day snake oil salesman was adept at playing both sides of the fence and had top telecom executives as well as investment giants like Fidelity and Janus eating out of his hands, with both sides acting upon his advice. All along, though, he was beholden to the investment banking division of his bank, Salomon Smith Barney. Instead of calling these polarities a conflict of interest, he called it a "synergy." According to BusinessWeek, since 1996 Salomon helped 81 telecom companies raise $190 billion in debt and equity, earning fees of more than $1.2 billion - more than any other firm on Wall Street - and today both Salomon and Grubman are under investigation for Grubman's ill-fated recommendations.

While some may say that it is unfair to single out Jack Grubman, his role in the broadband bubble cannot be understated. It is difficult to accept that this savvy, intelligent, and once-ethical man, who cohabited with the murky world of broadbandits, didn't know about the shenanigans inside the companies he was hyping. His actions (and sometimes inaction) ensured that the broadbandits stuffed their own coffers and then conveniently cashed out, in what will go down in business annals as the great $750 billion broadband heist.

Arrogant, confrontational

Grubman focused his energies on top executives like WorldCom CEO Bernie Ebbers, convincing them to borrow billions with the help of Salomon to grow their broadband networks. This, even though no one, least of all Grubman, was sure where the demand for this capacity would come from. For nearly a decade, whatever Grubman said was deemed the gospel.

The Jack Grubman story begins in Oxford Circle, a neighborhood in northeast Philadelphia. In October 1953, Jack Benjamin Grubman was born to Isadore "Izzy" Grubman, a former boxer turned city engineer, and Mildred Grubman, a dressmaker.

After graduating from high school, Jack attended Boston University and received a bachelor's degree in mathematics in 1975. Later, he attended Columbia University, where he received a master's degree in probability theory. This love for numbers helped him snag a job with AT&T as an analyst. A competitive streak and a desire to rise quickly pushed him to work 14 hours a day and then boast about it later. "He was extremely bright, analytical, and hard to supervise," Sam Ginn, a former AT&T executive and later chief executive of the cell phone service provider Air Touch Communications, told the Wall Street Journal.

Grubman was arrogant and often confrontational. He caused waves at AT&T a few months after he arrived by figuring out that the math behind the computer model used by AT&T to predict changing phone call prices and their impact on consumer demand was wrong. AT&T stopped using the model, but Jack was on the blacklist. His bare knuckles, take-no-prisoners approach wasn't making him any friends.

Tired of the political machinations at AT&T, Grubman quit Ma Bell in 1985 and joined Paine Webber, a New York brokerage firm, as a telecom analyst. He got off to a rough start at Paine Webber when he flunked his NASD exam, a requirement for all investment professionals. He succeeded on his second try, though. It was around this time that the lies began. He told his employers that he had gone to Massachusetts Institute of Technology and that he grew up in gritty South Philly. "I probably felt insecure," he told BusinessWeek later.

But nobody seemed to notice these half-truths on his résumé, dazzled as they were by Grubman's expertise in analyzing the new telecom landscape. In 1984, AT&T had been broken up by federal trustbusters into eight companies: Ma Bell and the seven Baby Bells. There was a dearth of professionals who understood the telecom business as well as Jack did.

And he was hard working - he would spend long hours and even weekends at work. His wife, LuAnn, whom he met while the couple worked for AT&T, must have spent a lot of time waiting for him in their apartment on fashionable 12th Street in Manhattan. But all that hard work was paying off: Six years into his tenure at Paine Webber, in 1991, Grubman made $1 million in salary and bonuses.

Grubman's gutsy calls and knowledge of the Bell system also helped him make double-digit profits for his clients. Having befriended Bernie Ebbers, then the chief executive of LDDS, Grubman got a closer look at the independent long-distance business; by 1993, he had helped turn Bernie's company into a growth stock. The word on the street was that Grubman was also advising Ebbers on what companies to acquire. Jack's reputation was spreading and he became a sought-after source for reporters on developments in the telecom industry.

Cementing his reputation

In late 1993, Grubman caught the attention of Eduardo Mestre, head of Salomon Brothers' telecom banking group. The Cuban-born banker had heard good things about Jack, and the two had set up a meeting at the Yale Club near Grand Central Station in New York City. But Grubman apparently got lost on the way to the meeting, and upon arriving, he reportedly yelled at his future boss for providing the wrong address.

Mestre's star was ascendant in Salomon Brothers, and he needed Jack. Paine Webber's business was advising retail investors and some institutional clients, but Salomon Brothers was a traders' firm. Its equity research arm was more geared towards large clients. And that suited Jack just fine. Since most Wall Street firms dole out bonuses either around or after Christmas, Grubman waited before announcing his departure. On March 17, 1994, Grubman joined Salomon Brothers, where the high testosterone culture and aggressive style meshed well with Grubman's own temperament. Mestre and Grubman later became the rainmakers for what became a telecom banking powerhouse.

Grubman's reputation was made in 1995, when he cut his rating on AT&T from a "buy" to a "hold" and reduced his earnings estimate on the company for 1995 and 1996. A "hold" rating is a subtle way of telling investors, "Don't buy this stock." His big call came right ahead of the Telecommunications Act of 1996, and he correctly figured that AT&T would be one of the companies that could come out a loser when these regulations went into effect. Grubman figured that the act would increase competition for AT&T, which would have little time to hang on to its long-distance lead. It was a prescient call. When Grubman downgraded AT&T on April 24, 1995, the stock fell $1.25, to $49 a share.

This call shut out Salomon from the forthcoming IPO for the AT&T spin-off, Lucent Technologies - an offering that generated $103 million in investment banking fees for many on Wall Street.

But Jack had cemented his reputation. Money managers loved him. AT&T stock was treading water, and shares of some of the new names Grubman was pushing - MFS Communications, MCI, and LDDS - kept going higher and higher. In the process he lined his pockets as well. Since Grubman had no qualms about skirting the line between research and investment banking, his Ebbers connection resulted in Salomon advising LDDS, which later became WorldCom, on more than 65 acquisitions from 1994 on and helped the firm raise around $24 billion in debt, which resulted in fees in excess of $140 million for the New Yorkbased investment bank.

The Telecom Act of 1996 brought the dawn of a new era in telecommunications and on Wall Street. Grubman knew a deregulated telecommunications industry would result in new start-ups that would need advice and money. He and Mestre were ready for all the newcomers. In 1996, Grubman's rise to absolute domination of the broadband world began.

'Swashbuckling deal broker'

AT&T executives were quitting in droves to start their own phone companies, and they were all calling Jack. Grubman also carefully used the media to bolster his image. He was everywhere, easy to reach, had a wry sense of humor, and often had a quip that made for good copy. His close connections with Ebbers made him the guy on the inside, and reporters lapped up his every word. The New York Times called him a "swashbuckler, who boasts about his close ties to the chief executives of the big telephone companies and whose research reports sometimes read more like polemics than dispassionate studies."

Grubman's rise to the top was helped by the numerous acquisitions WorldCom was making - acquisitions that Grubman was encouraging WorldCom to make. And of course, Salomon and Grubman stood to benefit from the deals through investment banking fees. In August 1996, when WorldCom made a play for MFS Communications, Grubman jumped to pump up Bernie's ego. "He's (Bernie Ebbers) organically smart. He's very shrewd. He does not believe in management by committee.

"He trusts his instincts and then has the guts to act on them. Anyone in this industry who dismisses Bernie Ebbers will find him eating their lunch," Jack Grubman told USA Today. (When WorldCom eventually bought Jim Crowe's MFS Communications for $14 billion in 1996, Salomon took home a cool $7.5 million in investment banking fees.)

By the end of 1996, it was quite clear that when it came to telecom, all roads led to Grubman. Even high-profile and successful businessmen - some worth billions - were taking his advice. Phil Anschutz, the reclusive billionaire backer of Qwest Communications, was one of them. During the course of a conversation, Anschutz mentioned he was looking for a chief executive to run Qwest, which was then relatively small. "I bet I can get you Joe Nacchio," Jack told Anschutz. And he did. In early 1997, Nacchio quit his job as the head of AT&T's $26 billion-a-year consumer business and went to work for Qwest in Denver.

"Jack has helped me make a lot of money," gushed Jacqueline Cormier of RCM Management, a money management firm based in San Francisco. Other money managers were equally complimentary in describing Grubman and would ring him for advice on many of the new companies that were going public. For Salomon, Grubman was proving to be a growth stock: In 1996, he helped bring in about $60 million in investment banking revenue. In turn, Grubman went home with $3.5 million that year, making him one of the best-paid analysts on Wall Street.

Even the mostly skeptical Wall Street Journal took notice. In a March 1997 article, the paper described him as a "swashbuckling deal broker who can sometimes make or break a telecom merger or stock offering."

The newspaper also noted that Grubman had no qualms forgoing his independence as a research analyst and tailoring his opinions in order to win investment banking business from corporations, adding, "Grubman is emblematic of a new breed of Wall Street analyst." He was hardly concerned about crossing the ethical line that keeps an analyst separate from the investment banking arm of his firm.

Bullish to the end

When Qwest went public in March 1997, Salomon was one of the underwriters - after all, Jack had introduced Nacchio to Anschutz.

Grubman and Salomon also helped Metromedia Fiber, Teligent, and Nextlink with their IPOs. Not surprisingly, all of these companies were given a buy rating from the get-go. This would become a dangerous pattern for Grubman and Salomon. The red flag should have been raised when Grubman told The Wall Street Journal, "It goes without saying that if you do a company's IPO, you are going to have a buy (on the stock), because frankly if you don't you shouldn't be doing the deal." In other words, Grubman was perfectly content to be bullish on Salomon's customers in research reports that were, theoretically, supposed to be unbiased.

And he would stay bullish to the very end.

But few paid any attention to this, for America was in the grip of a bull market like never before. Investors were looking at the world through rose-colored glasses, where stocks only went up, where markets defied gravity, and where Jack Grubman was as close to a deity as a mere mortal could get.

Grubman's thesis - build it (the network) and they (customers) will come - was just the kind of message a newly deregulated industry wanted to hear. "He walked around like he was a god. And it was perceived in the industry that he was a god," Elliot Dorbian, a former Salomon Brothers broker, told Money magazine.

In 1997, Grubman's connections helped Salomon become a powerful force in all things telecom - the investment bank helped 12 companies raise $2.2 billion from the markets in equity and layer it all with $7.4 billion in debt. For all this Salomon earned $120 million, and Grubman's cut came out to about $7 million.

Later in 1997, when Salomon was acquired by Travelers' Group and merged with Smith Barney's retail brokerage channel, Grubman's star rose even higher. He could literally move the markets. By 1998, it wasn't just the upstarts making a beeline for Grubman's office. Even old industry stalwarts like Grubman's former employer AT&T were calling him to get a feel for how investors would react to certain corporate moves and developments.

In February 1998, when the Baby Bell SBC Communications wanted to buy rival Ameritech, SBC's senior executives invited Grubman to a private meeting to seek his advice. SBC executives asked him what they should do in order to grow and stay alive in the newly deregulated environment.

Grubman said buy and grow or get acquired - standard advice he gave to all telecom companies. "Look at how fast WorldCom has grown" was the subtle message. Why not do the same? Of course, more mergers and acquisitions meant more investment banking and advisory fees for Grubman and Salomon. In May 1998, SBC followed up with a $72 billion purchase of Ameritech. Salomon was one of the advisers and got over $33 million for its efforts.

"There are others who may model better. There are others who may pick stocks better. Grubman knows more about what's going on in the industry than anybody," Rob Gensler, portfolio manager of T. Rowe Price Media & Telecom funds, told BusinessWeek later. Grubman's research reports or rating changes were major news for Wall Street. His opinions would be picked up by media outlets such as CNBC, which would feed them to the masses. Investors, both retail and institutional, would rush to buy the stocks based on his opinions - or sell them. The belief was that no one could see the telecom market better than Grubman.

Such was Jack's influence that the minute he said a stock was a great buy, the stock would soar heavenward. For instance, in late 1997, when Grubman issued a buy recommendation on Metromedia Fiber Network, an intracity broadband infrastructure provider, the stock grew almost 500 percent over the next 12 months. Similarly, a thumbs-up from Grubman sent Qwest and Global Crossing soaring in 1998.

Welcome to the -Club, Jack

It was the summer of 1998, and Gary Winnick desperately needed a friend. Winnick, the chairman of the telecom upstart Global Crossing, needed someone on Wall Street who understood telecom, was well connected, and was powerful enough to raise billions from the market on an as-needed basis. Enter Grubman - the man who became a cheerleader for one and all. The two men became close friends, chatting on the phone on an almost daily basis. When it came time to go public, Grubman and his Salomon Smith Barney cronies hit the road peddling what would become Global Double-Crossing.

After a successful offering that raised $399 million, Grubman issued his investment thesis on the company: "Global Crossing is building a truly unique and valuable asset." In February 1999, when Winnick was looking for a new chief executive, Grubman brought him Robert Annunziata, who had sold his Staten Island-based upstart Teleport to AT&T for $11.3 billion. In March 1999, when Global Crossing tried to buy Frontier Communications, Salomon and Grubman were on hand.

Grubman was such a nice guy that he even made a presentation to Global Crossing's board of directors, convincing them that the $11.2 billion bid for Frontier was a good one. (Global Crossing ultimately bought Frontier for around $8 billion.)

And when Winnick's crew decided that they wanted to go after U S West, the Denver-based Baby Bell, Grubman and company were at their beck and call. Later, when the deal fell apart, U S West had to buy 9.5 percent of Global's shares as a penalty, and Jack advised Gary to sell $350 million worth of his stock. Winnick wanted to sell more, but Jack advised him against it, as it would make large investors nervous about the prospects of the company. No wonder Winnick later described Grubman as the "Bruce Springsteen of Telecom." In 1998 and 1999, Winnick and Grubman were in close contact, but that relationship came to an end in 2000, when Robert Annunziata left Global Crossing to work for PF.Net, a competitor, and Leo Hindery joined as Global Crossing's CEO. Grubman didn't like Hindery, and apparently the feeling was mutual.

Through much of 1999, Grubman had the Midas touch. Salomon Smith Barney raked in about $24 million in investment banking fees, and the money managers who listened to Grubman were looking awfully smart, especially when they went on CNBC, the official cable network of the 1990s bull market.

While membership in Club Jack was expensive - millions in investment banking fees - the returns were equally high for some senior executives. To reward executives for their business, Salomon gave shares of some of their hot telecom initial public offerings to their favorite executives.

In turn, these executives could flip the shares on the first day of trading, thus netting millions for minimal work. This practice of spinning was quite widespread on Wall Street. Credit Suisse First Boston and Goldman Sachs were two other investment powerhouses that have been accused of the stock version of "commercial bribery."

Joker or king

Between 1996 and August 2000, Bernie "Grubman's buddy" Ebbers received 21 hot IPO allocations, including those of Williams Communications, Juno Online, and Rhythms NetConnections. His net proceeds were about $11.5 million. From 1997 to 2001, Qwest used Salomon on 18 different deals and paid the bank about $38 million. Qwest backer Phil Anschutz received 57 IPO allocations over that period and profited to the tune of $4.8 million. His lieutenant, "Jumping" Joe Nacchio, got stock in 42 IPOs and sold them for a profit of over $1 million.

No wonder everyone wanted to be part of Jack's inner circle. In fact, some at WorldCom were angry that Bernie was getting all the gravy and complained bitterly that they were not getting enough IPO shares. Scott Sullivan, WorldCom's CFO, was one of those who protested most aggressively for not getting enough.

These conflicts of interest on the part of both Grubman and the chief executives were an offshoot of the greed culture that permeated Wall Street and corporate America at the time. In the 1990s, the IPO market was like heroin for the new era of greed. Jack was the dealer, and the corporate titans the addicts. But Jack was merely a symbol of the crumbling ethical value system. Morals were sacrificed in an attempt to make easy money. The losers were small investors, who hadn't a hope in this rigged game.

By the fall of 2000, things were slowly getting out of Grubman's control. According to Salomon's internal documents, Grubman brought in about $255 million in investment banking revenues in 1998, and the number increased to $359 million in 1999. But in 2000 it dipped to $331 million, reflecting the downturn in the stock market that year.

These are still staggering numbers by all accounts, but the telecom nuclear winter was on the horizon. The endless chain of telecom bankruptcies was beginning, and the stocks Grubman had been touting were being pounded on Wall Street. In November 2000, Global Crossing was down to $16 a share, while Qwest slid to $37.75 a share (on November 30, 2000) from an all-time high of $64 a share on March 2, 2000.

It's hard to digest that Grubman, who took pride in his Rolodex and contacts with executives at most broadband companies, didn't know the market reality. He had a buy rating on most of his stocks.

Grubman would say "Buy," Salomon Smith Barney's retail brokers would push those stocks to millions of clients, and the stocks - be they WorldCom or Global Crossing - would go up. This would make the chief executives very happy, and for the mutual funds and hedge funds, Grubman remained the messiah of moola. The little guys who were buying on Grubman's advice would feel happy and count their paper profits. But when things started to go wrong, Grubman realized that he couldn't get off the treadmill of greed, and this was costing a lot of Salomon Smith Barney's retail clients a lot of money. These retail investors were angry, and they directed their venom at Grubman.

From 1994 to 1999, he might have been king, but in the new millennium he had become a puppet of the investment bankers, a joker in the pack. In the early days it was Jack who was bringing deals to Salomon and dictating terms, but as the markets tanked and Jack lost some of his influence on the investors, the bankers pushed him to compromise even more. Documents show that he was increasingly becoming a puppet in the hands of Salomon's investment banking group. And nowhere was it more obvious than in 2001, when Grubman lost all his credibility.

As the New Year began, the debris from the burst broadband bubble was catching Grubman in the face. His bosses were upset because revenues from telecom-related investment banking activities were down to $166 million, half of what Grubman had managed to generate in 2000.

Grubman was still working hard, but bankruptcies were starting as stocks tanked. On top of that, Grubman was losing any influence he had over the large institutional investors. Stocks were plummeting faster than an asteroid headed towards Earth.

Twin disasters hit

Having hit a peak of $61.81 in February 2000, Global Crossing was slowly sliding downwards, but that didn't worry Grubman. "These are historic opportunities to buy world-class assets such as Global Crossing that are evolving into world-class operating businesses at compelling value," Grubman wrote in a report dated June 18, 2001. The stock was trading at $7.68 a share, down 88 percent from its peak. It would sink to $1.90 a share by October 1, 2001.

"The bottom line is we believe that Global Crossing is not a potential bankruptcy candidate in the near term," Grubman wrote that day. Four months later, Global Crossing filed for bankruptcy. Then came the ultimate shocker: On February 8, 2002, WorldCom cut its revenue and earnings projections for 2002 and said it would take a charge of $15 billion to $20 billion to write down the value of some acquired operations.

Earnings in the fourth quarter were off 64 percent. As goes WorldCom, so goes Grubman. The bad news from both Global and WorldCom was like a left-right punch to Grubman's face. He was on the mat, bleeding, but he still had some fight left in him. As the number of bankruptcies increased in the spring of 2002 the media spotlight on Grubman was glaringly harsh. A defiant Grubman defended himself in a Money magazine story: "If you took the emerging telecom names in total from their peaks in March 2000 to today, there was a total of $230 billion or so of market cap loss. Do you know during that time Cisco lost almost $450 billion of market cap by itself?" Of course, if Grubman hadn't hyped those telecom stocks, it wouldn't have created a broadband equipment bubble, and companies like Cisco wouldn't have seen their stocks run up to irrational levels.

On April 30, 2002, Bernie Ebbers was fired by his own board of directors.

Investors, who had by now stopped paying heed to Grubman, were bailing from WorldCom, the company that had essentially made Grubman. WorldCom's debt was going to be downgraded to junk status, and it was only a matter of time before WorldCom knocked on the door of Chapter 11, which it did in June 2002. Grubman did his job and downgraded the stock, as expected, a few days before the bankruptcy.

The erstwhile long-distance discount reseller had the dubious distinction of being the biggest bankruptcy in the history of America, even bigger than Enron. But more than that, the company would admit that it committed an accounting fraud, which at last count misstated revenues by about $9 billion.

WorldCom's downfall was a blow from which even Grubman couldn't recover. For almost 15 years, he had carefully cultivated and nurtured his relationship with Bernie Ebbers. WorldCom was the kind of client that investment banks dream of - acquisition-hungry and always looking to raise more money from the capital markets. Between 1997 and 2001, Salomon Smith Barney got about $107 million in investment banking fees from WorldCom. If this meant steering some hot IPO shares worth millions to Ebbers, then so be it. If Grubman had to share his revenue models with Sullivan or prep the company about the questions he would ask on a conference call, those were small compromises.

The ensuing hullabaloo around WorldCom was too much for Grubman. He was hauled up in front of the House Committee on Financial Affairs that was investigating the WorldCom scandal. He was grilled mercilessly.

Signs of stress were showing on his face as he faced angry politicians on July 8, 2002. "WorldCom is a company that I believed in wholeheartedly for a long time. It fit my long-held, honestly held investment thesis that the newer, more nimbler companies would create value," he said.

During the hearings, not once did he come out and say that WorldCom had conned him. He defended his employer and his friend Bernie to the very end. But he was clearly becoming a liability. Salomon Smith Barney had to cut him loose.

On August 18, 2002, like Elvis, Grubman left the building. He left with $32 million in cash and stock compensation and a promise from his bosses that they would pay his legal fees. He was being sued by investors who had lost money; the New York State Attorney General Eliot Spitzer and the National Association of Securities Dealers were investigating him; and more legal troubles were sure to follow. In his resignation letter, Grubman wrote, "The relentless series of negative statements about my work, all of which I believe unfairly single me out, has begun to undermine my efforts to analyze telecommunications companies."

He did have a point about other analysts who were all desperate to be mini-Grubmans. He also had a point about the investment bankers at Salomon who pushed Grubman and funded companies they knew had no chance. And it is hard to digest that the Citigroup head honcho Sandy Weill didn't have a clue about what was going on. After all, you don't loan the CEO of one of your clients $499 million without checking with the boss.

What about the mutual fund managers and others who bought the stock? They didn't have to listen to Grubman. They all were as much a part of telecom companies' rise and fall and were equally guilty of succumbing to greed.

"Some people may not like this because you have to look beyond the sell side analysts and you have to go through the entire supply chain of who buys and sells stock. I believe that over the past certainly half a decade that the entire market has become much more short-term oriented than long-term oriented," said Grubman. "It is the mutual funds and pension funds and money managers out there who increasingly by their clients are getting graded every quarter. Pressure to perform quarter in and quarter out doesn't stop and start with Wall Street. It goes all the way through the supply chain of who manages money and each client at each turn of the corner puts increasing pressure to perform on a quarterly basis. So it is a big issue."

Adapted with permission of the publisher John Wiley & Sons Inc., from Broadbandits: Inside the $750 Billion Telecom Heist. Copyright 2003 by Om Malik. This book is available at all bookstores, online bookstores and from the Wiley Web site at www.wiley.com or call 1-800-CALL-WILEY.

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