Chapter One

When Markets Need to Be Tamed

Eliot Spitzer had had enough.

It was October 2004. For six months, the hard-charging New York State attorney general and his staff had been following a tip that the huge corporate insurance broker Marsh Inc. was taking secret payments to steer clients to particular insurance companies. And for six months the company's corporate parent, Marsh & McLennan, had been effectively stonewalling, contending that there had been no underhandedness—that Marsh's clients had known about the payments and that the money hadn't affected the recommendations of the firm's brokers. Months of combing through e-mails and company documents had shown just the opposite, and worse. Some Marsh brokers had solicited false bids and told insurance companies what fees to charge so that they could steer business to favored firms. That was price-fixing, which was not only fraudulent behavior but a crime. Several insurance executives involved had already confessed and agreed to plead guilty.

But when Spitzer and his lawyers met with Marsh & McLennan's general counsel, William Rosoff, on October 12, they didn't get the mea culpa they had expected. Instead, they got the brush-off. Rosoff insisted that his company didn't understand what all the fuss was about. It wasn't really clear what had happened. No clients had been hurt by the arrangements. This was just the way things worked. And finally he said dismissively, "You just don't understand the insurance business."

It was time to go public. Spitzer wasn't about to let an insurance broker push him around, even if it was the world's largest. As New York attorney general, Spitzer had spent much of the past six years mounting legal attacks on a variety of wrongs, which in his estimation included everything from Wall Street corruption to President George W. Bush's environmental policies. His balding pate, jutting chin, and pointing finger were ubiquitous on television news shows and in the pages of the country's top newspapers. When he ventured outside his downtown Manhattan office, he couldn't walk two blocks without being stopped by well-wishers who praised him for standing up to Big Business. Tipsters jammed his office phone lines with tales of woe and financial malfeasance. What's more, his investigations got results. Spitzer had faced down all kinds of giant firms, from the investment banks Citigroup and Merrill Lynch to the drug maker GlaxoSmithKline to the Food Emporium supermarket chain. He had exacted reforms and huge penalties: more than $1.5 billion from a dozen Wall Street investment banks for issuing biased research; more than $3.5 billion from mutual funds and brokers for improper short-term trading. And he was still only forty-five years old. All of this made him a rising star in the Democratic Party.

But in the Marsh case, Spitzer wanted to do more. He had decided to send a strong message to corporate America that his investigations were about more than money. From now on, top executives who presided over bad behavior couldn't simply claim they had had no idea what was happening, pay a fine, and expect to walk away unscathed. "We've been trying, through these cases, to make the larger point that some core ethical behavior is necessary," Spitzer reflected. "At some point you have to say, wait a minute, fellows. That's it. It's only when you hold the CEO accountable that you show people that something must change. The question is how to do that."

Dogged lawyers in Spitzer's office had already spent sleepless nights crafting a detailed and dramatic legal complaint that laid out the bid-rigging and contract-steering allegations against Marsh. But there was no evidence that the company's chief executive, Jeffrey Greenberg, had known about or condoned the scheme, which had started before his arrival at the company. Nor was it entirely clear that Greenberg had authorized Rosoff's stiff-arm defense. But even though the attorney general's investigators had never talked to the CEO directly, Spitzer was convinced the problems flowed from the executive suite. The bid-rigging case wasn't his first run-in with Marsh & McLennan. Its Putnam Investments subsidiary had been embroiled in the mutual fund trading scandal that had started the previous year. And its Mercer Consulting arm had paid a settlement as part of Spitzer's high-profile battle with New York Stock Exchange chairman Richard A. Grasso over Grasso's $140 million pay package. Marsh & McLennan "had three main businesses and no apparent controls in any of them. At some point you suspect the laxness is coming from the top. . . . It was at best a completely passive management," remembered David D. Brown IV, the assistant attorney general who spearheaded both the mutual fund and insurance probes for Spitzer. Bringing charges against Greenberg personally would be unfair, Spitzer knew. But there must be something else he could do.

On the morning of October 14, Spitzer gathered with his senior staff in his twenty-fifth-floor office in downtown Manhattan to prepare for that day's press conference about the Marsh case. Television cameras and newspaper reporters were already assembling in a room down the hall, and stock traders were hovering by their televisions, ready to dump their shares of whatever company turned out to be Spitzer's unlucky target. In Spitzer's office, his top deputies clustered beside his desk and peppered their boss with questions, pretending to be reporters. As the mock session broke up, Spitzer made an announcement. "I'm going to refuse to negotiate with this management," he said. Spitzer's lieutenants stared at him in silence.

Spitzer was proposing something unprecedented, at least in the recent annals of white-collar crime. In a free-market economy, boards of directors were supposed to have the freedom to choose company executives without government interference. By announcing that he would not negotiate with the firm's current leadership, Spitzer was imposing a Hobson's choice on Marsh & McLennan's board of directors—they could fire Jeffrey Greenberg or face possible criminal charges against the company. Recent history had shown that it was virtually impossible for a public company to withstand a criminal indictment. Just two years earlier, the accounting giant Arthur Andersen had all but vanished after being charged in federal court with obstruction of justice. And Merrill Lynch's stock had lost about 20 percent of its value in three weeks when Spitzer publicly refused to rule out corporate criminal charges. In the past, some prosecutors had asked for leadership changes as part of a settlement, but they had done it quietly, indirectly—the government might say to company lawyers with a knowing look, "You might find this case easier to settle if you had a different chief executive." No one could remember a case where a prosecutor went public with such a demand. "Are you sure you really want to do that?" asked First Deputy Attorney General Michele Hirshman, Spitzer's number two.

Hirshman and the others knew that Spitzer was already being roasted in the corporate world as a headline-hunting bully with no respect for market forces or due process of law. The Wall Street Journal editorial page, often seen as the voice of the business community's conservative wing, had made him its top enemy, editorializing against him weekly (and sometimes daily) as an ambitious meddler. The Forbes.com website was offering readers a printer-ready Halloween mask of Spitzer. Even some people who supported Spitzer's efforts to uncover fraud and change industries were perturbed by some of his tactics: the constant publicity, the rhetorical attacks on fellow regulators, and a perceived fondness for using the threat of criminal sanctions to pressure individuals and companies into cooperating with his probes. Forcing out Marsh's chief executive would only fan the flames.

To Spitzer, however, unusual times called for unusual measures. The collapse of the 1990s technology bubble had wiped out the college and retirement savings of millions of Americans. He believed that the country's business leaders had lost their moral compass. Some corporate giants, such as Enron and WorldCom, were so riddled with wrongdoing that they had collapsed when the fraud was revealed. Others, including some investment banks and mutual funds, had exploited their customers' trust in the name of higher profits. "How could we live in a society where we have so many smart people at the tops of these institutions and things have gone so terribly wrong?" Spitzer asked. "Have we forgotten our ethics?" Someone had to take action to protect the vulnerable, he believed, if only to restore the country's faith in its financial and political system. "The market does not survive without transparency, fair dealing and fair play," Spitzer explained. "We have persuaded tens of millions of Americans to invest in the market. If those new entrants to the market began to lose faith . . . they could withdraw from the market and put their money someplace else."

Spitzer believed that government officials should look back a century to another period when the country was coping with rapid economic change that created great wealth while impoverishing millions. Back in the 1890s, a small group of visionary but ruthless businessmen profited immensely from rapid industrialization and new economies of scale. Known collectively as the robber barons, titans such as John D. Rockefeller, J. Pierpont Morgan, and Edward H. Harriman built multimillion-dollar conglomerates and drove competition out of entire sectors of the economy. They dominated industry, finance, and commerce and tried to control the political process as well. But their success had a dark side. Factory workers lived and worked in appalling conditions. Poor harvests and rising indebtedness put many rural Americans at risk of losing their homes and livelihoods. Fraudsters abounded in the fledgling financial services sector, tricking innocent people out of their savings with promises that they too could make fistfuls of money.

The firebrand politician William Jennings Bryan tapped the rising anger of those who were losing out in the new industrial economy. He and his followers, the Populists, blamed Eastern banks and businesses for the high tariffs, expensive credit, and low agricultural prices that were impoverishing untold thousands of small farmers. The Populists wanted to flood the country's tight, gold-based monetary system with unlimited silver coins, a policy that would have made it easier for debtors to pay off their obligations but would also have sparked inflation. Dividing the world into "producers" against "elites," Bryan terrified the country's business and political establishment with his anticapitalist rhetoric. When the Democratic Party nominated Bryan for president in 1896, conservatives feared he would spark a bloody revolution. The nation's largest businesses ponied up millions of dollars to help elect William McKinley, dubbed by Republicans the "Advance Agent of Prosperity."

To some contemporary observers, Eliot Spitzer seemed to be a dangerous populist in the Bryan mold. In 2002, at a time when small investors were looking for someone or something—other than their own greed—to blame for their stock market losses, Spitzer supplied them with a ready target: the stock analysts who had blanketed the airwaves with rosy predictions for technology companies that later went bust. Wall Street and federal securities regulators had been talking for years about biased stock ratings and the conflict inherent in having investment banks rate the stocks of the companies they brought public. But they had taken little concrete action. In April 2002, Spitzer blew the issue wide open: he accused Merrill Lynch of fraud and released internal e-mails in which a star analyst called companies "dogs" even as he publicly rated those firms a "buy."

Spitzer's hyperactive manner, steely eyes, and burning sense of moral outrage played directly to investors' anger and charmed congressional committees and television audiences alike. He made the cover of Fortune and was named Crusader of the Year by Time. His flair for dramatic accusations and his willingness to use the media appalled executives accustomed to dealing with more discreet and less confrontational regulators. Many business leaders responded much as the old robber barons had done, by rallying around Spitzer's Republican opponents and using their influence within the political sphere to try to curb his power. U.S. Chamber of Commerce president Thomas J. Donohue took the unusual step of singling out Spitzer for criticism, calling his investigations "the most egregious and unacceptable form of intimidation that we have seen in this country in modern time."

But Spitzer explicitly rejected the populist label. Yes, some of his biggest cases touched on populist themes: he had gone after Wall Street and frightened supermarkets and restaurants into extending minimum-wage protections to some of New York's most vulnerable immigrant workers. He had also taken aim at gun manufacturers' sales practices, forced midwestern power plants to cut emissions, and challenged the Bush administration's efforts to gut the Clean Air Act. But none of that meant he wanted to destroy the market economy that had made his own family and the country rich. "The issues we've raised clearly have a populist air to them because they're designed to guarantee that there is equity and fairness regardless of who you are, the small investor, the low-wage worker," he acknowledged. "But the resolutions aren't designed to tear down the institutions. The effort was to make them work properly. A populist would have indicted the institutions."

Instead, Spitzer argued, his historical role models were Theodore Roosevelt and the Progressives, the less radical, and in many ways more successful, reform movement that grew out of the corporate excesses of the late nineteenth century. Spitzer kept a framed photo of TR on the wall of his Manhattan office, considering it a call to action rather than just another decoration. "I invoke him for the notion that capitalists understand when the market needs to be tamed," he explained. Spitzer also cited the Progressive influence in major speeches. "We are heirs to one of the most august, powerful political traditions in the world—New York's proud progressive tradition, embodied by Teddy Roosevelt, Al Smith and FDR," he said in late 2004. "Their politics of inclusion, opportunity and hope blazed the way for a capitalist system that went beyond favoritism and cronyism, a system that gave every person an opportunity to succeed. . . . During these last several years, their example inspired me. Our efforts in fighting fraud were meant to level the playing field, restore the integrity of the markets and give small investors and all others who participate in the markets the same opportunity as enjoyed by others."

Like the Populists, the Progressives sought to restore power and prosperity to the lower rungs of American society and tame what they saw as out-of-control capitalism. They agreed that ordinary people had lost their voice in government. But the Progressive solution was reform, not revolution. The Progressives believed that if politics and the financial markets could be cleansed of corruption and if power were given back to the people, the capitalist system could work well for all Americans, not just the rich. These reformers first sought to expose the country's ills through newspaper articles and civic investigations and then turned to sympathetic politicians to enact reforms, often at the state level first. Whenever the proposals proved effective and the Progressives could gather the votes, they sought legislation and regulation on the national level as well. New York was a hotbed for such crusaders, spawning not only Theodore Roosevelt, Alfred E. Smith, and later FDR, but also Charles Evans Hughes, who investigated the insurance industry, and Frances Perkins, the future labor secretary who did so much to establish worker-protection rules. Often derided at the time as traitors to their class and threats to America's prosperity, these reformist politicians and lawyers pushed through many of the laws and won many of the court cases that we now regard as cornerstones of our society. Among their accomplishments were minimum-wage laws, food and drug purity statutes, investor-protection laws, and limits on business consolidation.

Spitzer's interest in the Progressives was more than rhetorical. Many of his most famous cases relied on largely forgotten statutes and court decisions from the period: the Marsh bid-rigging case was based on violations of New York's first-in-the-nation 1893 antitrust law; his much-vaunted Wall Street investigations relied heavily on a largely forgotten 1921 antifraud statute known as the Martin Act; his efforts to crack down on illegal guns and out-of-state pollution both relied on the definition of a public nuisance that had solidified during the period. Months before the Marsh showdown, Spitzer and a former aide, Andrew Celli, Jr., wrote in The New Republic that the future of the Democratic Party depended on its ability to "promote government as a supporter of free markets, not simply a check on them" and to evoke "a vision consistent with trust-busting and other progressive market measures first enunciated early in the last century by Theodore Roosevelt." Nor was that article an isolated incident, Celli remembered. "He gets a perverse joy from pointing out to people that Teddy Roosevelt, the great trust-buster, was a Republican. He invokes TR almost to say you don't have to be a lefty Democrat to care about fairness in the market," Celli said. In political debates, Spitzer often described himself as a "pragmatic liberal" or "progressive." "What many people ascribe to the word liberal is a rejection of the market as a critical piece of what creates wealth," Spitzer said. "People understand progressivism as an effort to create opportunity within the market environment. . . . It has traction right now. Having seen a boom and bust, people feel that they've been taken. They understand that the rampant love we had for anything that had to do with the market was misplaced."

Though Theodore Roosevelt is remembered fondly today mostly for his groundbreaking efforts to protect investors, workers, consumers, and the environment, his attempts to rein in large companies and powerful businessmen—first in New York State as an assemblyman and governor and later as president—drew sharp criticism at the time. When Roosevelt made his first significant appearance on the political stage, as a New York assemblyman in 1882, he was widely ridiculed for his efforts to attack the state's entrenched culture of financial double-dealing. Colleagues dubbed him the "Cyclone Assemblyman" for his energy and lack of accomplishment and mocked him for his nasal tones—"Mister Spee-kar, Mister Spee-kar," he would call when he wanted attention on the Assembly floor.

Like Spitzer, Roosevelt first won attention for trying to protect ordinary shareholders. But his efforts to investigate whether a state court judge had taken bribes to help a financier take control of the giant Manhattan Elevated Railway company fell short. His fellow legislators, whose palms had been duly greased by the railroad, voted against impeaching the judge. Roosevelt was undaunted. When he was elected governor years later, he launched a series of reform efforts that so irritated New York business interests that they maneuvered to have him nominated in 1900 for the vice presidency as a way of getting him out of the state. National party bosses thought the move was foolish. One of them, Mark Hanna, scolded the delegates, "Everybody's gone crazy. . . . Don't any of you realize there's only one life between that madman and the presidency?" Hanna's fears were realized when an anarchist shot and killed President William McKinley in September 1901, propelling the forty-two-year-old Roosevelt into the highest office in the land.

As president, Roosevelt viewed regulation and gradual change as the best way to protect the capitalist system and stave off social upheaval. In a 1903 speech to the New York State Fair, he argued that a just society offered equal opportunity and equal protection to all people: "We must treat each man on his worth and merits as a man. We must see that each is given a square deal, because he is entitled to no more and should receive no less. . . . The welfare of each of us is dependent fundamentally upon the welfare of all of us." Unlike some of his fellow reformers, Roosevelt had nothing against bigness per se—he recognized that large-scale manufacturing could cut costs for consumers and that increased productivity could improve living standards for all. "In the long run, we all of us tend to go up or go down together," he said.

But Roosevelt was denounced as a dangerous radical when he decided in 1902 to take on the Northern Securities Company, a mammoth railroad holding company that had been formed a year earlier. The brainchild of J. P. Morgan, the firm dominated rail passenger and freight traffic between Chicago and the Pacific. It had an extraordinary market capitalization of $400 million but was considered to be overvalued by as much as 25 percent. Several states started antitrust investigations, but no one expected the federal government to act. The national regulators had sat on their hands while Morgan helped create a series of other enormous combinations—U.S. Steel, General Electric, and International Harvester—and the U.S. Supreme Court had largely neutered the federal Sherman Antitrust Act only a few years before. Roosevelt threw expectations out the window, ordering his staff to file an antitrust lawsuit against the holding company. "Government must now interfere to protect labor, to subordinate the big corporation to the public welfare, and to shackle cunning and fraud exactly as centuries before it had interfered to shackle the physical force which does wrong by violence," he explained. The stock market tanked on the news. "Wall Street is paralyzed at the thought that a President . . . would sink so low as to try to enforce the law," said the Detroit Free Press. Morgan and his peers were not only furious but frightened. How far was Roosevelt planning to go? Were all large corporations at risk? Morgan quickly reached out to Republican Party bosses and arranged a White House meeting with Roosevelt. "Are you going to attack my other interests, the steel trust and the others?" Morgan asked anxiously. Roosevelt was emphatic: "Certainly not, unless we find out that they have done something that we regard as wrong."

Five years later, Roosevelt enraged his business critics again, this time taking on the Standard Oil cartel that had been built by John D. Rockefeller. The company's president, John D. Archbold, complained that Roosevelt had treated his firm with less respect than he would have given an African colony, and said, "Darkest Abyssinia never saw anything like the course of treatment we received." The philanthropist and Rockefeller protégé Frederick T. Gates predicted in a 1907 letter that the case would prove to be Roosevelt's undoing: "This amazing and reckless robbery and plunder under the forms of law may awake the business interests in the country and thoughtful men to the perils into which we have drifted." In the end, though, Roosevelt's view prevailed, and the Supreme Court ordered the breakup of Standard Oil in 1911.

To Spitzer, Roosevelt's goals and the criticism he encountered felt extremely familiar. Both men were Harvard-educated sons of privilege who believed that government had a duty to even the balance of power between individuals and corporations and to make sure that capitalism worked as well for small investors, workers, and consumers as it did for business executives and big investors. Spitzer was the son of an immigrant Jewish family that rose from a Lower East Side tenement to fabulous wealth in a single generation. He believed in hard work and smart investments and saw his labor and financial services cases as a way of making those same opportunities available to others. As a young man, Spitzer had made a concerted effort to see every side of this country's economic equation. He spent one summer in college doing backbreaking day labor—picking vegetables, stacking insulation, and digging ditches; in law school, he interned for the New York State Attorney General's Office and for the consumer advocate Ralph Nader. As a young prosecutor he stood out in the Manhattan District Attorney's Office for his reading material over lunch—while his coworkers scanned the New York Post and Daily News for news of their organized crime targets and investigations, Spitzer read The Wall Street Journal. Later he worked for white-shoe law firms and helped manage his family's investments. Like Roosevelt before him, Spitzer knew the world of his corporate targets well, which made him a particularly effective enforcer. "He understood Wall Street. All his friends worked there and he knew where the bodies were buried," said his Harvard Law School mentor, Alan Dershowitz.

Though Spitzer played up the Roosevelt parallels, he lacked the powers and bully pulpit of the presidency. He had to find other ways to force change. His chosen methods were simple: use old laws to attack new problems; do meticulous research; and share his findings with the media to maximize public pressure. He was a master of the accusatory press conference and the selective leak. His office's legal complaints were pointed, well written, and chock full of dramatic details. When his targets and other regulators complained that he was more interested in headlines than in real change, Spitzer often turned to the words of another icon of the Progressive era to defend and explain his approach: Louis D. Brandeis. "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman," Brandeis wrote in 1913, a quotation that Spitzer repeatedly cited.

The two men shared more than a passion for using the media. Though Brandeis is best remembered as a Supreme Court justice, he got his start attacking many of the same targets that would draw Spitzer's ire a century later: Wall Street bankers, insurance firms, and companies that provided essential services such as public transportation and gas. Spitzer's critique of the financial services sector drew heavily from Brandeis's views a century earlier. Spitzer believed that the problems he uncovered in mutual funds, stock research, and insurance all stemmed from the same source: giant financial conglomerates that emphasized their bottom line and stock price at the expense of customer service. "We have seen larger and larger companies dealing with more and more atomized investors. These companies view customers as fee generators rather than individuals to whom they owe a fiduciary duty," Spitzer observed in 2004. Brandeis said much the same thing in 1905 as he argued that small customers were being overcharged for life insurance: "The extraordinary wastefulness of the present system of insurance is due in a large part to the fact that the business . . . is carried on for the benefit of others than the policy-holders. The needs and financial inexperience of the wage-earners are exploited for the benefit of stockholders." By 1907, Brandeis had convinced the Massachusetts legislature to increase competition by allowing savings banks to issue small life insurance policies. Other states soon did the same. Brandeis followed up in 1913 with an attack on the securities industry that was perhaps the most effective critique of Wall Street ever issued. First published as a series in Harper's Weekly, "Other People's Money and How the Bankers Use It" was a clarion call for antitrust reform. In it, Brandeis displayed a talent for boiling complex abuses into catchy slogans, such as "The Endless Chain: Interlocking Directorates" and "A Curse of Bigness." Although Brandeis's economic theory was simplistic, his articles stirred public support for banking reform and the creation of the Federal Reserve and led President Woodrow Wilson to tap Brandeis to help establish the Federal Trade Commission in 1914.

As a lawyer, Spitzer knew that muckraking wasn't Brandeis's only tool. Brandeis had also used the courts effectively, pioneering a new kind of legal argument that revolutionized American litigation. Until Brandeis came along, the courts had largely been hostile to Progressive causes such as worker-protection statutes, ruling that they violated an elusive constitutional right to "freedom of contract." But then Brandeis took up the case of an Oregon law that set maximum hours for female laundry workers. Legal precedents were against him—in 1905 the Supreme Court had struck down a New York state law limiting bakers to ten hours of work a day, ruling, five to four, that it was "mere meddlesome interference with the rights of individuals." So Brandeis tried something new. He turned in a brief full of sociological, statistical, economic, and even medical data showing that overworked women were less healthy and less effective mothers. The filing revolutionized the practice of law—similar arguments are now known as "Brandeis briefs"—and achieved exactly what Brandeis had hoped. Concerned about "the strength and vigor of the race," the Supreme Court voted unanimously in 1908 to uphold the Oregon statute.

Brandeis's methods—both in court and in the media—won him widespread praise. Newspapers dubbed him "the People's Lawyer," a moniker Spitzer later adopted to explain the public advocacy side of his role as the New York State attorney general. But Brandeis was also deeply controversial. When Wilson nominated him to the Supreme Court in 1916, Brandeis found himself under unprecedented attack by the business and social interests whose dominance he threatened. Two U.S. Steel lawyers were seen in Boston just five days after the nomination was announced, trying to round up "a little knot of men" to speak out against the nominee. Eventually fifty-five prominent Bostonians, including Harvard president Abbott Lawrence Lowell, sent a petition to the Senate, saying, "We do not believe that Mr. Brandeis has the temperament and capacity which should be required in a judge of the Supreme Court. . . . He has not the confidence of the people." The opposition fell short, but it served as a reminder how divisive Brandeis and his methods had been.

Spitzer also turned to Brandeis for another kind of inspiration. As a Supreme Court justice, Brandeis became a vocal advocate of allowing states broad leeway to try new ways of protecting consumers, investors, and workers. Most famously, he wrote in 1932, "It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country." Brandeis was often a lone voice, issuing dissents as his conservative colleagues struck down Progressive state statutes in the name of unfettered national commerce. But the justice's eloquent defense of federalism gained new relevance some seventy years later, when modern-day progressives such as Eliot Spitzer began seeking new ways to protect investors, workers, and the environment.

The country underwent not one but two sea changes in between Brandeis and Spitzer. First, the advocates of government regulation scored an extraordinary victory on a national scale. Rampant financial fraud and the devastating 1929 stock market crash made reformers believe that the states alone could not protect American society from the excesses of big business. As part of the New Deal, Congress enacted new national worker-protection rules, strengthened the Food and Drug Administration, and created the Securities and Exchange Commission, laying down rules that still hold sway over Wall Street. By 1938, even an initially skeptical Supreme Court had signed on by adopting the view that Congress's power over interstate commerce gave it the right to regulate business in areas that had once been the exclusive province of the states. The lasting impact of the New Deal reformers on our own times cannot be overstated: until 1934, for example, public companies did not have to submit to annual audits or make annual reports to either the government or their own shareholders. Until 1938, the FDA could not punish companies for making false therapeutic claims. With the addition of civil rights legislation and the creation of the Environmental Protection Agency in the 1960s and 1970s, the transformation was complete. The national government had become the main protector of consumers and investors, and the doctrine of states' rights was associated primarily with southern racists who had used it to try to fend off desegregation.

But by the time Spitzer ran for office in the 1990s, the balance of responsibilities between the states and the federal government was shifting back again. In the 1970s, federal officials, acknowledging that they couldn't do everything, gave grants to the states to beef up consumer and investor protection. Ten years later, President Ronald Reagan spearheaded a conservative revolution and launched what may be the greatest pullback of federal power in this country's history. Espousing a doctrine they called "federalism," economic libertarians and business interests began trying systematically to dismantle the federal government, arguing that power and programs rightfully belonged with the states. Reagan and his supporters cut back—or tried to cut back—federal regulation in areas ranging from consumer protection to civil rights to environmental safety. Cooperation with industry, rather than criminal enforcement, became the watchword of the day.

But the progressive impulse to use government to rein in business didn't wither away and die. Rather, it reemerged on the state level, particularly—but not exclusively—in areas where Democrats still held sway. In 1984, six northeastern states sued to force Reagan's Environmental Protection Agency to order pollution cuts, and twenty-one states teamed up to challenge a proposed settlement in a federal class-action securities fraud case in 1985. "They didn't really expect the states to step in, but we did," said Lloyd Constantine, who spearheaded antitrust issues for then New York State attorney general Robert Abrams's office. "Sometimes three states, sometimes five, sometimes all fifty sued at the same time on the same day." Led by Abrams, all fifty states worked together to combat price-fixing in the sneaker industry, and a coalition of forty-five states opened up the field for consumer satellite television by forcing seven of the largest cable operators to make more television programming available to consumer satellite broadcasters.

There was a brief pause in the 1990s, when Bill Clinton, a Democrat, became president and his administration began bringing more federal environmental and antitrust actions. Most liberal state attorneys general backed off or coordinated their actions with the federal government. But the 1994 Republican capture of Congress limited what Clinton and his appointees felt they could do in areas such as environmental protection and securities regulation. Arthur Levitt, the chairman of the Securities and Exchange Commission, wrote that fear of Congress had forced him to tone down his reform proposals on several occasions. He cited a 1994 decision to drop a proposal to change the way companies accounted for stock options. He called that decision "the single biggest mistake during my years of service." The federal pullback also picked up steam in the courts as judges appointed by Reagan and George H. W. Bush regularly reined in federal enforcers. In 1995, the Supreme Court ruled for the first time since the 1930s that there were limits to Congress's power to regulate interstate commerce—the part of the Constitution that authorizes most federal protection of investors, consumers, and the environment. In the next nine years, the high court would strike down nearly three dozen federal laws, circumscribing the federal government's ability to act in areas as diverse as stopping domestic violence and protecting rights of the disabled.

George W. Bush's election in 2000 completed the conservative sweep of federal power. Many of his appointees to key federal agencies had spent years working for or representing the industries they were going to regulate—Food and Drug Administration general counsel Daniel Troy and SEC chairman Harvey Pitt were prime early examples. The few obvious exceptions, such as Christine Todd Whitman, the moderate New Jersey governor named to head the Environmental Protection Agency, did not survive Bush's first term. Many of the regulatory agencies were also understaffed as the new century dawned. Thousands of skilled senior employees were nearing retirement, and competition from the private sector in the booming 1990s economy had made it all but impossible to replace them. By the time Spitzer turned his attention to the financial services industry, three-quarters of the SEC's front-line staff—the inspectors responsible for making sure brokers and mutual funds played by the rules—had been on the job fewer than three years. The combination of chronic overwork and Bush's political appointees left many federal agencies not only sympathetic to complaints about the high cost of complying with federal regulations but also too demoralized to fight hard when abuses were uncovered.

The Democrats concluded that they had to find a new strategy. Without control of the White House or Congress, efforts to control corporate interests would have to come from the states, using laws already on the books. State cooperation during the 1980s served as a blueprint, but in the 1990s and 2000s, key Democratic state officials were emboldened to take on far more. The epic 1998 tobacco settlement was one of the first and most dramatic successes. Forty-six states won billions of dollars for Medicaid and smoking cessation programs at a time when the federal courts were thwarting a national effort by the FDA to impose new regulations on nicotine products. "I doubt we could have done it if we were just one state," said Maryland attorney general Joseph Curran, Jr. "Collectively we are a much stronger adversary." The tobacco suits also introduced some state officials to a new resource: plaintiffs' law firms that added expertise and manpower and were willing to work on a contingency fee basis. At the same time, consolidation in the retail and health care sectors changed the nature of the consumer-protection work that has long been the bread and butter of many state attorneys general. "Twenty years ago, I did a bunch of cases against local drugstores," said James E. Tierney, a former Maine attorney general. "Today, what RiteAid does in Lisbon Falls, Maine, RiteAid does in San Francisco. . . . So it makes sense to pick up the phone and call California."

Eliot Spitzer took the practice to a completely different level. Progressive by instinct, prosecutorial by training, he had no compunction about diving headlong into areas that had previously been forbidden territory. If the federal government wasn't going to do it, he reasoned, New York State would. Just as Theodore Roosevelt and Louis Brandeis had ridden middle-class outrage at corrupt financiers and monopolists to national fame in the early twentieth century, Spitzer would become the avenging angel for millions of small investors who were angry that their dreams of easy wealth had vanished along with the 1990s bubble. "The timing was perfect, especially the issues involving the securities market," said Lloyd Constantine, who became a close friend of Spitzer's. "Once the stock market declined, people wanted to understand that everyone had played fairly, and they hadn't. There was a historical moment where the Bush administration wasn't going to do anything. . . . Eliot seizes the moment. He's fearless. He doesn't care that nobody's done this before. He doesn't care about offending the powers that be."

That willingness to overturn established norms also left Spitzer open to charges that he was an interfering hothead, convinced of his own righteousness and more interested in headlines than in forging compromises that would bring substantive change. Rather than hailing Spitzer as a hero, much of corporate America saw him as simply the most recent and most dangerous example of a pernicious problem they had been battling for years. Politically ambitious prosecutors had long viewed the financial services industry as an attractive target. As early as 1928, New York attorney general Albert Ottinger tried to ride his reputation as the hammer of Wall Street to the governor's mansion. He shut down one of the fledgling stock exchanges, investigated "investment trusts"—as mutual funds were known back then—and calculated that his prosecutions had saved investors $500 million a year. More recently, in 1993, Rudolph W. Giuliani parlayed a flamboyant career as a tough-as-nails federal prosecutor of white-collar crime in the 1980s into a successful run for mayor of New York. His high-profile cases had led the evening news—Wall Street executives were dragged out of their offices in handcuffs; the giant brokerage firm Drexel Burnham Lambert Group was forced to plead guilty to criminal charges and pay $650 million to settle a stock trading investigation; and Michael Milken, the "junk bond king," went to jail. But many of Giuliani's successes had a dark side—Drexel collapsed under the weight of the criminal case, costing thousands of jobs; Giuliani's office couldn't prove its case against several of the traders who had been so prominently arrested; and several of Giuliani's other high-profile corporate cases were overturned on appeal. "There should be a law passed that precludes any prosecutor from running for office for three or five years [after he leaves office]," said Robert G. Morvillo, a former prosecutor and a prominent white-collar defense attorney who tangled several times with Spitzer. "You really don't want your chief law enforcement officer running the office based on what's going to be politically popular. . . . It takes away the appearance of fairness."

Copyright © 2006 by Brooke A. Masters