Spitzenfreude

This week's outburst of Spitzenfreude—joy at the governor's suffering—has been deep and prolonged on Wall Street. Spitzer became governor in large part because he exposed the sins, indiscretions, and occasional criminality of the financial services industry. As attorney general he gained fame by becoming the scourge of Wall Street, forcing banks, mutual fund companies and insurers to admit to wrongdoing and change the way they do business.

So many Wall Streeters view Spitzer's downfall as a case of richly deserved bad karma for ruining the lives of countless innocents, and imply that his sins vindicate those he investigated and prosecuted. "He destroyed reputations of people who had good reputations and deserved reputations," said Kenneth Langone, a former director of the New York Stock Exchange and ally of Richard Grasso, the former NYSE CEO whom Spitzer brought down over compensation issues. "We all have our own private hells," Langone continued. "I hope his private hell is hotter than anybody else's." Charles Gasparino of CNBC has been all over the airwaves hyping his book about the Grasso-Spitzer episode (two guesses who his main source was) and writing in the New York Post of the "poetic justice" of Spitzer succumbing to his own shortcomings: "his zealotry, his wild temperament and his penchant for sleazy tactics." In the Wall Street Journal columnist John Fund skewered Spitzer for, among other things, bludgeoning Wall Street firms into expensive settlements "all without any trials of judicial determination that they had done anything wrong."

Please.

Just as Spitzer didn't need an indictment and a trial by a jury of his peers to know that his conduct was unacceptable and incompatible with holding a position of public trust, the subjects of most of Spitzer's investigations didn't need a grand jury and lengthy court proceedings to know that they had been caught in flagrante delicto. As a prosecutor Spitzer had an incredible tool in the Martin Act, a state law that gives officials extraordinary powers when pursuing financial fraud. Spitzer's willingness to wield this blunt instrument doubtless pushed many firms to settle cases even if they believed they had a good chance of beating Spitzer in court.

But that doesn't mean his targets were innocents. Spitzer's real tools were shame, embarrassment and concern for reputation. Many of those who ran afoul of Spitzer failed what I call the Parents' Night Test. Even if certain practices are commonly accepted in your industry or circle of friends (like going to strip joints), and are plausibly legal, or clearly illegal but rarely prosecuted (like running an NCAA betting pool in the office), would describing these practices to your kid's kindergarten teacher embarrass you and your spouse, cause other parents to place Junior on the no-playdate list, and spur the headmaster to rue the day he accepted your child?

Spitzer himself has now failed the Parents' Night Test. But so did Wall Street in the 1990s—time and time again, and in ways that led to significant and meaningful losses for millions of investors. Many of Spitzer's biggest cases simply revealed to the public possibly legal but undoubtedly sleazy ways of doing business. Take the 2002 investment banking research case. Spitzer showed that the nation's biggest and most prestigious investment banks, the ones that spoke grandly of serving their clients with integrity, systematically pimped out investment recommendations for the sake of ginning up investment banking business. The same firms, by the way, also parceled out shares of hot initial public offerings to favored executives in the hope they'd send investment banking business their way. Nobody on the inside saw anything wrong. But imagine that at Parents' Night a Citigroup telecom analyst had piped up: "I recommend that the public and our retail brokerage customers buy certain stocks even though I know they suck. I do it because those stocks are clients of my firm's investment banking unit."

Or take the mutual funds late-trading cases. Some of the largest asset managers, which had sworn on their sacred honor to treat all customers equally, allowed certain investors (mostly hedge funds) to engage in after-hours trading. Imagine if one of those managers had come on CNBC and said, "Yes, we let really rich guys make free money improperly—at the expense of you, the investing public—because they agreed to park money in some other funds we're starting." Another common industry practice that, when exposed to the light of day, became untenable, inexcusable, sordid. The same held true for the case in which big insurers admitted to rigging bids.

Spitzer didn't take these cases to trial because he didn't need to. The paper trails, the e-mails, and the trading records spoke for themselves. Once released to the public, they became a public relations nightmare, fodder for the press and class-action lawyers. Rather than fight back in a court of law or the court of public opinion—how can you justify the selling of recommendations, or late-trading?—the accused firms essentially pleaded no contest and entered expensive settlements. That's pretty much what happened with Spitzer. Like the Wall Street executives he tangled with a few years ago, Spitzer has been drummed out of the industry in which he had spent his entire career and has had to surrender something of great value.

Charles Gasparino responds.