By Mark Gimein

(FORTUNE Magazine) – On Wall Street right now, there may be no person as feared as the attorney general of New York State. This is in some ways an utterly banal statement, one that probably won't surprise anybody who has been following press coverage of Eliot Spitzer's campaign against corruption in the financial world, a crusade that has already netted a $100 million fine from Merrill Lynch and is now continuing with an investigation of Citigroup's Salomon Smith Barney. But in another way it is quite extraordinary, really kind of unbelievable, because of one very striking fact: Spitzer has become the most feared man on Wall Street without arresting a single executive and, amazingly, without so much as indicting one investment bank, or a single employee of an investment bank.

In this fact is encapsulated what might be the essence of Spitzer's character, and the reason this unlikely enforcer might be the pivotal figure in the broad-ranging rethinking of American business. If any single person has goaded U.S. corporations to change most vigorously in the last months (well, any single person besides Jeffrey Skilling), it has been Spitzer. He has done it with a staff of no more than 15 or 20 lawyers working on securities law, a legal staff smaller than that of a third-tier investment bank. And he has done it without yet prosecuting a single big securities case.

Spitzer has been criticized for this as an arrogant meddler and an opportunist with an eye on New York's 2006 race for governor (he's almost certain to win a second term as attorney general this fall). But he has persevered in his mission of shaming and compelling the investment banks and their executives--right up to Sandy Weill, the head of conglomerate Citigroup--to end the despicable practice of giving their clients investment advice so dishonest and fraught with conflicts of interest that it has become worthless.

At first glance, Spitzer, 43, hardly seems a prime candidate for the job of articulating the anger over corporate corruption that has gripped ordinary Americans. "Articulate" is an Eliot Spitzer word, as are "rearticulate" and "recalibrate" and "critique." He is a policy enthusiast who drags friends to lectures and seminars on public affairs in his spare time. He is a product of Princeton and Harvard Law School, and even spent a couple of years working on mergers and acquisitions at top-tier law firm Skadden Arps. Thanks to his family's real estate fortune (he owns a string of Manhattan properties), he can afford to live with his wife, Silda Wall, and three daughters in exactly the kind of Fifth Avenue building favored by financial barons. He quips that half his friends are investment bankers and the other half are lawyers who represent investment bankers.

The last time we went through a spasm of greed and retribution on Wall Street, in the late 1980s, the iconic figure in law enforcement was U.S. Attorney Rudolph Giuliani. It was Giuliani who was responsible for putting Ivan Boesky and Michael Milken in jail. But it was also Giuliani who was responsible for pulling an investment banker off the floor of Kidder Peabody in handcuffs--on charges that were dropped because the U.S. Attorney's office never amassed enough evidence for a trial. Giuliani, by the way, now represents Merrill Lynch in private practice.

Spitzer, by contrast, is the antithesis of that stock character of law-enforcement legend, the street-brawling prosecutor. "Prosecutors have classically done a very good job of putting people in jail, but it doesn't change anything," says Michael Cherkasky, Spitzer's former boss in the Manhattan D.A.'s office racketeering unit. For Spitzer, putting people in jail is not the point of the prosecutor's job. Look at his biggest case at the Manhattan D.A.'s office, in which he showed both his creativity and his penchant for thinking big. Instead of using a mole to penetrate New York City's closed garment world, he opened a full-fledged garment factory (and in classic Spitzerian fashion, made sure his workers had health insurance). He wound up shutting down gangster Tommy Gambino's extortion business by prosecuting the mob boss, who was already facing the prospect of jail on other charges, on (of all things!) antitrust grounds and exacting a $12 million civil penalty. That paid for five years of intensive oversight and led to wholesale reform of the trucking business in Manhattan.

When Spitzer talks about his biggest securities case--an investigation of Merrill Lynch in May that caused the venerable banking house to pay a $100 million fine--he argues that its most important aspect was "beginning a process of changing the rules." Spitzer's anticorruption campaign, while certainly not lacking in press releases, has been conspicuously devoid of handcuffs, perp walks, and photo ops. It is the campaign of a man who understands finance--who in the words of business commentator James Cramer is "not buffaloed by Wall Street." The overriding goal is real and rapid reform of American business.

There is no doubt, of course, that reform is needed. The public's regard for American corporations and the people who run them has fallen so low that it seems superfluous to go over the details. But let's go over them anyway. A poll conducted in February by the Pew Research Center for the People & the Press, as the Enron scandal was breaking, showed that 66% of Americans thought business executives had low ethical standards--a number that put them below journalists and Washington politicians. More recently an August poll asking Americans whom they trusted showed lawyers (never a popular group) beating brokers, brokers beating accountants, and accountants beating corporate chief executives, who came in a distant last.

Everybody is familiar with the basic outlines of these facts, but when it comes to solutions, the American body politic (let alone the business world itself) is divided. There are two main theories out there. One is the "few bad apples" theory, which says the problem is limited to just a small number of corrupt corporate executives. The other? Call it the "many bad apples" theory, which says that there is an epidemic of corrupt corporate behavior. Says Democratic pollster Stan Greenberg, perhaps the man most responsible for defining the Democrats' strategy on corporate misbehavior: "There is also a sense [among the public] that this is more about individual behavior than institutional behavior. High corporate executives who misuse their position and act in an irresponsible way without accountability. That allows people to be angry about those executives' values and norms."

The problem with both the "few bad apples" and the "many bad apples" theories is that they depend on what is ultimately a bogus belief that if we could just "get rid of the bad guys" we'd get the market hopping again lickety-split. Both are big oversimplifications (and FORTUNE has said so before, too--see "System Failure" on fortune.com).

That's where Spitzer comes in. He operates on the premise that the people at the top of the corporate world who let this happen are not a bunch of loose cannons and moral pygmies but most often are people not terribly unlike the rest of us, subject to motivations that can be understood, incentives that can be controlled--and even, sometimes, a desire to be good.

This is not to say that Spitzer is equivocal in his moral statements. He is not. He is able to cut through the malarkey of corporate-speak with a moral clarity. (Spitzer: "[Salomon analyst] Jack Grubman said that what used to be viewed as a conflict of interest is now viewed as a synergy. Well, he's wrong. A conflict of interest is a conflict of interest.") And he is certainly more than willing to call Wall Street on its ethical failure--but he looks for underlying reasons for that failure. Ask Spitzer how we got ourselves into this mess, and he'll point to a "gradual dissipation of standards and ethics," but he'll qualify that by explaining that this dissipation was "driven by an obsessive desire to get quarterly numbers up" and an "excessive confidence in new technologies."

Spitzer maintains a steady confidence in the basic idea that people want to do the right thing, and that it's his job not just to punish their failure but to change the system to help them do it. In three lengthy interviews with FORTUNE over the past weeks, Spitzer only once came back to the same point in almost exactly the same words. That point was that he believed Wall Street executives were willing to follow the rules, if the rules were applied consistently and equitably.

"With rare exceptions, there is an overarching recognition [on Wall Street] that the critiques have been fair. And the debate is not whether the critique is correct but what the nature of the remedy should be. For instance, when it comes to the analyst issues that have been brought to light recently, virtually nobody disputes that there is an enormous problem," Spitzer argues. "And in the conversations I've had with a fair number of investment bankers, what they have said is, 'We felt driven to the lowest common denominator by the pressures of competition. Somebody should define the boundaries for us, and we'll observe them. Please do that.' Almost a request that this be done."

Republican Michael Oxley, chairman of the House Banking Committee and a harsh critic of Spitzer (who is a Democrat), has tried to paint Spitzer's assault on Wall Street as nothing more than prosecutorial blackmail. Oxley derided Spitzer's $100 million settlement with Merrill, arguing that it's a prosecutor's job to prosecute, not legislate. "Attorneys general must aggressively prosecute fraud," Oxley said in a statement released to the press, "but no fraud charge was ever filed, ever tried, or ever proved. Also, let's draw the clear distinction between prosecuting fraud, which is the duty of the attorneys general, and setting national market policy, which is what the attorney general of New York clearly seeks to do through threatening firms with litigation."

Beyond such partisan sniping, though, there is in fact a real difference in philosophy between Spitzer and most other public officials and prosecutors, and it hinges on the question of why Spitzer has so far chosen to negotiate rather than prosecute. Negotiating rather than litigating long, complex securities cases makes for a very good use of Spitzer's limited resources, but there's more to it than that. It's a question that Spitzer clearly relishes answering.

At issue in the Merrill case was whether its analysts--and specifically the well-known Internet analyst Henry Blodget--were tailoring their stock picks to win investment banking business by recommending the stocks of Merrill's banking clients. The evidence included detailed e-mails from Blodget himself in which he expressed discomfort with the stocks he was recommending and admitted to one institutional investor that there was nothing interesting about a stock he had rated highly except that it was issued by a Merrill client.

Spitzer maintains vigorously that he had the evidence to prosecute but that to indict Merrill for misbehavior that was endemic throughout the investment banking world would have been a mistake. It would have led, he argues, to excessive punishment for Merrill, suffering for Merrill's clients and shareholders, and, most important, no systemic change. "What I was most interested in doing was laying out facts that would begin a discussion of how to address these problems. And I think we've opened that floodgate, a little bit. What we did that was important in the Merrill Lynch deal was not [to make Merrill] pay $100 million but to shatter the patina of legitimacy that surrounded investment banking research," maintains Spitzer. "It would have been disproportionate--and I can almost say irrational--to have indicted Merrill Lynch for what we saw. Could I have done so? Yes. Do I believe we could have made a criminal case? Yes. Would that have been the right policy objective? No."

There's a telling story about Spitzer's days in law school that's related by financial commentator James Cramer, a Harvard Law classmate and 20-year friend. In their third year of law school--when most students already had post-graduation job offers lined up--Cramer and his pals hatched a plan to skip their dullest class, sending one of their number to take notes at each session and report back before the final exam. "So Spitzer says, 'But that'll hurt those of us who go in and work hard every day!' I said, 'Come on, who's really getting hurt by this?' and Spitzer said, 'The system will be hurt. That's corrupt. That's a corrupt thing.'"

In Cramer's telling, the story has two points (besides poking some fun at Spitzer's extraordinary earnestness). The first is that Spitzer genuinely hopes that by his moral and intellectual force he will persuade people to do the right thing, even on a small scale. The second is that Spitzer really cares about the system. He cares about its integrity, and he wants to preserve it. "The criticism I hear in boardrooms," says his ex-boss, Cherkasky, now CEO of Kroll, the country's biggest security firm, "is that he's going to destroy New York's biggest industry."

If anything, it's the opposite--it's hard to imagine a prosecutor less interested in putting companies and industries out of business than Spitzer. "I'll bet if you asked him about Andersen," says Cherkasky, "he'd say there should've been a way to do that without shutting them down." Other friends echo this analysis. Says Cramer: "If Merrill Lynch had given Spitzer a call, and found out who wrote those e-mails [pressuring analysts], and fired him and fired his boss, and put in mechanisms, they wouldn't have had this happen."

Whether Wall Street will choose cooperation or intransigence is still very much an open question. Under the spotlight of public opprobrium and facing the specter of prosecution, at least some part of Wall Street has signed on to the reform movement. Two weeks after Spitzer's settlement with Merrill, Goldman Sachs chief executive Hank Paulson gave a much-publicized speech to the National Press Club in which he

uttered some pretty emphatic words about the failures of American corporations and the need for reform. "In my lifetime," he said in the most quoted sentences of the speech, "American business has never been under such scrutiny. To be blunt, much of it is deserved."

Less noticed was that, after covering accounting and ethics, when Paulson moved to talking about his own industry, his words became a lot more equivocal and jargon-filled. "Conflicts are a fact of life for many if not most institutions throughout society," Paulson opined blandly when he got to talking about investment research. "For an integrated investment bank like Goldman Sachs, conflict management has always been a core competence"--a self-congratulatory position that Spitzer, who likens Wall Street's compliance system to "the curtain that hid the wizard of Oz," finds unconvincing.

Even in the case of Merrill, it's tough to tell yet how dramatic the changes have been. Merrill has taken several companies public since the settlement. Its analysts have dutifully recommended all of these stocks. One of them, Liquidmetal, recommended by Merrill's analyst in three separate reports, has seen its stock drop from $15 to about $6 a share, making it a strikingly bad call.

So what happens next? Spitzer is willing to negotiate in a way that is more understanding of--and perhaps more sympathetic to--Wall Street than other critics, some of whom call for more radical steps, such as breaking up financial firms into separate brokerage and investment banking companies. But he also knows Wall Street well enough to strike where it hurts, and he has his game plan mapped out several moves in advance. In the investigation his office is now pursuing most aggressively--that of infamous Salomon Smith Barney telecom analyst Grubman--Spitzer has already gone right to the top, asking questions about whether Grubman's investment "opinions" were influenced by Citibank CEO Weill. Spitzer says that "spinning"--effectively a way of bribing company executives with cheap IPO shares to give banks more business--is likely next on his agenda. It's an easy-to-understand concept that, like dishonest investment research, has plenty of public appeal. And beyond Wall Street, the attorney general says he and his staff are already kicking around legal theories that could be used to make CEOs give back gains from any questionable dealings.

Spitzer has two kinds of critics these days. One group charges the attorney general, who only barely eked out a victory in the 1998 elections, with political opportunism in taking on the investment banks. Dora Irizarry, Spitzer's underdog opponent in this year's elections, argues that Spitzer could have gotten more out of Merrill if he hadn't been rushing to get headlines. The other group says Spitzer has been too easy on Wall Street (ensuring, the argument sometimes continues, its support in his next big campaign). The first charge seems unfair: If he'd really wanted to make political hay, Spitzer could have organized some of those Giuliani-era media events. And the second? Well, there isn't a scintilla of evidence that Spitzer has made any friends on the Street in the past few months. You try going down to the financial district and finding one of Spitzer's supporters.

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