Governor Eliot Spitzer came in for a bit of a drubbing on this page last week. After reviewing a history of the misconduct of his team when he was New York’s Attorney General—a pattern that seems largely unchanged now that he has been elevated by the citizens of our state to the governor’s mansion—we nicknamed him “Loathsome Eliot”—a tag we hope will stick.

But we did note—if not quite in defense of Spitzer then at least in mitigation—that the problem might not lie solely within, well, the soul of Spitzer. It may, indeed, sit at the very foundation of the modern office of Attorney General, which has lately become the font of many of the worst lawsuits launched against businessmen and Wall Street executives. This morning’s Wall Street Journal carried an editorial—at the World they call these things ‘randos,’ which is short for ‘reviews and observations’—drawing our attention back to the Attorney Generals.

It should hardly be news to anyone reading DealBreaker that Spitzer’s successes have spawned a generation of vipers—Mini-Me AGs who hope to follow Spitzer into their state’s executive suite by garnering notoriety for themselves by aggressively prosecuting highly publicized chases against long-standing business practices. At the heart of the problem with our Attorney Generals is a lack of any code of conduct or guidelines, according to the study out of the Institute for Legal Reform cited by the editorial board of the Journal. In this they are unlike district attorneys or federal prosecutors, who are—at least theoretically—constrained by official standards governing things like notice periods on criminal charges, public comments alleging misdeeds and investigating techniques. The AGs have been set loose upon the world without any manner or manual of restraint—save periodic election—and they are behaving, unsurprisingly, like Grendel in the great hall.

The editorialists at the Journal are perennial optimists, and they optimistically endorse the Institute’s call for a national code of conduct. But, while we continue to resist the label of ‘doomsayer,’ we cannot share their sunny outlook. The monster AGs are already on the prowl, and we’re not sure a manual or a code will be enough to keep them at bay.

AGs Gone Wild [Wall Street Journal]

Chief among the names being thrown around as the next Attorney General is Michael Chertoff. And when we say the name Chertoff is being thrown around, we mean that Chertoff’s associates seem to be engaged in shock and awe carpet-bombing of the media and White House to get the job for their man.

Sometimes referred to as “The First Attorney of New Jersey” (a title which, we’re assured, is meant as a compliment), the current Secretary of Homeland Security has spent most of his career as a government lawyer. After graduating Harvard law school (where he served on the prestigious law review), he began his career as a law clerk for Justice Brennan, became an assistant US Attorney and was appointed by the first President Bush to serve as US attorney in New Jersey.

At thirty-six, he was one of the youngest ever to get such an appointment. “ Kid Prosecutor,” a partner at a prominent corporate law firm once called him. He served as the Senate Republican majority’s chief counsel during the Whitewater hearings. He became the head of the Justice Department’s criminal prosecution arm and then was appointed by to the Third Circuit as a federal appeals judge by the current President Bush. Between government stints, however, he worked a partner at Latham & Watkins, where he won a number of high-profile cases for the defense. This guy’s resume has over-achiever written all over it. If you line up the letters according to your decoder ring it spells “Supreme Court Justice.”

But when the Bush administration considered appointing Chertoff to run the SEC, Wall Street acted quickly to shoot him down. Lobbyists with Wall Street firms stressed that his record as a successful and aggressive prosecutor gave him little experience in dealing with business issues, and behind closed doors they whispered that he might have developed a one-sided view of corporate America and Wall Street as being rife with criminality and fraud. Eventually the Bush administration settled on Chris Cox, a former Congressman and Latham & Watkins partner who was viewed as more sympathetic to Wall Street.

Some on Wall Street believe that the same criticisms might be applicable if Chertoff were appointed Attorney General. His controversial decision to prosecute Arthur Anderson for its role in Enron’s destruction strikes many as a bad sign.

“The best we can hope for is that he’ll concentrate on terror issues,” one Wall Street lawyer said. “He’s a born prosecutor and no friend of Wall Street or business in general.”

The resignation today of Attorney General Alberto Gonzales has ignited speculation about who might fill the top spot at the Justice Department. On Wall Street some are wondering whether the Gonzales’ resignation might help or hurt investment banks, brokerages and corporate America on a number of pending legal issues.

The Justice Department handles more than just the prosecutions of organized criminals, drug dealers and terrorists. It is also involved in law-enforcement in the finance community and corporate America. Chief among the legal issues that concern Wall Street is so-called ‘scheme-liability,’ where banks may be found guilty for assisting the corporate fraud of their clients. Wall Street is also concerned with other issues of institutional liability, for instance whether to prosecute an entire company or an individual when fraud is alleged by executives and employees. Wall Street firms are generally friendly towards insider trading prosecutions, except perhaps when prosecutors get zealously creative and go after financiers whose acts are not widely thought of as illegal.

Under Gonzales, the Justice Department has had a mixed record on Wall Street issues. Gonzales himself, a former corporate lawyer whose list of clients once included Enron, is viewed as having a generally pro-business outlook. Some critics, who asked not to be named for fear of political or legal retaliation, dispute this.

“He’s pro-successful business,” one critic said. “But if your company is in trouble, his Justice department made no bones about going after you.”

The Department has aggressively prosecuted the folks its lawyers like to call ‘wrong-doers,’ including accountants who helped clients develop aggressive tax-avoidance structures, executives involved in back-dating and a host of others involved in the business scandals of the late nineties and early part of this decade. Since Gonzales ran into trouble following revelations of the firing of several government lawyers, many have seen the department as “rudderless.”

“It’s been an asylum run by inmates,” said one court observer.

There is a widespread view on Wall Street that career government prosecutors tend to be more hostile to business than political appointees with more experience in the private sector. There is a fear that a “rudderless” Justice department will drift into a more aggressive current for prosecuting alleged wrong-doing by corporate executives and Wall Street financiers. The hope on Wall Street is that Gonzales’ replacement will be named quickly and come from a background that displays some sympathy for business.

Several names are being talked about as potential nominees. The Wall Street Journal’s Law Blog has a great rundown of the likely suspects. Whether this will be a boon or a bane for Wall Street firms will likely depend on who President George Bush appoints to replace Gonzales, and how quickly that appointment is made. As the day goes on, we’ll profile some of the leading candidates for the job.

Who Will Be Our Next Attorney General? [WSJ's Law Blog]

Four Ernst & Young partners were indicted today for allegedly creating illegal tax shelters for the firms wealthiest clients. At the same time prosecutors announced it would not bring charges against the accounting firm.

The four worked in a group Ernst & Young set up in 1998 to create tax shelters for clients making more than $10 million per year. At first it sported the color name Viper, which officially stood for Value Ideas Produce Extraordinary Results. At some point someone seems to have thought snakes in the accounting firm was not the best idea and the name was changed. But the goal of helping clients minimize taxes remained.

The accounting firm may have helped its clients create more than $7.56 billion in tax deductions, according to the business reporters at ABC News. The firm collected a fee of between 1.25% and 2% for ever dollar of tax deduction created, for a total of more than $115.7 million, according to the indictment.

The indictments come after a long investigation that stems back to the plethora of tax shelters that were big business for the accounting firms during the stock market rally of the late nineties. The decision not to charge Ernst & Young will likely be taken as a signal that the Justice Department is ratcheting down the investigations into the tax shelters of the last stock market boom. At one point it looked like law firms and investment banks might also be indicted. Declining to indict Ernst & Young may be a sign that the Justice Department is now aiming at the individuals involved with the allegedly abusive tax shelters rather than their employers.

At least one of those indicted today is not going quietly. A lawyer for Ernst & Young tax partner Richard Shapiro said today that his client was “disappointed that the Department of Justice and the United States Attorney’s Office have decided to go forward with the prosecution of an innocent man.” He went on to describe the charges against Shapiro as “baseless.”

Shapiro is a well known figure in tax circles. His views have been quoted widely in the press, and he has authored a booklet on taxes and investing.

How the Super Rich Avoided Taxes; Despite Making Millions [ABC News]

Ernst & Young Partners Charged in Tax Fraud [SmartMoney.com]

Professor Larry E. Ribstein points out a sentence in that Bloomberg-Schumer article we discussed earlier that got us all going "on snap!."

While our regulatory bodies are often competing to be the toughest cop on the street, the British regulatory body seems to be more collaborative and solutions-oriented.

Hear that, Eliot? Your tough guy act is even pissing off your fellow Democrats now. (Oh, and emphasis added by us, of course.)

That’s the gist of today’s Wall Street Journal editorial discussing the pressure coming for tighter regulations on hedge funds from, well, just about anywhere you look. There’s Senator Charles Grassley’s letter to regulators looking for suggestions on how to regulate hedge funds. (Our bet is that they’ll somehow come up with a couple!) And Connecticut’s Attorney General Richard Blumenthal’s mini-Spitzerism. And the noise from Germany about putting global regulations in place. (Look for more of this if Barney Frank gets control of the House Finance Committee.)

You see, a regulated industry is an industry whose players need to make campaign donations in order to influence lawmakers. It’s a pretty simple formula: regulate an industry and you instantly politicize it. Which is another way of saying that you monetize the industry for politicians.

But it’s not all about wringing donations from hedge fund managers. There’s also corporate managers who are tired of getting those pesky shareholder letters from hedge fund types, and worried they could lose their jobs as hedge funds buy up their shares. And those folks have lots of money to spend on campaign donations, as well. It’s a win-win if you’re a politician.

All the other talk—about “systemic risk” or pension funds or low-liquidity real estate millionaires—is just the sound of a policy in search of a rationale. And that policy, of course, is the enrichment of politicians. That’s always the policy.

Targeting Hedge Funds [Wall Street Journal]

Both Eliot Spitzer and Dick Grasso are saying they won’t settle the case after yesterdays summary judgment opinion came down from State Supreme Court judge Charles Ramos. Charlie Gasparino reported this morning on CNBC that he’d spoken with Grasso, who told him that this was looking like a heavyweight title fight—a champion will be declared. We prefer the Terrordome analogy: two men enter, one man leaves. Meanwhile, Jim Cramer told CNBC that Spitzer has also ruled out a settlement. This thing isn’t going away, and its only going to get messier from here. We can’t wait.

It’s no secret that political pressure to regulate some of our more high-flying financiers has been mounting recently. From recent Senate hearings on hedge funds, a Justice Department investigation into private equity club deals, the Connecticut Attorney General’s hedge fund task force, the Connecticut banking regulators new hedge fund unit to legislation recently passed ordering a study into new federal hedge fund regulation, the writing has been on the wall. And hedge funds and private equity shops are starting to respond by forming their own advocacy groups to lobby regulators and lawmakers and launching law suits in US courts.

That’s all well and good. It’s the normal process of American politics. Politicians, regulators and lobbyists were bound to respond to the opportunities presented by events like the Amaranth collapse to enhance their power and prestige. Public ignorance of financial markets and government operations would allow the fear-mongering exploitation by political jobbers. Some of the larger and wealthier financiers would sense an opportunity to burden smaller competition with ungainly regulatory costs. And, of course, enough money is being made in New York and Connecticut that eventually some of it is going to have to get siphoned off to campaign funds and lobbying groups. This is, after all, still a democracy.

But what is the financial community going to do about the new pressure for regulation starting to emerge from international bodies? In the last two-days we’ve heard concerned noises about hedge funds and private equity from both the future head of the G8 economic group—Germany—and the United Nations. As it turns out, in many parts of the world the increase in foreign investment and cross-border deals isn’t seen as universally enhancing efficiency and spreading wealth. In Germany, for instance, private equity shops are affectionately known as “locusts.”

So how do you lobby the G8 or the UN? Where do you go to court to get international regulations overturned on constitutional grounds? Who do you pay off to keep these political jobbers out of your coffers? Does the rise of global finance require the rise of some sort of global governance? There are (or will be) answer to these questions. Answers we all may be discovering soon enough.

Private Equity Has Few Friends Abroad, Report Finds [DealBook]

Germany Wants G8 Summit to Consider Hedge Funds [DealBook]

The Connecticut Department of Banking has created a new unit to oversee hedge funds based in the state. The regulatory move comes after legislative attempts to regulate hedge funds failed earlier this year. But why bother with democratic processes like legislation when you can just pass fiat regulations anyway?

The Connecticut Department of Banking has created a unit that will oversee hedge funds based in the state. Connecticut has been pushing for more rules governing the growing industry in the wake of high-profile collapses including bankrupt broker Refco, failed hedge fund Bayou Management and more recently Amaranth Advisors. The unit’s main objective is to help prevent or detect fraud and will give the state greater oversight of the hedge fund industry. The unit, which has recently begun operating, has not yet passed any new regulations for hedge funds.

This comes on the heals of news that Connecticut's Attorney General has assembled a hedge fund task force. There’s good reason to be skeptical of moves by Connecticut bureaucrats to regulate hedge funds. In the first place, there’s always the possibility of hedge fund exit. Hedge funds don’t have to locate in Connecticut, and if the regulatory burden gets too intense, many could probably relocate.

Second, it’s not at all clear that this is sensible use of Connecticut tax-revenues, since the benefits of greater regulation (assuming they exist) would accrue to investors world-wide while the costs would be borne by Connecticut tax-payers. Why should Connecticut foot the regulatory bill for the world. And any attempt to try to shift the costs back on to the hedge funds themselves only increases the likelihood of exit.

Nothing we’ve seen indicates that anyone in the Connecticut Department of Banking has thought this through very well. Does Connecticut really want to make itself inhospitable to hedge funds? What's more, does it really want to make this decision by regulation and administrative action rather than legislation?

Connecticut creates hedge fund oversight unit [FinancialNews]

When the Senate judiciary committee announced it was holding hearings on hedge funds a lot of people scratched their heads and wondered why this wasn’t something that would be taken up by the banking committee, which has oversight over the SEC and financial market regulation. Even some of members of the banking committee wondered about this, worried the judiciary committee was infringing on their turf.

Well the quick answer to why the judiciary committee started looking into hedge funs was: to get the US Justice Department involved. The judiciary committee has oversight responsibilities for U.S. prosecutors, and holding hearings was a way of putting the Justice Department on notice that the Senators expected them to start paying more attention to the hedge fund industry. It was a loud and clear message: “Don’t leave this to the SEC!”

And sure enough, the Justice Department’s taskforce on corporate crime is about to start looking into hedge fund fraud.

Fraud in the $1.2 trillion hedge-fund industry poses an ``emerging threat'' to investors, the head of the Bush administration's task force on corporate crime said in an interview.

Deputy Attorney General Paul McNulty said the potential for wrongdoing in the lightly regulated investment pools makes them ripe for scrutiny by prosecutors, regulators and investigators. The corporate-fraud task force is also studying the scandal involving backdating stock options for executives, he said.

The task force will discuss hedge-fund fraud at its next meeting at the end of this month, McNulty said. ``There's been some interest in the media recently on hedge funds, and that would be a good example of an emerging threat that we would want to talk about and ensure that we are handling,'' he said.

It's also interesting that the taskforce is looking into backdating. While the SEC is pondering rules or guidelines regarding options timing, prosecutors may be drawing up arrest warrants. In short, just cause commissioner Atkins says your 'well-timed' options look okay to him don't think you are immune to the law coming down on you.

Hedge-Fund Fraud Is `Emerging Threat,' McNulty Says [Bloomberg]

Just when he thought he was getting out, they pull him back in.

In this case, it's Hank Paulson who thought he was getting out--the outgoing head of Goldman Sachs is preparing to leave Wall Street for his new role as the next Treasury Secretary--and Richard Grasso, the former boss of the NYSE, who may pull him back in.

CNBC's Charles Gasparino is reporting that Grasso served Paulson with a subpoena. Or, more likely, lawyers who work for the one served a subpoena to lawyers who worked for the other.

New York Attorney General has launched a lawsuit against Grasso, claiming his pay package at the NYSE violated New York laws requiring that compensation at non-profits be reasonable. Spitzer wants Grasso to return $100 million of the $140 million he got in compensation while running the NYSE. At the time the NYSE was a non-profit organization.

Paulson sat on the board of the NYSE and is said to have led the push to force Grasso to resign amidst public scandal over the size of the pay package in 2003. Despite this, Paulson's testimony may help Grasso since Paulson has praised Grasso's work as an executive. (Alternatively, and we're just speculating here, Grasso may just want a chance to embarrass one of the people who forced him out of the NYSE.) Gasparino reports that Grasso's lawyers fear that once Paulson assumes his job at the Treasury he may attempt to claim an executive branch immunity and avoid being forced to testify.

Spitzer. Grasso. Paulson. It's 2003 all over again. But this time its personal.

Paulson Subpoena [SquawkBlog]

If you haven't seen it, Eliot Spitzer's second TV ad (the "newsmaker" ad mentioned here) consists of a Times bureau's worth of positive Spitzer press clippings rushing away from the viewer like intergalactic bodies in the opening sequence of Star Wars. Headlines paraphrased: "Eliot Spitzer Fights for the Little Guy," "Eliot Spitzer Nails Corrupt Banker Scum," and, of course, "Eliot Spitzer Demonstrably Kind to Small Children." The moral of this well-crafted story is that Eliot Spitzer is... definitely press savvy.

But to continue the Star Wars analogy, it still remains to be seen whether Spitzer is more Skywalker (young and ambitious with something to prove) or Vader (a dark Sith lord who dresses like a large metallic garbage bag and sounds like James Earl Jones.)

Note to Overstock CEO Patrick Byrne: I know what you're thinking and I don't want to hear a word about this in the Q1 conference call.

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