The Devil's Casino (25 page)

He reportedly asked Callan about the rejiggering of the Level 3 assets, and how the firm could justify its minuscule $200 million write-down on a $6.5 billion pool of collateralized debt obligations (CDOs), when the value had plainly collapsed in the past few months.

Einhorn claimed not to have gotten a single straight answer from Callan, but the phone call gave him plenty of material for his next public anti-Lehman diatribe—at the Ira W. Sohn Investment Research Conference on May 21st.

Among other things, he said: “Now, given my experience with . . . the
SEC
, I have no expectation that Lehman will be sanctioned in any material way for what we believe it has done. I suspect that some of the authorities applaud Lehman’s accounting ingenuity.” But, he cautioned, “If there is no penalty for misbehavior—and, in fact, such behavior is rewarded with flattering stories in the mainstream press about how to handle a crisis—we will all bear the negative consequences over time.”

Lehman’s stock price fell a dollar from $29.50 and slowly drifted lower.

Lehman’s executive committee was squirming. “She’s been caught in her underwear,” one of them later griped. But Callan, “spiraling out of control,” according to someone on the executive committee, continued her media blitz, shilling for Lehman, and herself.

Around this time David A. Viniar, Goldman Sachs ‘s 53-year-old
CFO
, picked up the phone and called Callan. He was concerned for his young rival, who seemed to be on
CNBC
every time he turned it on. Viniar had held his seat for nine years and no one had ever seen
him
on TV. He wanted to pass along some friendly advice: He didn’t think the young
CFO
was helping herself or Lehman by taking on Einhorn or the short sellers in the open like this.

According to Callan’s colleagues, she wasn’t overly receptive to the call. When he suggested they meet, she said she didn’t have time. “I think she may have thought he was the enemy, Goldman Sachs,” says Michael Thompson, her ex-husband, in her defense. But even Fuld always took the calls of his Goldman Sachs counterpart, Lloyd Blankfein. A couple of years back, Fuld’s son Richie even went to work for Goldman Sachs. Callan seemed to think she was too good to speak to a rival
CFO
. What had happened to the smart young banker? Where was her judgment?

“We didn’t know she would turn into a rock star,” Tom Russo said later.

And that was just the beginning. In the Saturday edition of the
Wall Street Journal
on May 17, right before Einhorn’s devastating speech, a long profile on Callan concluded with a snippet about her personal shopper at Bergdorf Goodman. Her colleagues were appalled. She was now the most senior woman on Wall Street, Lehman was fighting for its life, and this was how she was presenting herself to the most important business paper in the country?

Callan had been given little or no guidance on this stuff by Gregory, according to Russo. She had just done her own thing.

“She wanted the limelight. As smart as she was, she should have been smart enough to know her own limitations,” says one of her former colleagues, adding that she should have known enough to turn down the job of
CFO
when she was offered it, “and she didn’t.”

During the buildup to George Walker’s June wedding, Callan stayed out of the limelight. She knew that this time there could be no gloss on the earnings she had to sign off on. Lehman was about to report a $2.8 billion loss for the second quarter, its first quarterly loss as a public company. She needed to prepare the market for this very bad news.

But on June 4, three days before the Walker wedding, an article appeared in the
Wall Street Journal
by Susanne Craig, breaking the news that Lehman was considering a “capital raise.” This was technically incorrect, and it made Lehman look like it was running scared. Freidheim, who kept a tight lid on the communications staff, went ballistic when he read it. Sources say he went through the Lehman phone records to find the leak.

“Lehman had been looking for a strategic partner for the past three years and equity in the open market—not a capital raise,” he told people at the time. The distinction was important—a capital raise would dilute the stock and therefore lower its price, while an open-market purchase of equity from a strategic partner would not.

In the logs, Freidheim found calls from Callan’s office to the
Wall Street Journal
. Fuming, he reported this to Fuld and Gregory, telling them, “We should consider all options, including firing her.”

“We can’t,” Gregory said. “She’s under a lot of pressure with the earnings coming up. We don’t want her distracted right now.” Fuld deferred to his deputy. Callan was Gregory’s domain, his project.

Over at the
Wall Street Journal
‘s offices, Craig got a call from Fuld telling her “she was “no longer considered a friend of the firm.”

Startled, Craig phoned Kerrie Cohen in Lehman’s press office. “I just got off the phone with Dick,” she told Cohen. “You tell Erin to call me immediately.”

Meanwhile, Andrew Gowers, the
Financial Times
veteran who now was a senior PR executive for Lehman, quietly went behind Fuld’s back and put in a call to his buddy, Robert Thomson, the managing editor of the
Wall Street Journal
. The two men had a long history together, since Thomson had preceded Gowers as editor of the
Financial Times
. “I told Robert to ignore what Sue had been told. I ‘d make sure they had access,” Gowers says. “I felt, at least from my narrow corner of the thing, that proprieties were preserved, no matter what idiocies were being pronounced from the top floor [of Lehman].”

But tensions in and around the press department spilled over into George Walker’s wedding. As they danced to the band, Skip McGee found himself in a heated discussion with Freidheim—there with his pretty French fiancee, Isabelle Dufour—over Lehman’s recent press. McGee had not agreed with a recent decision to fire a press officer, Hannah Burns, whom others had felt to be too “emotional” when dealing with the press.

In fact, McGee hadn’t agreed with much he’d seen recently, and he was dreading the earnings results.

The next morning, Sunday, the day before the earnings announcement, McGee walked into Fuld’s office, shut the door, and insisted that Gregory, who was sitting there, leave. McGee then told Fuld that Gregory had to go. The market needed that much; Fuld had to fire him. “You need to do this,” he said.

Fuld told him, “I’ ll never do that. We’ve been partners for 30 years.”

On June 9, Callan released her earnings report. As insiders feared, the market was horrified by the mammoth losses. Immediately, Lehman stock started to free-fall from $30, falling 7 percent by Tuesday evening and another 14 percent on Wednesday.

Everybody was anxious and unhappy. On Tuesday, June 10, in an executive meeting, Fuld asked everyone at the table to take a turn airing their suggestions about “restoring confidence.” McGee spoke first, at Fuld’s behest, in part because McGee had received—and forwarded to Fuld—an e-mail dated June 9 from Benoit D’ Angelin, a former Lehman employee who had left just months earlier for the hedge fund Centaurus Capital. It read:

In my view two things need to happen very quickly.

1. Some senior managers have to be much less arrogant and internally admit that some major mistakes have been made. Can’t continue to say “we are great and the market doesn’t understand.”

2. Some changes at senior management level need to happen very soon. People are not and
WILL
not understand that nobody pays for that mess and that it is “business as usual.” We also need to hire a few very senior guys
VERY
quickly to bolster confidence.

Sorry to be so blunt but a serious shock is needed to allow the firm to rebound quickly and aggressively.

bq.

Keep it up and good luck.

At Fuld’s prompting, McGee summarized the contents of the e-mail.

He told his fellow executives, “Morale has never been worse. . . . “Somebody in very senior management has to be held accountable. I think we’ re supposed to stand up and say that we’ve made mistakes, and we’ re going to change things. . . . ”

Gregory glared at him. McGee knew that some people sitting around that table agreed with him—he’d spoken to McDade, among others—and he was hoping that one of them would back him up. No one did.

The meeting continued, almost as if he had not spoken. If anything, he was attacked. Gregory talked about the importance of “sticking together” in times like this.

Under the table, McGee typed a two-word e-mail to Jeff Weiss, a banker who was not present: “I’m dead.”

But by now, like a sleeping giant just awakened after a 30 -year slumber, Fuld was slowly coming to grips with the turmoil inside his firm--and outside. Over the next couple of days he attended executive committee meetings in different divisions and made it clear that he wanted to hear the truth. He
wanted
to know what the troops thought of Lehman’s senior management.

On Wednesday, June 11, he had lunch with the people in McGee’s division, and solicited their opinions. He didn’t eat a thing—highly unusual for a man with a voracious appetite—and as he got up to leave, he asked one last question: “What would you say if I wasn’t here?”

Their answer came back as if from a Greek chorus: “You are not listening.”

But, for once, he was.

I don’t know what you’ve been told, but absolutely I was not fired.

—Joe Gregory

L
ate in the afternoon following McGee’s executive committee lunch with Dick Fuld, Tracey Binkley, head of human resources, informed Scott Freidheim that Joe Gregory was “looking at his stock holdings.” The obvious inference was that Gregory was looking to bail out. At the time, he had over $260 million worth of Lehman stock; records show that since 2003 he had taken home $40 million in compensation and sold over $260 million worth of Lehman stock ($70 million of which was used to pay taxes on the stock sales).

How quickly things had changed.

Two days earlier, right after the earnings call, Freidheim’s press department was besieged; there was a rumor that Gregory and Callan were leaving. Was it true?

This was a story Friedheim had never heard before: Joe Gregory leaving the firm? In shock, Freidheim walked down to Fuld’s office and asked if such a thing had even been considered.

“No,” Fuld had said. “It’s not under consideration.”

Gregory had been even more emphatic. “Absolutely not,” he told Freidheim.

But that was before Fuld had gone around the firm, division to division, and heard the resounding cry: Joe must go!

What actually happened next is known by only Fuld and Gregory, who had a closed-door conversation.

“Falling on his sword for the good of the firm” was how Gregory would later explain his abrupt departure, according to sources.

Not many people inside the firm were fooled. “He was fired,” Lessing later told people. But Gregory had one last card left to play. He realized the dramatic media coverage of the fall of “The Most Powerful Woman on Wall Street” would eclipse his demise.

Erin Callan was manning the phones with analysts and investors, running damage control on Monday’s cataclysmic earnings announcement that Wednesday afternoon, when Gregory told her he was stepping down and that she was, too.

She was shocked but she dutifully went into Fuld’s office and said, “I think I’ve lost my relevance.” His terse response, a source says, was: “I think you have.” Just minutes later, she was seated in a conference room listening to her mentor, Gregory, tell the executive committee he was stepping down.

“She’s resigning, too,” he said, and motioned to Callan. Tears began rolling down her cheeks.

Later Callan would tell
Fortune
magazine a rather different story. Had just Gregory stepped down, she said, “it would have mattered a lot internally, but I didn’t think it would have a big impact on the market” because Gregory “was not known to the outside world.”

Callan characterized her resignation as something she and Gregory had decided to do together, for the good of the firm. What she did not say was that both of them had agreements drafted that specified they would be paid until the end of the year. (Gregory moved to a nearby office on Sixth Avenue to justify the paycheck.)

Gregory had calculated correctly. The resignation announcements went out on Thursday, June 12. The next day’s business press was dominated by the riveting tale of the humbling of Wall Street’s most senior female executive. In a typical headline, the
London Independent
wrote: “Wall Street’s Leading Woman Pays Price for Lehman’s Losses.”

Gregory was scarcely mentioned.

Now Fuld needed to do something he had never done before. He needed to hire a new president, and for the first time since becoming Lehman’s
CEO
, he had to choose ability over loyalty. He had to hire someone shrewd and powerful enough to protect his life ‘s work, even if that person might very well unseat him. In one of life’s most bitter ironies, he realized he needed Chris Pettit—12 years too late.

There was an obvious successor: Bart McDade. The former boss and business school roommate of Mike Gelband was the dissidents’ favorite to replace Gregory.

A veteran of the fixed income market who had chaired the bond market association, he was, thanks to Gregory’s eccentric human resources maneuverings, now also an expert on the stock market; he had the chops.

No one doubted that McDade, who had joined the firm in 1979 as an intern, bled Lehman green. If he lacked for anything, he perhaps lacked Pettit’s charisma. But he was, in the words of one colleague, a “businessman’s businessman.”

McDade was quietly, fiercely intellectual. “He had the brilliance of being able to look at things complicated, break them down in a way and reimagine them imaginatively, and move the business forward in a way that makes sense,” says one colleague. “One example: It’s now common on the Street for everybody to do equity transfers—CSAs, commission sharing agreements. Bart came up with that idea, pioneered it with Fidelity.” Basically, CSAs allow the transfer of commissions on a trade from a broker to a third party.