The last tycoons: the secret history of Lazard Frères & Co (19 page)

In perhaps the first recorded instance of a congressman trying to come to grips with the massive problem soon to be known as insider trading, the Illinois Representative Robert McClory asked Felix what he would think if an M&A banker told his clients to buy the stock of a company targeted for purchase before the deal had been announced.

"It would be illegal," Felix said.

"What is the illegality involved?" asked McClory, trying to follow.

"The situation as you describe it, sir, would be if we, for instance, were retained by a corporation to act as their adviser in the acquisition of another company, and prior to the announcement of any transaction we went around to our clients and said, 'Buy this stock,' that would be the use of inside information," Felix said. "The arbitrage as I tried to underline, only begins--"

"Does that violate the SEC rules?" McClory interjected.

"Yes, sir," Felix continued. "But the arbitrage transaction only begins after the announcement of the terms of the transaction, so there is no use of inside information involved here, because the terms are out in the open. But the situation as you describe it, Congressman, would be an out-and-out illegality, as least as far as my understanding of the law."

Celler then stepped in. "Let me ask you this question," he said. "This restriction that you have placed on yourselves, has that restriction been followed by other houses on Wall Street who are competitors of yours?"

"I don't know, Mr. Chairman," Felix answered. "We don't talk to our competitors."

"You don't know?" Celler continued.

"No," Felix replied.

"They know about your restrictions, don't they?" Celler asked.

"No, sir," Felix answered. "They would not."

"It is not secret, is it?" Celler wondered.

"Well," Felix replied, the irony of the situation apparent, "the way we operate our firm, Mr. Chairman, is not something that we--let me say we are very jealous of our privacy."

"What you have adopted is credible," the chairman concluded. "Would it be to your advantage to spread that good gospel around the street?"

"I think, Mr. Chairman, people might think that we were being a little presumptuous," Felix answered.

"Maybe they would think you are fools," Celler followed.

"Maybe," Felix said.

After this pleasant exchange, the subcommittee moved on to Lazard's role as a paid strategic adviser to corporations. Celler said, "Can you tell us, roughly, how many concerns, and for want of a better term I use the words 'marriage brokers'--how many so-called marriage brokers effecting these mergers there are, say, in New York City, of the size and consequence of Lazard Freres?"

"I would hope that you would add moral caliber, Mr. Chairman, as another of our characteristics," Felix responded. "I would say, Mr. Chairman, that of the major, reputable investment banking firms that perform functions in this area, you would find most of the major investment banking firms in this business, I would say, being 10 or 15 firms of a major character." Felix would return often to this public obsession with the moral and ethical conduct of his fellow investment bankers--seemingly so fraught with cognitive dissonance--even as recently as July 2004, some thirty-five years after his testimony before the Celler commission. In a
New York Times
interview, he opined, "You should come to the business with a moral code. You're certainly not going to learn it later on. If people conduct themselves in ways that could be deemed immoral, I really wouldn't blame Wall Street, I would blame the individuals themselves who by and large should know better."

BETWEEN 1966 AND 1969, investment banking fees soared, mirroring the merger boom across Wall Street. The year 1970 would be very different. On Wall Street a full-fledged crisis was brewing, with brokerages becoming overwhelmed by an explosion in the volume of equities traded, without having the back-office capability to handle the increased paperwork. While the problem sounds mundane in the computer age, it was anything but boring for those involved. Even the most prescient firms suffered. The New York Stock Exchange quickly figured out it had a major problem. To get a handle on how to solve the crisis of failing firms and to salvage as many of them as possible, the exchange created the Surveillance Committee of the New York Stock Exchange, loosely referred to as the Crisis Committee. The exchange appointed Felix to head up the Crisis Committee in June 1970. He had been appointed to the stock exchange's board of governors in May 1968. Among his five partners in the effort were Bernard "Bunny" Lasker, then chairman of the board of governors. These wise men were very concerned that the collapse of one big firm would start dominoes falling, badly undermining confidence in the markets and potentially destroying the country's position as the center of global finance.

The crux of the problem, which Wall Street historians have dubbed the "back-office crisis," was that during 1967 trading volumes on the major stock exchanges exploded, and the private, poorly capitalized Wall Street partnerships were ill equipped to handle the extensive paperwork of settling trades occasioned by the "sudden and unexpected upsurge" in volumes. Many firms were slow to add the back-office personnel required to handle the new flow. Unfortunately, when the personnel were eventually hired--in a rush, of course--talent suffered. Some firms were drowning in a sea of unprocessed, and inaccurately accounted for, paper. But by the end of 1969, "the worst of the paperwork problems had been surmounted," according to Lee Arning, then a New York Stock Exchange executive. The crisis, though, had just begun, for at the very moment that many brokerages had increased their personnel costs to scale the mountain of paper, the volume of business fell off a cliff.

There was a feeling that 1970 was capitalism's most acute test since 1929. "We were looking at the world from a 650 Dow Jones, the Penn Central bankruptcy, a credit crisis, Cambodia, Kent State--and we didn't know where anything was going and it was a pretty grim world at this time," Felix told the
New York Times.
By midsummer 1970, Felix had a full-fledged crisis to resolve as head of the Crisis Committee: the near dissolution of the old-line, blue-blood retail brokerage Hayden, Stone & Co., where Joseph P. Kennedy had begun to build the fortune that would be used to propel his second son to the presidency. Hayden, Stone had sixty-two offices nationwide, but its back-office systems were a mess. Compounding its problems, the firm's older partners, upon retiring, were withdrawing their capital from the firm. This, combined with the failing fortunes on Wall Street in general, created operating losses that together pushed Hayden, Stone dangerously close to defaulting on a $17.5 million loan made in the spring of 1970 to the firm by a few of its clients in Oklahoma. When a lawyer for the Oklahomans discovered that Hayden, Stone couldn't account for some $7 million in securities, Felix and the exchange began searching for a buyer.

Although the Street would be aghast, Felix quickly found a savior for Hayden, Stone in Sandy Weill, the wunderkind financier who had presciently built a state-of-the-art securities clearing operation at his firm, Cogan, Berlind, Weill & Levitt (known as "Corned Beef with Lettuce" among Wall Street wags). Felix decided that Weill, who would go on to create the financial behemoth Citigroup, was one of the few people able to grapple quickly with Hayden's accounting deficiencies. According to
Tearing Down the Walls
, Monica Langley's authoritative account of Weill's Wall Street career, Hayden, Stone's scion, Hardwick Simmons, was dispatched to meet with Weill to see whether "a bunch of blue bloods would work for these scrappy Brooklyn Jews." Simmons, who later would head Prudential Securities and become chairman and CEO of the Nasdaq Stock Market Inc., recalled that he had "never heard of them, or 'Corned Beef and Mustard' or whatever it is. They're not even on our radar screen." On the three days leading up to the September 11 deadline, Felix alternated between meetings at the stock exchange, with Lasker and Robert Haack, the president of the exchange, and those with Harold Geneen, up at ITT. For his part, Simmons, the great-grandson of the founder Galen Stone, had no choice but to acquiesce, of course, and on September 11, 1970, CBWL purchased what it wanted of Hayden, Stone, especially the tony name, and became the new Hayden, Stone with, voila, instant prestige and history.

It was a real nail-biter, though, as the September 11 deadline loomed--either to approve the CBWL deal or to shutter Hayden, Stone. Felix recalled:

At 9:15 that morning, Lasker and I were talking to Golsen [Jack Golsen, the last holdout against the deal and one of the Oklahoma investors] and he said why shouldn't Hayden Stone go broke? Why should this be any different from Penn Central or Lockheed? He was mad. Somebody told him the financial community would never forget it if he failed to go along and he felt this was a threat. I think he also felt he was going to lose everything either way. The Cogan people had flown out there the night before and were working on him from 4 a.m. on. Golsen wanted to talk to Bunny and to me.... Bunny and I talked to him for over an hour. We talked national interest. We talked self-interest. Bunny was extremely effective. He's an enormously sincere man and in the clutch this was important because it came through. Finally, he said how much time can you give me and we said 15 minutes is all we have because we have to close the firm down before the opening of trading. Larry Hartzog [a lawyer for Mr. Golsen] got back to us and said, "Felix, you've got a deal." I went into the next room and told all these people they had a deal and then I took a very deep breath and walked out. It was five minutes to the opening.

On behalf of the New York Stock Exchange, Felix cut a deal with Weill that required the exchange to contribute $7.6 million in cash to the new company and to assume $10 million of Hayden's liabilities. The deal was a brilliant one for Weill and set him on his extraordinary path.

TWO MONTHS LATER, Felix and the Crisis Committee had another near disaster on their hands. This time, one of the Street's largest brokerages, F. I. DuPont, Glore Forgan & Co. started to fail barely six months after the shotgun merger that had brought F. I. DuPont & Co., Glore Forgan Staats, and Hirsch & Co. together in the first place. According to the
Times,
"The brokerage firm found itself in deep distress...its back office an insoluble snarl of paperwork and its account ledgers mired in red ink." Felix had had doubts about the three-way merger from the outset. "Figures from firms with huge back-office problems are meaningless," he told
Fortune,
"because you can't really know their position."

Once again, nothing less than the future of Wall Street was at stake with the potential failure of DuPont Glore. At the same time as DuPont was imploding, Felix and Co. had corralled the venerable Merrill Lynch into saving yet another firm, Goodbody & Co., a firm similar in size to DuPont. Felix remembered a particularly poignant moment when James Hogle, the principal investor in Goodbody, appeared before the Crisis Committee but refused to divulge the extent of the firm's capital shortage. "If you don't tell me the facts, you are not leaving here," Felix told Hogle. "And he looked at me and two tears rolled down his cheeks. It was a terrible, terrible moment."

But the deals had a house-of-cards aspect to them; Merrill agreed to take over Goodbody--after a $20 million indemnification from the New York Stock Exchange--but only if no other firm failed before Merrill could complete the deal. Recalled Lasker: "If DuPont had failed, Merrill Lynch would not have taken over Goodbody, and if both of these leading firms had gone down at once, there's no question that the effect on the country, on the industry, on investors, on the economy would have been severe, if not disastrous."

Riding in from Texas to rescue DuPont, sporting a three-piece suit and a crew cut, was H. Ross Perot, the founder, in 1962, with all of $1,000 in his pocket, of Electronic Data Systems Corporation, a computer services company. At that time, Perot was "one of the few men who ever made a billion dollars on paper," after EDS went public in 1968, at $16.50 per share, before soaring to as high as $161 per share in 1970. DuPont was also one of EDS's largest customers, a fact that had no doubt drawn Perot's attention since he owned, at that time, 80 percent of EDS's stock and the loss of a major customer would surely affect EDS's stock price. Perot claimed that EDS's stock price was not what motivated his interest in DuPont. "At
any
price per share, I am worth more than I ever dreamed I'd be," he said.