The last tycoons: the secret history of Lazard Frères & Co (70 page)

Steve walked away from the job as head of banking after the 1994 bonus and review period; Michel selected Ken Wilson to replace him. "When Steve arrived at the firm, Felix embraced him," Mezzacappa remembered. "He was young enough to be Felix's son. He was extremely talented and bright. My guess is that he was the most intelligent. It was all fine until Steve started getting some press--because the rule was you don't do that, only Felix can get the press--and Felix was unhappy about that. That's when the strain developed. Steve didn't back off, because he had his own clients. He wasn't in a position like everyone else--dependent on Felix's castoffs. He didn't back off, and of course Michel tacitly encouraged it because Michel liked to see division among the partners because it gave Michel the opportunity to come in and say, 'See, they can't operate without me.'"

WITH THE EFFECTS of the
Vanity Fair
article still reverberating around the firm, the lymphatic cancer in Lazard's municipal finance department continued to spread. The
Journal
's 1993 unflattering portrait of Richard Poirier's unsavory behavior in New Jersey coincided with the news, reported aggressively by the
Boston Globe,
that Poirier's partner Mark Ferber had quit Lazard in Boston, along with all eight members of the office, to join the regional brokerage First Albany Corporation as vice chairman and co-chief executive officer. "The guy's a good guy," one Lazard colleague told the paper. "He's not irrelevant. But it's not Felix Rohatyn. He was a very junior partner."

Thanks in part to well-crafted tips from many of Ferber's enemies, including Poirier, the
Globe
had a sixth sense that there was more to the story of Ferber's departure from Lazard than was readily apparent. Such was Ferber's stature that in the past, when he left Kidder, Peabody for First Boston and then First Boston for Lazard, a meaningful portion of the state's financing business followed him to his new firms. This is no small accomplishment for a banker. In explaining his success, Ferber had always maintained it came as a result of his knowledge of the intricacies of state government and his relationships with state leaders, rather than from any hidden arrangements. As expected, within days of Ferber's departure from Lazard, First Albany started to be included in the syndicate of firms underwriting Massachusetts's bonds. Then came the news that the Massachusetts Water Resources Authority, charged with cleaning up Boston harbor, had voted to move its $2.375 million, four-year advisory contract from Lazard to First Albany. First Albany, a tiny firm that did not even rank among the top hundred brokerages, would be paid nearly $600,000 a year for its financial advice. "In our view and in the view of the financial services industry generally, the transfer of the former Lazard team to First Albany positions First Albany as one of the most qualified financial advisers in the country," the head of the MWRA, Douglas MacDonald, wrote to explain his group's decision after the Massachusetts inspector general, Robert Cerasoli, raised questions about it. Cerasoli remained concerned, though, about potential conflicts of interest between the people and firms awarding and benefiting from the state contracts and demanded that all advisers to state agencies disclose all potentially conflicting arrangements. He also didn't believe First Albany was qualified for the assignment or deserved the same compensation for it that Lazard had received.

To comply with the inspector general's request, on May 27, 1993, Ferber--now at First Albany--wrote a one-paragraph letter to the MWRA, his client, revealing the existence of a contract between Lazard and Merrill Lynch, the MWRA's lead underwriter, under which they split more than $6 million in fees and commissions in exchange for Ferber and Lazard recommending that state agencies in Massachusetts use Merrill for financing and interest-rate swaps, a way for municipalities to reduce their interest costs. Merrill also paid Lazard $2.8 million in "consulting fees," and in return Ferber "was expected to help introduce Merrill Lynch to his contacts in government agencies" with the expectation that these agencies would choose Merrill Lynch as an underwriter of bonds and other financial transactions.

At the same time, of course, Ferber and Lazard were supposed to be giving the firm's municipal clients in Massachusetts unbiased, independent advice. The Lazard-Merrill arrangement, eerily reminiscent of Lazard's undisclosed deal with Mediobanca in the 1960s, ran from December 1989 to December 1992 and had never before been disclosed to the water authority. When the
Globe
broke this story on June 21, the paper reported that during the time period covered by the contract, Lazard helped "select Merrill Lynch as the agency's bond underwriter and has been involved in overseeing its work." The nub of the problem, the
Globe
wrote, was that "while by no means illegal, the fee-splitting arrangement between Lazard Freres and Merrill Lynch is a symptom of an underregulated municipal finance industry, where political connections can often bring more dividends than the substance of an underwriter's proposal and where hidden conflicts often abound."

When asked at the time to comment about the arrangement with Merrill that he engineered, Ferber told the
Globe:
"I'm not telling you it's pretty but there is absolutely no violation of my fiduciary responsibilities." When Douglas MacDonald heard about the existence of the Lazard-Merrill contract, he was not happy. Still, he told the paper he felt that the water authority's "interests were protected" by Ferber's earlier oral disclosure to the authority's director of finance, Philip Shapiro, of the existence of Lazard's contract with Merrill. Cerasoli, though, first heard about the Lazard-Merrill contract in the
Globe
story. In a letter to MacDonald two days later, he wrote he found it "especially alarming" that MacDonald had told the paper about Ferber's "unwritten disclosure" of the contract to Shapiro when more than three months earlier Shapiro failed to disclose any knowledge of the contract to the inspector general's office during an interview about the matter. Now, clearly exercised, Cerasoli started a full-scale investigation of Ferber's behavior. Even MacDonald began to realize he had been duped.

A month later, with the controversy still percolating following the MWRA's decision to bar all of Lazard, Merrill, and First Albany from working with or for the agency, First Albany's board of directors voted "to terminate the employment" of Ferber. The
Globe
had also revealed that while Lazard and Merrill had their contract and First Albany had been an underwriter of Massachusetts bonds, First Albany had also paid Lazard and Ferber $170,000 for general corporate financial advice. A September 1993
BusinessWeek
cover story featured the controversy and described Ferber as "the investment banker who played by his own rules." Richard Roberts, an SEC commissioner, told the magazine that Ferber's side deals "violate everything that a financial adviser is supposed to be about: impartiality, objectivity, third-party advice." Ferber disagreed. "The contract, as reviewed at the time by Lazard's general counsel and as drafted by a major New York law firm, did not violate any laws, regulations, ethical standards or fiduciary duties owed by this or any other financial adviser," he said. A Lazard spokesman sought to pare responsibility for the matter away from the firm. He said that the "contract clearly envisioned disclosure to Mr. Ferber's clients" and that Ferber had "assured us that he did so." Merrill described the contract as "proper, ethical and legal." The inspector general, meanwhile, continued his probe throughout the summer and fall of 1993.

Inside Lazard, the senior partners were working with Wall Street's best lawyers to formulate a legal strategy to deal with the growing scandal. Loomis wrote a September 9 memo to Mel Heineman, with a copy to Michel, recommending that the law firm Cravath, Swaine & Moore be hired to work with Wachtell, Lipton, Lazard's usual outside counsel. "I believe that our best assets are our franchise, or reputation, and our leadership, Michel. Both of these may erode as defenses if we engage in a protracted process of attrition which leaves us small but not unique--an ideal target," he said. He recommended closing the municipal finance department immediately and establishing a blue-ribbon panel to review Lazard's activities in municipal finance as well as the industry as a whole across Wall Street. "The problems of business practice would be those common to other firms and constitute industry reform by the first example of how to avoid problems, having forthrightly addressed them on our own," he wrote. His recommendations were ignored--until it was almost too late.

On December 16, Cerasoli released his report, and in a cover letter to Massachusetts's governor, William Weld, he wrote that what he had uncovered was "so extraordinary and compelling" that he felt the need to make a public disclosure and "accentuate the need for a dramatic switch away from business as usual in negotiated bond sales, toward a policy which favors open and competitive bidding. The issues are national in scope and not solely those of the Massachusetts Water Resources Authority." The inspector general's December report revealed that Merrill and Lazard had misrepresented their relationship in disclosure statements made to the MWRA. The report also disclosed that Ferber had been coaching Merrill's bankers about how to win business from the state and revealed helpful information about what other underwriters had proposed in their efforts to win business. Even worse, "the evidence suggests that despite Merrill Lynch's disclaimer, [Ferber's] advocacy of Merrill Lynch as a member of the Massachusetts Water Resources Authority's underwriting team was a
quid pro quo
for the firm's delivering lucrative business to him in other deals, including out of state deals." Documents showed that Ferber told his counterpart at Merrill that Ferber "works to make a positive spin for Merrill Lynch's performance at every turn" but that he wanted business in return, from Merrill, with "his name on it." The documents show further that Ferber had given the Merrill banker a "warning that without a return on his investment, he will hurt us. I will discuss this in more detail when I have a chance to reflect on it--right now, my mind is mush." Not only did Merrill then direct non-Massachusetts business to Ferber and Lazard--they worked together in Washington, D.C., Indianapolis, Arkansas, Florida, Michigan, and for the U.S. Postal Service--but this led to the advisory contract between the two firms, initially for an annual retainer of $800,000 for 1990, and subsequently increased to $1 million annually for 1991 and 1992. Cerasoli also documented other instances where Ferber had tried to pressure other investment banks to throw some business his way in exchange for favorable treatment from the agencies he represented: the report stated that Goldman Sachs accommodated Ferber's requests and received underwriting business, while Lehman Brothers ignored him and was cut out of the underwriting syndicate. Merrill was an enthusiastic player in Ferber's scheme. Wrote the Merrill banker Jeff Carey to his bosses: "We need to find a way to 'reach' Ferber since everyone acknowledges that he will not only shape the [MWRA's] evaluative process but also critically influence the finance committee and Board actions" in selecting bond underwriters.

The inspector general's report went on in this vein to detail other breaches between the two firms and the fiduciary duties they owed to the citizens of Massachusetts. "In summary," Cerasoli wrote,

I have provided this information to you because it contradicts the disclosure made to MWRA by Merrill Lynch that its contractual relationship with Lazard Freres & Co. "was not in connection with its provision of, or expectation to provide services to the MWRA...." On the contrary, one of the most disturbing implications of these communications is that Merrill Lynch did not tell the MWRA the truth in its disclosure statement (i.e., that it expected [Ferber] to encourage the Authority to give the firm business). Just as important is the fact that Lazard Freres, which owed its loyalty as a fiduciary to the MWRA, mistreated the Authority and put it at risk. The MWRA contracted with Lazard Freres, on the assumption that it would be its advocate, and paid the firm a premium, approximately $600,000 per year for its financial advisory services, despite the misgivings of some Board members about the amount of the contract. Any expectation that paying a high fee would translate into quality was not met. Instead, Lazard Freres treated the MWRA as collateral to increase its own profit by seeking and obtaining other business with the Authority's underwriters.

It is difficult to conceive of a more damning indictment of Lazard and Ferber's behavior--a mere six months after
Institutional Investor
had lionized the firm and Michel, in a May 1993 cover story, as seeking to be the paragons of ethical behavior on Wall Street. Without its carefully cultivated reputation for independent and unbiased financial advice, the firm might as well not exist. But there was no firm-wide statement from Michel or from Mel Heineman, the general counsel, about Cerasoli's report. There was no discussion at all, in fact, about these allegations, at least among the rank and file at Lazard.