The last tycoons: the secret history of Lazard Frères & Co (71 page)

As the paper that broke the story, the
Globe
had a field day with Cerasoli's report. On December 17, the paper faithfully described the report's scathing contents on the front page and also revealed that the "dealings" between Merrill Lynch and Lazard had "become the focus of federal and state investigations" in which "thousands" of pages of subpoenaed documents were being reviewed to "determine if Ferber violated his fiduciary responsibilities as financial adviser to the MWRA and other agencies through his ties to Merrill Lynch." Ferber's lawyers called the inspector general's report "outrageously erroneous, incomplete and out of context." But MacDonald, the MWRA executive director, said the report "is really unbelievable. If what is alleged in these documents is true, we're talking about a very serious statewide problem, not one confined to the MWRA."

The press coverage of Cerasoli's report led to another bit of bad luck for Lazard and its municipal finance department. Michael Lissack, a senior investment banker in the public finance department of Smith Barney, read an article about the report while on vacation in Florida and realized the Massachusetts state investigators were missing another important--and quite complicated--part of the emerging illegal activity that had been occurring in municipal finance departments across Wall Street, including at Lazard. From the beach, he walked to a pay phone and placed what started as an anonymous call to the U.S. attorney's office in Atlanta "to let the government in on Wall Street's dirty--but very profitable--little secret." For several years, he told them--in an act of betrayal that would not win him many friends on Wall Street but would get him "whistle-blower" millions--investment banks had engaged in systematic, industry-wide overpricing of securities sold in connection with certain municipal bond transactions. Hundreds of millions of dollars in illegal profits had been pocketed by Wall Street. Lissack stressed that these overpricing practices--known as yield burning--were the true scandal on Wall Street, for they infected thousands of transactions across the country and touched nearly every public issuer of municipal debt. Yield burning was hurting the Treasury, the bond markets, and taxpayers far more than any market-splitting arrangement.

Thanks to Lissack's call, Lazard would soon be embroiled in yet another scandal--the so-called yield-burning scandal--to go along with investigations into the questionable behavior of both Poirier and Ferber. There was now a nagging sense that Lazard, despite its immense prestige and profitability, was dangerously out of control and a pattern of criminal malfeasance had emerged. Not surprisingly, the federal authorities were by now in regular communication with the Lazard senior partners and the firm's lawyers about the goings-on in the municipal finance department. There was the possibility that the firm would be prosecuted under the Racketeer Influenced and Corrupt Organizations Act, known as RICO, which would likely put the firm out of business. One partner recalled, sadly, "Lazard was told by the feds, 'Hey, look, guys. You got two bad actors. Ferber and Poirier. Kidder went down. Drexel went down. We're really trying to be sensitive to the fact that we can put companies out of business, because we see we can do that, just by suggesting something. You know, the RICO word. So we're just letting you know.' And we cooperated like sons of bitches. So then all of a sudden, along comes yield burning. It's like, 'Holy shit. We are teed up like nobody else is teed up.' And our pitch to clients does not have a broad appeal: it's trust and close relationships, and all that. And we ain't got much capital. And we were teed up."

To this point, the New York papers had no coverage of the matter. But in May 1994, the
New York Times
weighed in with a devastating thirty-four-hundred-word article about Ferber and Lazard. There wasn't anything particularly new in the article, but since it was the
Times,
Lazard felt the need to react to it. Two days after the article appeared, a memo was sent to the firm's partners and vice presidents, under Michel's name (but clearly written by lawyers), seeking to definitively refute its implications. "Many of you undoubtedly read with great frustration" the Ferber story, Michel wrote. "While the article covers old ground, yet again, it is important to note a few key points which the article mischaracterizes or fails to reflect, despite our best efforts to educate the reporter."

The firm's view, as articulated by Michel's memo, was: "The New York partners who approved the 1990 contract between Lazard and Merrill Lynch believed it to be entirely proper and it was reviewed by counsel. It provided that Mark Ferber would provide consulting advice aimed at improving Merrill Lynch's marketing of municipal swap transactions (in return for an annual retainer), and that Lazard and Merrill Lynch would jointly pitch swap transactions to Lazard municipal underwriting clients (in return for a split of the fees paid by the municipal client). We were of the view that Ferber had negotiated the contract at arm's length and that it involved a fair exchange of legitimate consulting services for appropriate compensation." Michel denied the contract was kept "secret" and stated that Lazard had insisted that disclosure clauses be added to the contract to ensure that Ferber explained to clients that "Lazard had a swaps-based relationship in those situations where Merrill Lynch was pitching swaps to Lazard's financial advisory clients." Michel wrote that Ferber had informed the New York partners "both in writing and orally" that he made proper disclosure of the relationship "wherever Merrill Lynch was proposing swaps to Lazard advisory clients." As to the Massachusetts inspector general's allegations against Ferber, whom the firm by this time no longer had access to, Michel wrote that Lazard had "stressed" to the
Times
reporter that "we were profoundly disturbed" by them and that if Ferber had indeed breached his fiduciary duties to the firm's clients, as alleged, this behavior was "abhorrent," adding, "We could not have been stronger on this issue, and it disappoints us that the story as printed fails to reflect this." In closing, Michel wrote that the firm would await the outcome of the two investigations into the matter. "In the interim, we intend to continue to assist them to the best of our ability," he stated.

Michel's Cartesian logic was, as usual, impeccable. But the fact remained that despite the precise explanation, Lazard had entered into a most unusual arrangement with one of its competitors to the apparent detriment of its clients--a cardinal sin if your reputation is premised on offering unbiased, independent advice. "Seldom do you see two national firms coming together to co-pitch business," a managing director at another firm told the
New York Times.
"You might see a regional and a national, but rarely two nationals." In October 1994, the SEC informed Lazard, Merrill, and Ferber that it intended to file charges against them all "for maintaining a secret contract to split millions of dollars in bond fees." In January 1995, in order to avoid a lawsuit from their dealings with the District of Columbia, Lazard and Merrill each agreed to pay $1.8 million. And by the middle of 1995, Richard Poirier decided to quit Lazard amid the ongoing SEC and U.S. attorney investigations into how he and Ferber won business for the firm.

DESPITE THE INCREASINGLY public nature of the feud between Steve and Felix because of the
Vanity Fair
article--now compounded by rising concerns about the mushrooming municipal finance scandals--Steve's deal-making prowess continued unabated. And what was fascinating about his oeuvre was how it sprang mostly from a well of his personal relationships--not all that dissimilar from the way Andre worked. First, in late 1993, came the blockbuster $13.9 billion sale of McCaw Cellular to AT&T (for a $20 million fee) that forever transformed the wireless industry in this country from an entrepreneurial endeavor to a high-stakes, well-capitalized, essential service. Steve, of course, represented his friend Craig McCaw. Then, in July 1994, he represented his friend Brian Roberts in the first of several of Comcast's audacious and transformative deals, the successful hostile acquisition, with its partner Liberty Media, of the home shopping network QVC, a deal that thwarted the merger between QVC and CBS. The QVC deal proved to be incredibly lucrative for Comcast; in December 2004, Liberty bought Comcast's 57.5 percent in QVC for almost $8 billion, a stake Comcast had bought, with Rattner's help, for $1.9 billion. Just as the AT&T-McCaw Cellular deal was closing, in September 1994, the Ziff family (and in particular Steve's friend Dirk Ziff), of New York, hired Steve and Lazard to sell, discreetly, the Ziff Davis Publishing Company, the nation's leading publisher of computer magazines. Before long, Steve had contacted Forstmann Little, and the firm quickly made a preemptive bid, buying 95 percent of the company for $1.4 billion. Forstmann's offer of speed and certainty to the seller had prevented other buyers from having a chance to get the business. But others were still interested. Ten months after Forstmann closed the Ziff Davis deal, the SoftBank Corp. of Japan formalized its interest and bought the company for $2.1 billion, a profit of $700 million for Forstmann--one of the more stunning and lucrative buyout deals of the 1990s. Steve advised Forstmann on the sale. Then, if all this wasn't enough, Steve represented another buddy, Amos Hostetter, in the sale of his cable company, Continental Cablevision, for $10.8 billion to the telephone company US West.

Felix was busy doing deals, too, including the landmark sale of the software pioneer Lotus Development Corporation, the maker of Lotus 1-2-3 and Lotus Notes, to IBM for $3.5 billion in cash, at that time the largest software deal ever. The deal was also notable because IBM, the bluest blue-chip company in corporate America, had launched a surprise all-cash $60-a-share hostile bid for Lotus on June 5, 1995, a premium of nearly 100 percent to where Lotus was trading before the offer. Everyone considered Lotus dead in the water given IBM's offer. Felix, who had no idea how to use a computer, worked on the Lotus deal with his partner Jerry Rosenfeld, who had joined Lazard in 1992 after a stint at Bankers Trust. Rosenfeld knew the Lotus CEO, Jim Manzi, well from their days together at McKinsey & Company, and Rosenfeld had, typically, introduced Felix to Manzi in an effort to seal the relationship between Lotus and Lazard.

When IBM launched its hostile bid, Manzi called Rosenfeld and Felix. After initially rejecting IBM's all-cash offer, Lazard and Lotus negotiated to increase the IBM offer from $60 a share to $64 a share. Lazard received a $9 million fee for its work. Ironically, six months before IBM launched its bid for Lotus, Manzi had feared this very thing and had confided his concern to Felix. "I'm a bit worried that IBM might try to do something hostile with us," Manzi said he told Felix. "This was six months beforehand. And Felix said, 'Don't be stupid, they would never, ever do anything like that, that's not the way they operate,' or words to that effect." They still joke about the turn of events today.

Lazard, thanks to the dynamic duo of Felix and Steve, had become
the
premier media and communications advisory firm on Wall Street. But all was not well in paradise. The two men were like prizefighters circling each other warily in a title bout, and the challenger's incessant rope-a-dope had just opened a bloody gash under the eye of the aging champ. There was a moment early in 1995 when Felix considered leaving Lazard altogether. He had been skiing in the picturesque village of Zurs, Austria, with his wife when he got a call from Roger Altman, the Clinton confidant and friend of Steve's who several months before had resigned his position as deputy Treasury secretary. Altman was still close to Clinton, of course, and Clinton had authorized him to talk to Felix about becoming the next president of the World Bank, replacing Lewis Preston, who had just told Clinton that he was ill with the cancer that would soon kill him. The Rohatyns were very friendly with the Prestons, and Felix knew of Preston's illness and that he had told Clinton he would be stepping down. Altman told Felix: "'You know, Clinton really likes you. He thinks you'd make a great World Bank president. [Treasury Secretary Robert] Rubin doesn't like [James] Wolfensohn, who was the leading candidate. And if you told us you'd be interested, you would get appointed. But also remember that you really should--if you do, you should be able to make a moral commitment for two terms, which would be twelve years.'"

Felix asked Altman for a few days to think about the offer. He was very intrigued for any number of reasons--among them, his growing frustration with the dynamic inside Lazard. But he had never
run
anything before, let alone something as massively bureaucratic as the World Bank. "Running a big bureaucracy was never my cup of tea," he said. And Elizabeth was dead set against it. Aside from the requisite move to Washington, there would have been extensive travel worldwide to attend ponderous meetings. And there was also the twelve-year commitment, which would have put Felix close to seventy-eight years old by the time he left the job. Felix called Altman and told him he would pass. Wolfensohn got the job and served for ten years. There was only the barest mention in the press that Felix had been considered for the post. But that mention revealed to the outside world a character flaw. "I didn't want the World Bank," he reportedly said. "But I almost took it so Jim Wolfensohn wouldn't get it."