The Devil's Casino (10 page)

For a while, however, he concentrated his energies elsewhere.

Fuld and Hill soon learned what Golub was up to. Through the trading floor rumor mill they heard that he was planning to shed Shearson, and that Sandy Weill, who had sold Shearson to American Express in 1981 and was an old friend of Golub’s, was prepared to buy it for $1 billion. The catch: He didn’t want Lehman. He knew about its rowdy culture and prickly senior management.

Not being told of these discussions greatly irked Hill and Fuld, and Hill confronted Golub. He asked him, “What’s the price tag for Shearson?”

Hill says, “He threw out a number. And I said, ‘Well, who’s the buyer? What was the process?’ He said, ‘ I’ve decided this is the best offer.’ And I said, ‘Well, were there other bidders? Was there competition? How do we know this is the best price out there?’ He said, ‘ I’ve made a strategic decision to sell it. I want you to do one thing, and that’s to make sure this deal closes. If I hear anything that you are getting in the way of this deal closing, I’ m going to fire you.’ ”

Worried that Lehman was going to get hammered in the deal because it would lose distribution, Hill went behind Golub’s back and talked to an acquaintance, Sandy Weill’s then-deputy, a rising financier named Jamie Dimon.

Hill says he told Dimon: “‘I know what’s going on. Sandy knows Harvey has told us to roll over. But we’re not going to do that. We’ re not going to get in the way of this deal, but you can’t screw us. We’re going to defend the value here, just as you would be defending the value if you were in our shoes.’ And Jamie agreed to work with us.”

The only leverage Hill had was his friendship with Dimon. Their daughters went to the same school in New York. Perhaps both sensed that Wall Street is a small place and that they were destined to cross paths again (they did), or Dimon knew that in the long run there was no upside in upsetting Hill. “Jamie knew that he was already getting one hell of a deal on a plate and that he didn’t need to make it worse for us,” says Hill. “There was zero upside for him in doing that.”

Fuld and Hill knew they had only forestalled the inevitable—that Golub would dump Lehman. He just wanted Amex. After meeting with Golub in order to discuss his concerns going forward, Hill told Fuld: “He [Golub] doesn’t like the securities business. He wants to be in the credit card business. And he’s going to get rid of us just as soon as he can, too.”

Hill was right. But he had not foreseen one important detail in Golub’s grand plan. On March 29, 1993, Golub fired
Hill
.

“Where’s Dick on this? ” was Hill’s first question to Golub. “In the office next door,” replied Golub. In other words, Fuld already knew.

Gallatin, who had by now earned the official title “minister without portfolio,” says that Hill’s exit was inevitable. “Golub knew he had to spin off Lehman, and between the two of them [Hill and Fuld], the one he least wanted to deal with was Hill, because Hill was this mature, brilliant M&A banker he didn’t want to have to negotiate with. It didn’t cross his mind that maybe by now Dick Fuld had every attribute that made Tom who he was.”

Gallatin thinks that Fuld was now finally ready to apply all that he’d learned in his so-called postgraduate studies of Tom Hill. “He realized that there was only going to be one leader—but who? In Dick’s mind, that was a silly question: it was going to be him.”

I knew I would be retiring soon. I thought: “What the heck.”

I will take it upon myself to fight one last battle for Lehman

Brothers.

—Ronald Gallatin

I
n early winter of 1994, Harvey Golub hosted a meeting in a conference room in lower Manhattan to negotiate the spin -off of Lehman with his hand-picked opponent, Dick Fuld. With Hill gone, Fuld knew he needed help getting favorable terms from Golub, who knew Fuld wanted desperately to be the next CEO of Lehman Brothers. If Fuld was too disagreeable in these negotiations, Golub had the power to fire him, thus ending Fuld ‘s campaign to get the top job. To help him, Fuld had brought John Cecil and Ron Gallatin.

After announcing that he planned to spin American Express out, Golub blithely told Fuld, Cecil, and Gallatin that he’d leave Lehman with $2.8 billion in equity—enough, he said, for them to get a single A rating.

Gallatin smiled at Golub and said, “Three point six.”

Gallatin’s counter-proposal was understandable. He believed Golub was trying to shortchange Lehman. With only $2.8 billion on their books, with a strong fixed income department but weak banking and equities arms, Lehman needed a cushion. But Golub thought Lehman could get by on $2.3 and was furious that his half-billion of padding wasn’t enough for Gallatin. He screamed, “Two point eight!”

Gallatin, still calm, his voice low, repeated, “Three point six.”

Perhaps thinking he hadn’t much to lose—he was nearing retirement—Gallatin decided he would be the one to fight for Lehman’s future, and maybe establish his legacy as well.

Golub screamed at Gallatin, “You can convince them to give you an A rating with $2.8 billion!” Gallatin smiled again and said, “Maybe I could, but I’ m not going to.”

Golub told everyone at the table that it was $2.8 billion or “I will crush you like a fly!” Some executives were startled at his display of temper.

Gallatin calmly threatened to take the story to the press—and reminded Golub that he had already announced he would be doing the spin-off at a single A rating. Gallatin’s implication was obvious: Did Golub want to look like he wasn’t keeping his word? Would people start to wonder about the sincerity of the management of American Express?

In the end, Gallatin won out; but when Lehman was finally spun off, it had a few onerous terms foisted on it by Amex.

Golub forced Lehman to buy from Amex several floors in the World Financial Center at top-of-the-market prices, so they were now “co-tenants.” Together, Lehman and Amex had issued $700 million to $800 million of long-term notes to finance the property. Lehman’s share of this debt was about 50 percent, but the debt was guaranteed by Amex, to whom Lehman had to pay a “guarantee” fee of 928 shares, and Nippon Life Insurance Company acquired 72 shares of Lehman redeemable voting preferred stock. There was also a noncompete clause with regard to bankers; Lehman could not hire any American Express bankers for eight years (fortunately the Lehmanites didn’t want to). Amex would be entitled to 50 percent of Lehman Brothers’ net income over $400 million for each of the next eight years, with a maximum of $50 million in any one year. The Lehman senior management saw it as a “Get Out of Jail Free” card. The terms weren’t that bad—and finally they were in charge of their destiny.

To fund the spin-off, Amex agreed to inject over $1 billion into Lehman—$904 million to buy Lehman common shares that would then be distributed to Amex shareholders as a special dividend, plus another $200 million to buy Lehman preferred shares. American Express would not hold a single common share of Lehman, nor have a single seat on its board.

The deal still had to be approved by American Express’s board--most of whom were skeptical that a spin -off was a good thing. Lehman, after all, made money. Golub placated them by saying that the spin-off would be tax-free.

Golub asked John Cecil and Lehman investment banker Michael Odrich, a good-looking, personable banker who was then Fuld’s chief of staff, to make a presentation to the board, explaining how Lehman could be successful as a public company. It was set for January 20, the day of the AT&T Pro-Am golf tournament at the legendary Pebble Beach golf course, and Odrich says he appealed to Fuld for a dispensation so that he could play in that event. He reminded his boss that if one played even once in the Pro-Am, one was “in” for life, but if one declined an invitation, one wasn’t invited back. Golf was an obsession for both Fuld and Odrich (and was the hobby of choice at Lehman), but Fuld told him no, and said he ‘d make it up to him. (He never did.)

The presentation—a basic run-down of the businesses within Lehman, and what the economics looked like going forward—went over well, and the board signed off on the deal. Two memorable moments occurred, first, when former Secretary of State Henry Kissinger, then on the American Express board, opened a sweetener packet, emptied it into his iced tea, then stirred the beverage with his pencil—eraser end first.

The second was when another board member, former U.S. President Gerald Ford, asked Golub if he could please explain the difference between “equity” and “revenue.” There was an awkward moment of silence as everyone digested this.

One person in the room recalls that Golub “did a very skillful job. I was very impressed. It’s a very basic concept, and he explained it to the former president without making it sound like he was talking down to him.”

On May 2, 1994, Lehman went public. By the end of the month, the spin-off complete, Golub reportedly exclaimed, “Let this puppy fly!” Cecil had been persuaded to come onboard—theoretically as chief administrative officer (
CAO
). Cecil understood implicitly that he was number three in the food chain, with Pettit immediately above him.

It was an arrangement that sat well with all three. Neither Pettit nor Fuld felt threatened by Cecil, who was aided in this regard by his unimposing physique and academic manner. Traders regularly joked about his analytical brain being woefully out of place in a bank made up of rough-and-tumble brawlers.

At one meeting Fuld said, “John, what do you think?”

“I’ m still thinking,” came the reply.

“Well, get yourself warmed up,” said Fuld. “We’ re waiting.”

But Cecil was a valuable member of the team. He was able to analyze the new bank objectively, identify its strengths and weaknesses, and give Fuld and Pettit guidelines for what they needed to do.

The short answer: There was a lot that needed fixing.

Despite the valiant predictions to the American Express board and the garish celebration held in the Winter Garden Atrium, a party venue in downtown New York where balloons cascaded down from the ceiling and where Lara Pettit recalls her father standing “very proud, upright, his fist in the air” reminiscent of a triumphant French revolutionary, the new Lehman Brothers was very fragile.

By September, Lehman began buying back stock from investors who owned fewer than 100 shares. Earnings in the second quarter of 1994 dropped 79 percent from the prior year, and profits fell by over half. In July, the employees who could afford to do so bought Lehman stock; Fuld sensed that at $14 the purchase would be a steal. He bought a lot.

By the end of October, Fuld owned more than 179,000 Lehman shares, the majority purchased at $25.54 per share; Pettit owned more than 132,000 shares. It wasn’t a tactic they could use forever, but it worked in the short term; and over the long term, it made them all very rich, at least on paper. “We had the last laugh,” says Ronald Gallatin.

“The stock did trade poorly initially,” says Cecil, “in part because there hadn’t been a market created for the stock, really, as a new company, but also because these shares were given to American Express shareholders, who really wanted to own American Express.” Those folks quickly dumped their Lehman stock, devaluing it.

Adding to the new company’s problems: In 1994 the Federal Reserve tightened interest rates, which, as a general rule, impacts the price of bonds negatively, and thereby weakened Lehman’s fixed income division. Its share price fell 30 percent in just five months, from $20 per share when it first went public in May to $14 per share in October. (In a final kick to the 14 or 15 executives on Lehman’s operating committee, Golub had made them buy the stock at book value. They had to pay $20 per share when it was trading for $14.)

Less than a year after Lehman went public, Moody’s would downgrade its rating.

It was time for Fuld, Pettit, Gregory, Tucker, Lessing, and their band of merry men to do what they did best—roll up their sleeves and go to war.

According to the methodical John Cecil, Lehman had to do four things if it hoped to survive.

Above all, it had to cut costs—there was still a vast amount of fat, including luxuries such as the barbershop and shoe-shine stand on the executive floor, and Lehman was paying out over half of its revenues in compensation and another 41 percent in “nonpersonnel expenses.”

Not only was cutting costs “the right thing to do,” Cecil argued, but it would also buy them time and capital to grow their other businesses. Still, there was the inevitable push-back. One person joked, “When the milk came out of the refrigerator and they replaced it with dairy creamer, we knew it was a bad market.”

Cecil also decreed that the nepotism had to stop. Family members and friends could no longer be hired unless they actually merited a spot. (Steve Lessing, in particular, was infamous for placing an inordinately large number of alumni from Fairfield University, his alma mater.)

The new recruiting strategy was largely led by Joe Gregory and Pettit, and only the best would be hired. According to Tom Tucker, “the best” did not mean “the elite.” In other words, Harvard MBAs were welcome in areas such as investment banking, where Harvard MBAs were likely to do well. In other areas, like bond sales, Lehman was looking for people who were hungry and could work in a team.

The third goal was to be competitive in all capital market areas, globally, beginning with Europe and Asia.

The fourth and most important part of Cecil’s survival strategy was to fix the culture of the firm. “Doing the right thing for the firm” and “One firm” had to be more than platitudes. Everybody had to buy into that ethos if Lehman was to become the place Dick Fuld, Chris Pettit, Joe Gregory, Steve Lessing, and Tom Tucker wanted it to be.

Cecil thought this was crucial for many reasons, but chiefly because he knew that a securities house could be ruined at the whim of a single trader. The only way to stop “selfish ” or “foolish” acts of trading, as he called them, was to get people to always consider the firm’s return on equity (
ROE
)—and not just their bonuses—before acting. In pursuit of this Cecil introduced the restricted stock unit (
RSU
)—as a form of payment to every “firm member.”