The last tycoons: the secret history of Lazard Frères & Co
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Lazard Brothers dispatched one of its most senior partners and a close friend of Altschul's, Robert Brand, to Vienna to negotiate, along with the other hundred or so creditors of the failed Austrian bank, how Lazard would get its money back. After days of negotiation, Brand took the train from Vienna to Brussels, and from there he was to make his way back to London to inform his partners about the status of their loan. On the train platform, as steam and smoke billowed through the glass-covered station, Brand saw Joe Macartney-Filgate, his junior partner, in the distance. When Macartney-Filgate saw Brand on the platform, he rushed over to him with shocking news he knew Brand did not have. But Brand spoke first. "There'll be a terrible time," he told Macartney-Filgate. "We're not going to get our money back. We're going to lose PS40,000." Then the junior partner blurted out, "Well, I really have something to tell you. We are bust. We have lost PS4 million." The loss was more than the entire capital of Lazard Brothers; the firm was technically bankrupt. The two partners then boarded the last night train for London, and over an entire bottle of scotch Macartney-Filgate proceeded to tell Brand the saga of the shocking overnight demise of Lazard Brothers.
Thanks to the cash infusion from Pearson, Robert Kindersley had decided after World War I to open a Lazard office in the quaint Belgian port city of Antwerp to conduct a business in foreign exchange. The office was successful, but the firm apparently felt "handicapped" without an additional office in Brussels, the capital of Belgium. An even smaller office was opened there, and a man of Czech nationality--whose last name has alternately been said to be "Vithek," "Wilcek," and "Cireak"--was put in charge. The Brussels office "developed quite a business" in foreign exchange. What Macartney-Filgate told Brand on the evening train to London on that July 1931 night was that he had been dispatched that day to Brussels to investigate reports that the Czech had made a massively bad bet against the French franc and had covered up the error by issuing unsecured promissory notes across Europe in the name of Lazard Brothers. Several holders of the promissory notes had called the firm to demand repayment, thus setting off a series of events that led to Macartney-Filgate's shocking discovery. When Macartney-Filgate confronted the banker with the rumor of malfeasance, the Czech confessed to his mistake.
Later that evening, though, as the magnitude of the capital loss became known and a full-scale investigation had begun, the Czech pulled out a gun and shot himself. He was found dead, in a pool of blood, underneath his desk. Kindersley had been increasingly suspicious of the Czech's behavior in the months leading up to his suicide. He had been getting odd reports that the Brussels office had been borrowing money on the Continent at above-market rates, a sign of financial distress. An immediate investigation revealed that the Czech had been engaged in an unsupervised series of catastrophic bets using the firm's capital. It is not clear whether these aggressive trades were limited to foreign exchange or whether he had also made several poorly timed major investments in the Brussels stock market. A subsequent, secret report by the Bank of England found that "the irregularities to which this state of affairs was due had been going on for some years but had not been discovered by the Company's Brussels auditors (Whinney, Smith & Whinney) owing to the facts that--1. All the senior members of the staff were implicated, 2. A secret set of books had been kept by the bookkeeper in addition to the ordinary books produced to the auditors, and 3. The office had been able to borrow large sums on the Company's credit without having to pledge security.... The Company has now to consider whether to suspend business at once and liquidate or, provided the necessary funds can be obtained, to reconstruct and carry on." The Czech was the classic rogue trader who doubled down on bad bets and hid his deception from the firm's auditors by keeping a duplicate set of accounting records. His suicide, combined with the confession of "another member of the staff," revealed a loss of some PS5.85 million, some 50 percent more than Macartney-Filgate had thought originally and almost twice as much as the stated capital of Lazard Brothers. There was said to be a posthumous note from the Czech sent to the David-Weills in Paris: "Tomorrow, the Lazard House will go down."
A full-blown crisis engulfed the firm, one even more serious in its way than that caused by the great earthquake twenty-five years earlier. David David-Weill was summoned immediately from Paris to London. Pierre, his son, had been traveling in Egypt with his fiancee. He returned, too. On the night of July 14, 1931, Kindersley asked for--and received--a secret meeting with Montagu Collet "Archie" Norman, the governor of the Bank of England. Kindersley told Norman about the huge loss Lazard Brothers had suffered and said the firm needed, immediately, PS5 million (estimated today to be equivalent to PS250 million, or $450 million) to "put matters straight" or the firm would go under. Coming on the heels of the failure of Creditanstalt and the debt repayment moratorium declared soon thereafter by banks throughout Germany and Hungary, the Lazard disaster proved to be a major test of the Bank of England's role in rescuing one of its prized Accepting Houses.
At first, Kindersley told Norman he needed PS3 million from the Bank of England, with the balance of PS2 million to come evenly from Pearson and from Lazard Freres et Cie. On July 17, a Friday, a special meeting of the Committee of Treasury--made up of the most senior executives of the central bank--agreed to try to rescue Lazard after concluding that the Bank of England could not allow "an Accepting House of the standing of" Lazard to fail because that "would probably give rise to a state of panic in the City and create serious difficulties for other important Houses." The proposed rescue plan called for the Bank of England to make a secured PS3 million loan to S. Pearson & Son, which then owned 50 percent of Lazard Brothers, proceeds of which Pearson could use only to help resurrect Lazard. Another PS1 million would come from Inland Revenue (the U.K. equivalent of the IRS) in the form of a tax refund of Lazard Brothers' previous several years of tax payments. The balance of PS1 million, the deputy governor of the Bank of England "had reason to believe," would come from Lazard in Paris and in New York. The committee further agreed that "the matter should be kept secret from everybody and that the advance should not be reported to the Committee of Daily Waiting or be included in the list of advances audited at annual audits."
On Saturday, at another special meeting of the Treasury Committee, the deputy governor reported that "late the previous evening" he had met with Clive Pearson, chairman of Pearson, who told the deputy governor that Lazard in Paris could no longer pony up its PS1 million obligation because it "might unduly weaken their position" and requested that Lazard in Paris only be required "to find" PS500,000. The Bank of England was now asked for PS3.5 million and told that, absent the infusion, the firm would not open for business on the following Monday morning. Pearson also asked that the bank charge a lower rate of interest on the proposed loan. "Mr. Pearson feared that unless the Bank could agree not to allow some concession on these points his Board would decide not to proceed further with the matter but would accept their existing loss and allow Messrs. Lazard to suspend payment on Monday," the deputy reported to the full committee.
The Bank of England, though, was not inclined toward compromise. Negotiations continued all day Saturday and concluded with a deal to save Lazard at Kindersley's house that night. Along the lines as originally proposed, the bank lent PS3 million to S. Pearson & Son, Ltd., which in turn made the money available to Lazard. The Bank of England loan to Pearson was secured by all of Pearson's assets; in effect, the Pearsons had pledged their company as collateral to save Lazard. The central bank charged "penal rates" for the loan, which increased over time, and required the money to be repaid over seven years. Lazard, in both Paris and New York, invested a combined PS1 million for the rescue of its sister firm. This money came from the owners of the French firm themselves, among them the David-Weills, Andre Meyer, and several of the heiresses of the recently deceased male Lazards. "For a long time," Michel David-Weill said later, "Andre Meyer and my father had a negative capital. It lasted at least until 1938." Help also came from the U.K. Office
of Inland Revenue after Norman asked it to refund the taxes that the Lazard partners had paid on the firm's earnings for the previous five years. Somehow over that fateful weekend, Inland Revenue managed to refund to Lazard some PS1 million.
The cost of the rescue was high in other ways as well. First, the remaining Lazard Brothers partners were no longer partners of the firm, and so no longer were entitled to both a sliver of ownership and profits. From then on, the U.K. working partners became employees--and not particularly well compensated ones at that. Since the Bank of England had determined that mismanagement had caused the near disaster, it forced Lazard Brothers to shutter its branch offices in Brussels, Antwerp, and Madrid, where yet another rogue trader had also done some misguided foreign exchange speculating.
When the rescue financing was completed, Pearson had increased its ownership in Lazard Brothers to 80 percent, with the balance still owned by Lazard Freres et Cie. But within eight months even that would change. The first inkling of further trouble at Lazard, this time in Paris, came at the end of a late April meeting of the Bank of England's Committee of Treasury when Archie Norman excused three members of the committee from the meeting and "then gave to the other Members of the Committee information, which cannot be disclosed to the Committee of Daily Waiting or to the Court, concerning certain Advances made by the Bank in support of their policy of maintaining the credit of the City." A month later, this oblique reference to "maintaining the credit of the City" became clarified when Lazard Brothers informed the Bank of England that now Lazard Freres et Cie, in Paris, was in financial distress, with a desperate need for PS2 million. "The Paris House are now in trouble and need PS2,000,000 to enable them to continue, but they cannot borrow in Paris without affecting their credit," according to the once secret notes of the Bank of England's Committee of Treasury. Once again, the Bank of England stepped in, giving Lazard Brothers a new PS1 million loan, secured by "French Securities" sent to London from Paris. Lazard Brothers, in turn, used the PS1 million "to support the Paris House." National Provincial Bank provided the balance of PS1 million to Lazard Brothers, for the benefit of Lazard in Paris, after examining "their Balance Sheet and the list of Shareholders." The badly needed PS2 million was made available to Lazard in Paris.
No word of how close Lazard once again came to total liquidation leaked to the press or to its competitors. At the time, there were no articles about the crisis, which also happened to be the precise strategy devised by the Bank of England to prevent a widespread financial panic. Hugo Kindersley, grandson of Robert Kindersley and himself a longtime Lazard Brothers partner, said he remained stunned the news never leaked but also explained that this was how his grandfather wanted it to be. "The most remarkable part of the whole affair was that there was no press coverage and no rumors about any problems with Lazard London," he explained. "My grandfather insisted that partners continue to live their lives as before with all their servants and all their houses and not show by the blink of an eyelid that anything was wrong. I don't know how they got away with it because they were wiped out."
FOLLOWING THE UNEXPECTED death, at age fifty-one, of the second Viscount Cowdray--also known as Weetman Harold Miller Pearson, the son of Weetman Pearson--on October 5, 1933, the executors of his estate commissioned a valuation from Deloittes (the accounting firm) of Lazard Brothers & Co. The remarkable fourteen-page document makes clear, at the time of the second Viscount Cowdray's death anyway, that S. Pearson & Son owned 100 percent of the 337,500 then issued and outstanding shares of Lazard Brothers, not just 80 percent of the firm. Understandably, resolving the May 1932 crisis in Paris must have wiped out, for a time anyway, the 20 percent stake in Lazard Brothers held by Lazard Freres et Cie. Also, the accounting states that Lazard Brothers' exposure to Creditanstalt was actually PS200,000, not PS40,000, and that the firm could reasonably expect to recover only 20 percent of the amount owed.
The document also revealed just how minuscule was Lazard Brothers' valuation at that time. Deloittes set PS931,250 as the "fair valuation for probate" of the holding of 337,500 shares, the total number of Lazard Brothers' outstanding shares. The conclusion was unmistakable: the events of the previous two years had fully wiped out the ownership stake in Lazard Brothers previously held by Lazard Freres et Cie and by the English working partners. Lazard Brothers did get back on its feet during the mid-1930s, thanks in large part to a slow but steady increase in the number of the firm's corporate bond underwritings and the general slow improvement of the European economy. Over time, the obligation to the Bank of England was repaid.
What role, if any, Lazard Freres in New York played in rescuing Lazard Brothers is difficult to discern. There is no public mention of its involvement, other than that contained in the "secret" Bank of England minutes suggesting that some of the PS1 million contribution to the rescue effort was to come from New York. Michel David-Weill said he believes Frank Altschul and his fellow New York partners were asked to support the rescue mission but that any contribution from them would have been small given the perilous economic environment at that time. "And the people of New York were furious," he explained. "Having successfully survived the Depression, they were now being asked, without explanation, to send money to Europe. This did not create a very happy atmosphere between Paris and New York." Altschul's many letters are devoid of any reference to what happened in London and Paris in 1931 and 1932. Indeed, there is no correspondence between Altschul and his partners in Paris and London between March 30, 1931, and April 13, 1934.
There was one very cryptic cablegram, dated August 10, 1931, between New York and London addressed to Altschul that seemed to relate to the London crisis. The original cable was written in a secret code, where each nonsensical word was ten letters long. The translation of the cable, a few weeks after London's rescue by the Bank of England, conveys an air of desperation: "In view of what we must be prepared to do here not for sake of prestige but as a matter of necessity in the event of those extremely unfavorable developments which appear every day more likely[,] we feel it might be serious and fundamental mistake to disturb our present position which though comfortable is no better than it really should be. [M]oreover it seems to us Paris would be in far better position if they borrowed entire amount from Banque de France at the beginning when skies are clear than if they borrowed a lesser amount and then filled their line under stress of circumstances at a time when doing so might create most unfavorable impression."
AT THIS TIME, Altschul appeared to be far more preoccupied with what the consequences of the recently passed Banking Act of 1933, also known as the Glass-Steagall Act after its main congressional sponsors, would mean for Lazard. The act, which rose out of the bank failures of the Depression, sought to separate commercial banking--the taking of deposits--from investment banking, that is, the underwriting of securities. Wall Street firms were given a year to decide which business line to choose. For Altschul and Lazard the decision was simple, considering it had long before withdrawn from its commercial banking roots in San Francisco.
Pursuant to the decision to focus on investment banking, at the end of September 1934 Lazard opened Lazard Freres & Co. Inc., at 15 Nassau Street, to underwrite and distribute corporate and municipal securities. Altschul was named chairman of the board of the new company, and Stanley Russell was recruited from National City Company (today's Citigroup) to be the president. "In the development of such business, it is our hope that Lazard Freres & Co., Inc., may play an appropriate part," Russell said at the time. The new business started with $5 million of capital. Newsweek lauded the firm at the time, without even the slightest hint that it had almost been dissolved: "While investment bankers complained that the Securities Act of 1933 was stifling their business, Lazard Freres boldly formed Lazard Freres & Co. to underwrite and sell corporate and municipal bonds. Although a smaller star in the financial firmament than J. P. Morgan & Co., Kuhn Loeb & Co., and Dillon Read & Co., Lazard Freres is no less brilliant. Its prestige is enhanced by its affi
liated firms in Paris and London."
While the near-disastrous events were unfolding in London and New York was focused on complying with Glass-Steagall, Andre Meyer was busy in Paris transforming himself from a currency trader into the then far more prestigious and respected role of investment banker and a man who provides counsel to governments and to corporate clients. The first opportunity he had to showcase his skills as a financial alchemist came in cooperation with Citroen, the French automobile manufacturer in which Lazard had previously bought an important stake, no doubt in part because Andre Citroen was the father-in-law of Pierre David-Weill's sister Antoinette. (Andre Citroen first met David David-Weill at his home in Neuilly, a wealthy suburb of Paris, where, after showing off his impressive art collection, David-Weill told the industrialist he must reorganize his company to make it more profitable.) Andre Meyer, in turn, also befriended Citroen and convinced him to sell to Lazard ownership of Citroen's finance subsidiary, known as Societe pour la Vente a Credit d'Automobile, or SOVAC. Andre's idea was to turn SOVAC into a broad-based finance company. With the help of his two financial partners, J. P. Morgan & Co. and Commercial Investment Trust, now known as CIT, Lazard bought SOVAC and turned it into a finance giant before selling it for a huge profit many years later to GE Capital, the finance subsidiary of GE. Andre's next astonishing performance was to rescue Citroen itself from sure bankruptcy during the depths of the Depression. At first, Andre Citroen had asked Pierre David-Weill to assist him, but the situation was so dire that Pierre turned the assignment over to Andre Meyer, who in short order went on the board of the company and negotiated a deal with the tire maker Michelin, Citroen's largest creditor, to exchange Michelin's debt for equity. Overnight, as this sophisticated alchemy had never been seen before, Andre had become a sensation in France, sought out by corporate executives throughout the industrialized world.