The last tycoons: the secret history of Lazard Frères & Co
Page 21
The IRS's 110-page ruling explained why the service had changed its mind. According to the IRS, though, the document has been destroyed, in keeping with its policy to shred all rulings that are more than three years old; all other copies seem to have disappeared. Therefore, the only insight into the ruling's content comes from some brief press reports at the time. "We believe," the IRS report stated, "the subsequently developed evidence establishes that the ITT-Mediobanca transaction was not consummated in accordance with the representations made to the Service in ITT's ruling application. Rather, ITT was aware that Mediobanca did not want to assume any risk and intended to sell the stock transferred to it. ITT then styled the transaction to take on the appearance of a sale to satisfy us, when in reality, Mediobanca was an agent, broker, or best efforts underwriter for the sale of the shares on behalf of ITT and did not acquire any interest in the shares."
In the wake of the IRS reversal, ITT moved quickly to try to assuage growing shareholder unrest related to the tax consequences of the Hartford merger. By letters dated March 11 and April 4, 1974, ITT agreed to reimburse the former Hartford shareholders: "In the unlikely event that the exchange is ultimately adjudicated to be taxable, ITT will reimburse any Hartford shareholder whose net overall tax liability with interest (taking into account any other years involved) is increased as a result of the imposition of tax liability on the exchange of his shares." Needless to say, the IRS's change of heart and ITT's immediate concession to the former Hartford shareholders began to make Hilde Herbst, the housewife from Queens, look like a very smart lady indeed. A couple of months before the IRS issued its new ruling, on January 16, 1974, Herbst added Lazard as a defendant to her shareholder suit. Following the revocation of the 1969 tax ruling, the IRS made tax claims against a number of the former Hartford shareholders. Consequently, these shareholders filed some 950 petitions against the IRS in U.S. Tax Court, seeking to fight these new tax bills.
As a result of ITT and the ITT board of directors being named a defendant in Herbst's original lawsuit, and then since Lazard had been added as a named defendant, Felix, Andre, and Tom Mullarkey all testified in the case. As Yogi Berra would say, it was deja vu all over again. Felix testified twice in the Herbst matter. On November 16, 1973--before the IRS's new ruling--he testified about the circumstances related to ITT's "sale" of the 1.7 million shares of the Hartford stock to Mediobanca. And once again, he stuck to his story of having no role whatsoever in the transaction between ITT and Mediobanca and that only Andre and Tom Mullarkey were even the slightest bit involved, and then only tangentially.
When Felix testified again in the Herbst matter, for two and a half hours on April 24, 1974, it was six weeks after the IRS had reversed its ruling. Felix's story did not change. "My recollection is of minimal involvement," he said.
Mullarkey also testified twice in the Herbst matter, immediately following Felix's testimony. This time around, he shed a little more light on how he had come to work in the back office--"this was receipts and deliveries of securities, payments, sales, all the trivia that makes a banking firm operate internally." It turns out that Andre had reassigned Mullarkey, then an associate, to work in the back office for the partner Walter Fried in late 1969. Fried had become ill in December 1969 and taken a leave of absence from the firm (before passing away in October 1972). He originally suffered from circulatory problems, and then had a nervous breakdown. Mullarkey described him as "a very sick man" and said that Andre had moved Mullarkey into the back office because of Fried's deteriorating health.
For the first time, Mullarkey acknowledged his own role, along with Cuccia's, in the creation of the November 3, 1969, side agreement between Lazard and Mediobanca with regard to ITT's "sale" of the Hartford shares. "Fried instructed me shortly before I went over there"--to Milan to meet with Cuccia on a Saturday in late September 1969--"to see what Cuccia wanted us to do because we had responsibilities under the basic ITT contract. We would be a courier, a custodian and we made some market valuations and it was really to find out how Cuccia wanted this handled, so I really went over with nothing but to talk to Cuccia about what he had in mind." He came back to New York with Cuccia's handwritten notes of the agreement, showed them to Fried--but, he testified, no one else at Lazard--and continued to work with Cuccia on drafting the document. He knew his place. "Because I was an associate in the firm at that time and I had no direct access to Mr. Meyer," he testified.
For the first time in the whole blessed ITT-Hartford matter, Andre Meyer was obliged to testify. He did so on four separate occasions in March and April 1974, in the Lazard offices at One Rockefeller Plaza. The transcripts showed him to be quite firm in his recollections, and often quite loquacious. He characterized his role as extremely minimal and restricted solely to his initial contacts with Harold Williams, the CEO of the Hartford, in the fall of 1968, and with Cuccia, the CEO of Mediobanca, in the summer of 1969.
Like Felix and Mullarkey, Andre put the responsibility for Lazard's role in the ITT-Mediobanca stock arrangement at the feet of Walter Fried, the dead man, an Austrian immigrant whom Andre described as a "self-made man," a very simple man, a very modest man who came to Lazard as an accountant. "Mr. Fried was in this firm 15 years before or 17 years before I came to this country, and I had before not the slightest idea about rules or regulations or tax or overall fiscal and administrative policy as it existed in the United States and I was relying and always relied and everybody in this firm was relying entirely on Mr. Walter Fried," he testified. "It was a great loss when he died. He was a tower of strength and had the full confidence of all the partners. He was the kind of young grandfather of everybody in this firm and everybody can tell you that."
At various times in the almost eight hours of testimony, Andre became quite irritated with Leon Silverman, Herbst's attorney. "Mr. Silverman, I am an old man and I have taken three pills this morning to be able to be with you, to be able to do the job of trying to answer properly but I am not going to speak of things that I don't know in which I have not been involved in." When Silverman asked Andre if he understood the inner workings of the Lazard mailroom, Andre could take it no more. "This firm has always been very carefully run. Its existence is 130 years and we never had any problem of any kind." He was then asked how the mail was routed around the firm, and he replied:
I have no idea. Really, I don't know. I have told you and I am prepared to repeat that my role in the firm has always been very clear. I would like to say something which may not please my counsel because I am doing more than answering the questions but I feel that I should tell you. I was a Frenchman and I flew from France in 1940, a few hours before the Gestapo came to my apartment to pick me up. I was not persona grata, and the best evidence is that I was denationalized by the Petain regime, and that same day as General de Gaulle was denationalized, I was on the first list. In the first week of August 1940, I arrived in this country with my wife and my two then young children and I was a refugee, in fact, I did not speak a word of English. I don't speak too well still, but I have never taken one lesson of English. For two years I was sick. The doctors said that there was a cancer of the pancreas; it was not so, and in 1943 I came to the firm with the minimum of knowledge and I learned but I relied on the people who were in this firm and with good people in whom I had confidence. I did not interfere with what they were doing because this firm never had any trouble and had a very clean balance sheet and was considered as a firm of high standing. Step by step I took responsibility of the firm and I am proud with what I did with it but I did not disrupt a lot of things. Among the things that I did not disrupt because I was very ignorant about it and I knew my limitations with such things was what we call the inside machinery and about Walter Fried, a man who was, I believe here since 1930, even before and who has been successful and a young employee and who has shown a lot of quality and who became the head of the accounting department and then his activities were broadened. I had to learn from him many things in many respects and I tried
step by step to make of this firm, as I said, one of the most respected and one of the largest firms in this town in every respect but it has been a full time job. I was lucky enough to have competent and serious people who were following the machinery and I relied upon them. I thought that it might have been useful for me to give you that little bit of background. My role consisted of many things in this firm in respect to its policy, in connection with the kind of business that we are doing and more especially the one that we should not do but my principle also was, after a decision is made after the policy has been established, not to have interfered in the implementation of the things which were done. I have had in these 35 years enough to do in respect to that battle in that jungle of Wall Street, in doing a certain number of constructive things and in maintaining a tradition and this has been really my job, and I am even too old to pursue that job in my judgment, but when you ask me who was opening the mail, I will be ashamed to tell you I don't really know.
Finally, though, in the remaining moments of Andre's testimony, Silverman asked him about the critical unanswered mystery. How could Felix, the head of Lazard's mergers business, essentially eschew responsibility for one of the most crucial aspects of his most important client's most important deal at the most important time? "What department did the ITT-Hartford merger fall into or under?" Silverman asked.
"Rohatyn," Andre answered.
"That would be new business?" the lawyer wondered.
"Yes," Andre replied.
"What department did the ITT disposition of the Hartford stock fall under?" Silverman asked.
"I don't believe that we have created a special department for that," Andre answered.
"Would that be new business?" Silverman asked.
"Mr. Rohatyn was the director of ITT and he was the liaison in the matter of that kind between the Lazard firm and the ITT firm, and as I told you, this firm is a very compact firm, including the partners and messenger boys and which has between 200 and 240 people," Andre explained. "Things are not that compartmentalized as they would be in Merrill Lynch."
"But Mr. Rohatyn would have been in charge of the ITT-Hartford merger as it affected Lazard?" Silverman asked again.
"Yes, but he was also helping or helped by a certain number of people who were dealing more in the machinery or with the legal work," Andre offered.
"Are you telling me that in the matter of the ITT-Hartford that would fall under new business, Mr. Rohatyn would not perform every single function that had to be performed in connection with it?" Silverman asked incredulously.
"Yes," Andre replied.
"Are you also telling me that in such a situation Mr. Rohatyn would be the partner who would be the supervisory person of all of the little functions?" Silverman asked.
"No, not the supervisory necessarily for all," Andre answered. "The machinery agreement and so on, I would say no, but if it comes to discussing with the chief executive of the company, it is certainly not Mr. Mullarkey or Mr. Fried who would do it."
That is as close as Andre got to trying to discern the logic of how Felix abdicated his advisory role for ITT at such an important moment. In any event, soon after the IRS ruled that the ITT-Hartford merger was now taxable to the Hartford shareholders, ITT made its offer to cover the taxes payable for any of the still eligible Hartford shareholders. In keeping with our litigious society, following this announcement by ITT four new derivative shareholder lawsuits were started against ITT. The Herbst case was settled in and around the first week of April 1977, with ITT agreeing to pay each original Hartford shareholder $1.25 in ITT stock for each of the twenty-two million Hartford shares, or about $27.5 million in ITT stock, and also agreed to indemnify any Hartford shareholders for any future tax liabilities that might arise from the IRS decision. Lazard and Felix were released from all the claims of the shareholder lawsuits.
DESPITE THE DEPOSITIONS, the never-ending lawsuits, and the harsh glare of negative publicity, Felix remained convinced he had done nothing wrong in his advocacy of ITT's goals, and so set about once again doing what he knew best how to do: advising on landmark M&A deals. And of course, he continued to rehabilitate his tarnished image. Both of these goals were happily advanced in one particularly timely pairing of June 1974 articles, one in Time and the other in the New York Times. Written once again by the reporter Michael Jensen, who had written about Felix and Lazard often in the past years, the Times article described Felix as a "merger mastermind" for his deft architecture of a cleverly conceived and structured rescue of the struggling Lockheed Aircraft Corporation by Textron. Felix's idea, as Lockheed's adviser, was to have Textron invest $100 million in the ailing Lockheed in exchange for a 46.8 percent interest in the company. The Textron investment would have also, crucially, relieved the federal government of some $250 million in controversial loan guarantees made to Lockheed's banks. These guarantees, approved by Congress by a single vote, saved Lockheed from bankruptcy in 1971. The Textron equity investment also convinced Lockheed's banks to convert $275 million of debt to preferred stock, reducing Lockheed's interest expense by $100 million in the first two years after the restructuring. "It's far and away the most intellectually satisfying thing I've been involved in," Felix told the paper. The generally laudatory article did contain the requisite cheap shot from an unnamed competitor, no doubt jealous of Felix's continued acclaim. "Nobody's better than he is," this person told the Times. "His ability is that he turns people on. With the backing of Lazard, he's able to get good people. I don't think all that highly of Felix, but that doesn't mean he isn't as good an investment banker as there is on Wall Street. The problem is that no one is a saint." The article correctly linked Felix's "rise" to two "powerful forces," Andre Meyer and Harold Geneen at ITT, the same two mentors Felix still credits. But it also offered the thought about Felix, presumably Jensen's own, that "some of his successes, generally heavily publicized, are considered on Wall Street to be as much a triumph of public relations as a display of financial acumen."
The Time article turned the epithet "Felix the Fixer" on its head, making it a laudatory reflection of his skill in putting together the Textron-Lockheed deal rather than a von Hoffman-esque reference to his unfettered access to political power. "If he pulls it off, it will be the investment banking deal of the decade," one corporate executive told the magazine. Felix described the deal to Time as "very satisfying from an aesthetic point of view."
Felix's efforts to resurrect his reputation had been boosted enormously by both the Jensen and the Time articles. He was once again heralded as the boy wonder of Wall Street. Rarely complacent, though, he used the opportunity afforded by the blast of favorable publicity--and the quieting of the negative--to, for the very first time, put a toe in the water of public policy debate. Obviously for years, on behalf of his clients, he had been cleverly pulling the levers of power in Washington, but this was something entirely different; this was Felix using his considerable intellect to take a stance politically. (More than thirty years later, he is still at it.) In a two-thousand-word essay on the Sunday Times editorial page, in December 1974, Felix boldly endorsed the idea, then being floated by several congressional Democrats, to resurrect the Depression-era Reconstruction Finance Corporation. The original RFC, commissioned by Congress in January 1932 with the former Lazard partner Eugene Meyer as its chairman, eventually disbursed some $10 billion in capital, both debt and equity, to struggling American corporations. Forty percent of the RFC's capital went to financial institutions. The original RFC effectively pumped badly needed capital into corporate America when the public markets were still having trouble providing that service. The economic struggles of the early 1970s had revived the idea in Felix's mind. He wanted the U.S. Treasury to capitalize the new RFC with a $5 billion equity pool, plus the authority to offer an additional $10 billion in federal guarantees, all of which could be used to again inject fresh capital into struggling American corporations, not unlike how Textron's offer to inject $100 million into Lockheed proved p
ivotal. "The RFC, therefore, should become a revolving fund--hopefully a profitable one--which steps in where no alternatives are available and which steps out when the public interest has been served and normal market forces can again operate." Felix suggested that the private sector would finance the Treasury's contribution to the RFC by having those companies earning more than $1 million donate 1 percent of pretax profits annually to the Treasury. In five years, the government would be repaid, he believed.
The financial establishment warmed to Felix's proposal. "I agree emphatically," said Gus Levy, Felix's friend and the managing partner of Goldman Sachs. "It is essential we move in this direction," William McChesney Martin, the former chairman of the Federal Reserve, wrote the Times. But politically, where Felix often had a tin ear, the proposal was virtually dead on arrival. "If Lockheed is the kind of example Rohatyn is thinking of, he's dead before he starts," one senior congressional staffer told Forbes, in a typical comment. "Remember the vote on the Lockheed debt guarantees? It passed by one vote in the House and two votes in the Senate. Today the leadership wouldn't even bring it up!" Wisconsin's Democratic senator William Proxmire dismissed the idea as "a formula for protecting buggy whip manufacturers."
If by late 1974 Felix had begun the process of public rehabilitation, it was equally true that there was hardly a government entity that had not investigated, or itself been the subject of an investigation into, Felix's and Lazard's role in ITT's acquisition of the Hartford. The insurance commissioner of Connecticut had ruled twice. The federal courts in Connecticut had ruled repeatedly on the matter of ITT and antitrust. The state courts in Connecticut had ruled on Ralph Nader's lawsuits. The House of Representatives had conducted hearings into boxes of purloined ITT documents. The Senate Judiciary Committee had dredged up the whole sordid affair as part of the Kleindienst confirmation hearings. The Justice Department had settled antitrust claims against ITT after intervention from Nixon, Kleindienst, and Felix. Justice was also looking into charges of perjury against the witnesses at the Kleindienst hearing, including both Kleindienst and Mitchell, the current and former attorneys general. The SEC had settled securities fraud violations against ITT and Lazard before shipping the documentary evidence to the Justice Department. Nixon's White House was up to its eyeballs in trying to influence the outcome of the antitrust matters, thanks to ITT's intense lobbying efforts and its substantial donation to the Republican National Convention. The IRS had reversed its original rulings about the tax-free nature of the deal, and the original Hartford shareholders affected by the new IRS ruling had sued for damages. Shareholder litigation abounded. One could reasonably expect that by 1975 enough would be enough in the matter of Lazard, Mediobanca, ITT, and the Hartford.