It wasn't just Steve's shameless self-promotion that so upset Felix. The Paramount deal was one of Felix's most important and complex assignments of the decade. Not only did the spotlight's glow on Steve necessarily detract from the light on Felix, or so Felix thought; there was also the revelation of those confidential details from inside the boardroom. After he read the galley, Felix insisted that Marty Davis be called immediately and informed about the article's contents. Steve was in Arizona at a conference when he got Davis's call. "Marty went berserk," Steve recalled. "And he had every right to. We were in the middle of a deal. He called and screamed at me, which he did all the time, so there wasn't anything unusual in that." Steve denied to Davis he had been the source of the boardroom leaks. Felix, though, blamed Steve. "Steve," Felix said publicly, "made it seem like he was talking right out of the boardroom." Questioning another partner's loyalty and judgment, in public no less, was the worst sort of professional affront. Steve once again denied he was the source of the leaked information. "That's bullshit," Felix insisted. (Steve continues to insist he was not the leaker and that a careful rereading of the article will reveal Deep Throat; a subsequent Vanity Fair article about Marty Davis showed him to be the "loose-lipped cannon.")
As the Vanity Fair article came out in the middle of the Paramount deal--a deal experience he now believes was a "horror" and "one of the most awful deals that I've ever worked on"--Felix felt obliged to take action against his younger partner. "Steve was almost fired over that," Felix said. "I demoted him on the deal and put Bob Lovejoy on it. The only reason I didn't take him off the deal completely was because it would have created press stories." The consensus among the senior partners was that the Vanity Fair article was a mistake for Steve and for the firm. "I have the utmost respect for Rattner," Damon Mezzacappa said. "I think he is a brilliant guy, very open, at least with me. And direct. And honest. I'm a big fan of Steve's, a big fan. But I raised hell with Steve when they did that article in Vanity Fair, and I told him I thought it was a stupid thing to do and I was really pissed off at him. He was surprised. He thought it would be helpful to the firm. Well, it was helpful to him." For the more junior bankers at Lazard, so steeped in deference and the importance of hierarchy, the Vanity Fair story was a serious wake-up call about Steve's ambitions. In particular, the quotation that set tongues wagging incredulously from the Hudson River to the East River was Steve's entirely serious description of taking his kids to school on the crosstown bus, "even though a car and driver is certainly within our means." In any event, this high-profile saber rattling was beginning to remake the secretive, mysterious Lazard into a noisy public battlefield.
The fallout was immediate. The first person to become radioactive was Kim Fennebresque, though he had nothing to do with the article, nor was he even mentioned. Fennebresque decided he no longer had the stomach for the battles raging inside the firm. Whether it was Felix being increasingly irked by Steve's favorable publicity or Loomis's brooding in exile, the fun had vanished. When the Loomis loyalists wanted a scalp, they came after Fennebresque's. His higher profile and marginal productivity made him a sitting duck. Plus, he always knew the job as co-head of banking "was a death sentence." And then he had a falling-out with Loomis himself, who a few months after he took the job began to think Kim "was disloyal to him" because he stopped coming around as often to seek his counsel on how to run banking. "But I really wasn't doing much," he said by way of explanation. "I was there to help Steve. I was not there to be a hero." Loomis and Fennebresque stopped talking. When he got a call from a headhunter at the start of 1994 about a senior position in investment banking at the Union Bank of Switzerland in New York, complete with a multiyear, multimillion-dollar contract, Fennebresque pursued--and then took--the job "purely for the money" and the financial security. The memory of the seven-figure debt to First Boston remained fresh. He left Lazard without saying good-bye to Loomis, a recollection that still makes him a little melancholy. "I was unbelievably happy for the first eighteen months at Lazard," he said. "I was proud to be a partner there. The name was incredibly lustrous. I loved using the words 'my partner.' I just loved the whole thing. And then that one night when Michel said, 'Will you do this?' I never recovered. I became unhappy, and I knew it was a ticking bomb. I knew the day I got it, it was a ticking bomb and it would go off and blow up."
Michel made no effort to change Fennebresque's mind--not that he expected that to happen. "My guess is that in the end he didn't care," Fennebresque said. He called Steve and told him of his decision to leave. Steve said he "sensed that this was coming." Maureen called Kim in tears. Fennebresque's wife was pregnant with their fourth child, and Maureen told him, "You know, you and Debby will now have the time and money to really enjoy this," he said. "It was really a bittersweet moment for the Rattners and the Fennebresques."
Steve was now all alone running banking, although he had successfully dished off many of the more ministerial duties to Steve Langman, a vice president, as he had wanted to do. This gave him more time to focus on deals and his outside interests. He more or less gave up trying to make reforms. "When I ran banking the first time, our mistake was to think we could accomplish as much as we set out to accomplish," he said. "Bill was good at it in part because he understood the limitations of what could be done in the context of the firm and 150 years of history. London. Paris. New York. Michel. Felix. The feudal lords, all this stuff. I was more naive." But there was still the small matter of Felix's continuing rage. Unlike Kim, Steve had an ability to generate huge fees that made him nearly untouchable in the mercenary Lazard firmament, but he soon realized that he could no longer effectively run banking without Felix's support.
And it was obvious around the firm that his heart was not in it. He was aloof, cool, and distant within the firm's corridors, although he could turn on the charm with clients and in social settings. Some of the other, long-tenured partners were beginning to be put off by his diffidence. His year-end obligation to the nonpartners became even more perfunctory than it had been the year before; the highlight of the five-minute sessions was being able to see, up close, the original Warhol lithographs alongside the black-and-white etchings of old New York on the walls of his office. It was nearly impossible to carry on a conversation with him, as he rarely made eye contact with subordinates and preferred monosyllabic responses. He executed this duty with a detached efficiency. Steve said he did not think he was particularly good at running banking at that time. "I didn't and I still don't particularly like conversations where people are trying to figure out what's in it for them," he said. "But I do enjoy the process of trying to move the firm forward, getting good people to come, thinking through the business and strategy, and going to get clients."
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 an
d 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 a
t 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,
The last tycoons: the secret history of Lazard Frères & Co Page 50