The last tycoons: the secret history of Lazard Frères & Co

by William D. Cohan

  Wasserstein also moved quickly, some say too quickly--two weeks, start to finish--in the summer of 2002 to lease, for Lazard's European headquarters in London, a brand-new seventy-thousand-square-foot modernist building on Stratton Street in the West End. It was the largest real estate transaction in the West End of London in ten years. The Daily Telegraph described the Mayfair offices as "some of the plushest used by any investment bank in London." Word is that Bruce spent close to $25 million outfitting the new offices (but that was apparently not enough to keep the telephone system from malfunctioning in the summer of 2003). Lazard agreed to pay PS76 per square foot to lease the space for twenty years, or a total of about PS5.3 million a year in rent (more than $9 million), a far distance indeed from the Dickensian ideal set by Andre Meyer both at the spartan 44 Wall Street and at One Rockefeller Plaza and from his pledge that Lazard would never pay more than $7.75 per square foot for office space. The problem was that Lazard still had about five years left on the lease at its old office building, at 21 Moorfields, a nondescript and ratty monster in the City of London. As a result of Bruce's move, Lazard had much more space in London than it needed. (Some of the old space was finally subleased in 2005.) Bruce also ordered the long-overdue renovation of the sacred La Maison on the Boulevard Haussmann. "Instead of a dimly lit waiting room with worn couches, the building now features marble floors, tall white columns, recessed lighting and beige furniture," Bloomberg reported. "Three blond female receptionists have replaced the aging male guards who used to greet visitors from behind a glass partition."

  The combination of the pricey London lease, the aggressive recruiting effort, and the continued decline in the M&A business led to an almost immediate clash between Bruce and Michel over the way Bruce was running the firm. Michel knew--or certainly should have known--that Bruce intended to invest money in the hiring of new partners. What he may not have counted on, though, was how aggressively Bruce would do so, essentially by having the old partners and the capitalists pay for it. The leasing of the new London office was downright excessive in Michel's view. If nothing else, like Andre before him, Michel had always believed that the Lazard offices should be modest, if for no other reason than that clients would not get the impression that all of their fees were being spent on expensive furnishings. Profits should go into the partners' pockets, Michel believed, and then could be spent as they saw fit in multiple homes and priceless art collections. Michel subscribed to Descartes' dictum "He lives well who is well hidden." Bruce clearly felt money needed to be spent for elegant office space as well, especially when he could use the capitalists' money to pay for it all.

  Not surprisingly, the two men fought over these money issues. "Michel was torn about that," one senior partner said.

  On one hand, he desperately knew that the only way the U.S. or any part of the firm was going to come back was to hire. In fact, we should have done much more in Europe than we did, in retrospect. On the other hand, he didn't like the idea that we were spending any money to do it.... The discussions were very antagonistic almost from the beginning. And it wasn't only Michel; it was all the old historical capitalists. They couldn't understand the concept that one had to reinvest to rebuild the firm.... I also think Michel was too clever by half when he cut his deal with Bruce. I think fundamentally he thought that putting Bruce on the same system he, Michel, was on--that is, he'd make more money if the firm made more money--would motivate Bruce. But it didn't. What motivated Bruce was making the firm successful, not short-term profits.

  To help pay for his spending spree, Bruce hit upon a formula that had worked brilliantly at Wasserstein Perella: that of selling a minority stake in the firm to a foreign investor. In September 2002, he did it at Lazard when he came to Milan for the first time and Braggiotti introduced him to IntesaBci, Italy's largest commercial bank and the successor of Banca Commerciale Italiana, Braggiotti's father's bank. In return for Intesa's $300 million investment, Lazard set up an investment banking joint venture in Italy--with Braggiotti as chairman--combining Intesa's capital with Lazard's investment banking business in the country. The deal had two parts. First, Bruce agreed to contribute the sixty Lazard employees working in Italy to the joint venture with Intesa, which agreed to pay Lazard $150 million--$100 million in equity and $50 million in the form of a subordinated note. Lazard retained 60 percent ownership in the operation and day-to-day management control. Intesa owned 40 percent of the venture. In the second part of the deal, Intesa also agreed to invest an additional $150 million into Lazard itself, in exchange for a note convertible into 3 percent of the firm's equity.

  The deal marked the end of Lazard's fifty-year association with Mediobanca in Italy. Still, Lazard partners were astounded at the price Intesa was willing to pay for this tiny piece of Lazard but were appreciative of the addition to the firm's capital at a time when the overall business was suffering and Bruce was luring new bankers with expensive guarantees. The Intesa price--$50 million for each 1 percent of Lazard--valued the equity of the entire firm at a nifty $5 billion, 25 percent higher than the Ernst & Young valuation of $4 billion that Michel had scoffed at earlier and 32 percent higher than the $3.8 billion valuation that Bruce had told new recruits the firm was worth (the premium, though, was in line with other convertible preferred financings at the time). Some partners saw the deal as the Italians throwing the firm a much-needed financial lifeline. "Bruce was on a spending spree and needed the money," one partner said. Another added, "Liquidity doesn't last forever. I mean, you just can't go on spending more than you make, you know, and that's why the Intesa sale was such a huge fucking deal because basically it was a lifeline to run the firm. There was a couple of hundred million bucks that they could continue to spend and spend and spend. And that's the best thing Bruce did." (By the summer of 2005 the Intesa deal was in shambles; the firms unwound the joint venture in the first quarter of 2006.)

  The Intesa deal put a delightful and unexpected exclamation point on the end of Bruce's first year at the helm. He had reeled in $300 million of capital for Lazard at a very healthy price, especially given the firm's poor performance in the past two years. He was no doubt feeling ebullient when he gathered his seven lieutenants in his New York office for an orchestrated interview with the Financial Times in December 2002. And this led to a little blithering. "We have a spiritual ethos that creates a cohesion," Bruce served up. Even the New York CEO, Ken Jacobs, usually inscrutable and unemotional, explained that despite the decline in the M&A market, Lazard was winning mandates. He cited Lazard's role in Pfizer's $60 billion acquisition of Pharmacia, the largest deal of the year (Pfizer was a longtime client of the departed Felix and was one of the very few clients that he handed off to one of his partners, in this case Steve Golub), and made reference to Lazard advising Microsoft on a number of deals (the former Lazard partner Richard Emerson was head of M&A at Microsoft). Lazard was also benefiting from the surge in corporate bankruptcy filings; revenues in its financial restructuring business surged to $125 million in 2002, up from $55 million the year before (helping to offset the $100 million decline in M&A revenues to $393 million in 2002, from $492 million in 2001). The firm's leaders were trumpeting their success, though. "When you look across Wall Street, we are the hot investment bank," Jacobs boasted.

  Bruce also sat down with the Wall Street Journal for an end-of-year interview. He defended his hiring binge. "Some people see talented people as difficult," he said. "I just see them as talented." He also said that a sale of the firm was not imminent. "Selling would be a pretty easy thing to do but that's not what's under contemplation," he said. "I'm more interested in implementing my plans and seeing how we develop."

  Bruce's cheerleading masked the reality of the firm's financial picture at the end of 2002. By revamping Lazard's compensation structure to rely heavily on guaranteed contractual arrangements with the working partners rather than paying them a percentage of the profits, Bruce had effectively upended the firm's P&L statement. Whereas the firm had no
t lost money since the dark days of World War II, Lazard lost $100 million in its first year with Bruce as CEO. Of course, Bruce, the Ubermensch, refused to look at it as a loss. He preferred to describe what happened as having "reinvested extensively in our future," according to a memo on the 2002 performance sent around to the partners by Michael Castellano, the firm's new CFO. But there was no getting around what was happening. Castellano's own writing proclaimed that the firm had a "good year" in 2002 "in a difficult environment" with revenues essentially flat from 2001, at $1.166 billion, and explained that the firm's "pre-tax operating profit before Managing Director compensation" was $337 million, which needed to be reduced by another $40 million due to minority rights of others to Lazard's profitability, leaving some $297 million of profit before making payments to the managing directors. The problem--ignored explicitly by Castellano in his memo--was that the payments made to Lazard's 160 worldwide managing directors in 2002 amounted to $395 million, leaving shareholders with a loss of roughly $100 million. Now, this was not much of a problem for the working partners, who still got their multimillion-dollar payouts and controlled some 60 percent of the firm's equity.

  The problem instead arose for the nonworking partners, the capitalists, such as Michel, who controlled about 40 percent of the firm's equity and had nothing to show for 2002 but the losses Bruce had created. For the first time ever, Michel and his cronies received nothing from the firm aside from the $8 million in dividend payments on their $100 million preferred stock investment made at Loomis's behest in 2001. Bruce and Castellano knew the allocation of this $100 million loss to partners' capital accounts could be a problem, especially for those historical partners who had accumulated a fair amount of capital in these accounts. To try to assuage these partners' concerns, Bruce and Castellano created something called "memo capital," short for "memorandum capital deferred compensation," an accounting gimmick designed to create shadow equity for the increasingly disgruntled historical partners. The accounts would be credited with a fixed return of 6 percent per year. To get the allocation and the account, a partner had to execute an agreement with the firm.

  The memo capital was to be paid out over three years after a partner left, so Bruce actually began making the argument that historical partners were better off from a tax point of view having their existing capital accounts depleted and the new accounts created that were akin to a deferred compensation scheme. "Bullshit capital" is how one partner referred to this idea. But there was a coherent explanation for it. "Michel wasn't going to watch his capital account get fucking wiped out," one partner said. "So they created a preferred level of capital. So as the capital gets rammed down, there was a preferred level of capital re-created so they paid you as if you still had your capital to make you indifferent. They would have had a riot because none of the partners had any say as to how the money was spent. That affected some guys differently than other guys. And frankly the guys who were getting all the money were stealing the money out of the other guys' capital accounts. Michel was furious."

  David Verey described what Bruce accomplished as akin to a Communist revolution in the right ventricle of capitalism. The working partners at Lazard--the workers--with virtually no capital at risk in the business had picked clean the pockets of the nonworking partners with all the capital at risk--the capitalists--and there wasn't a thing the capitalists could do about it. The sheer brilliance of the workers' revolution that Bruce led inside Lazard--the blueprint of which Michel had directly negotiated with him--commanded admiration. And Bruce was only warming up.

  Michel's fury continued into 2003, as did Bruce's prodigious hiring. Bruce's first move of the new year came as the dust was settling on the previous year's bonuses at Merrill Lynch. In February, Bruce airlifted a team of nine bankers--five of whom were managing directors--from Merrill to create a new business for Lazard in the blazingly hot area of raising capital, for a fee, for private-equity and hedge funds. (Eventually fourteen former Merrill employees from this area joined Lazard.) While Lazard had never before been in this business, the proliferation of buyout funds and hedge funds--and huge amounts of capital flowing to them--made the business of raising money for them extremely attractive.

  But there were consequences to Bruce's aggressive move, namely the decimation of Merrill's market-share-leading fund-raising practice.

  At first, Merrill tried to reach an amicable solution with Lazard. On February 14--a day after the resignations--a Merrill internal lawyer FedExed a letter to Charles Stonehill, the newly installed head of Global Capital Markets, asking Stonehill, "in order for Merrill Lynch to even consider forgoing litigation," to provide him with written assurance that Lazard would not hire any more Merrill bankers, would not "contact or solicit" any Merrill clients or prospective clients the former employees "knew of" while at Merrill, and would not further hinder Merrill's ability to do business in this area. Stonehill, with the help of Dave Tashjian, had recruited each of the former Merrill employees. He assured the Merrill lawyer the "Former Employees" would "respect their legal obligations" to Merrill and that Lazard had no further intention of hiring Merrill employees into the new "Private Equity Group." But Stonehill did not satisfy Merrill, which believed Lazard continued to ransack the Merrill business by hiring additional employees, by bad-mouthing the firm to clients, and by stealing confidential information.

  On March 19, Merrill decided to sue Lazard and the nine bankers who left. In its amended statement of claim, as part of an NASD arbitration of the matter, Merrill stated that while all the facts were not then known, "the known facts compel the conclusion that the Former Employees breached their fiduciary obligations to Merrill Lynch and--aided and abetted by Lazard--conspired to destroy a Merrill Lynch business by misappropriating substantially all of its senior employees and clients and Merrill Lynch's Confidential Information." Merrill claimed that as they were walking out the door to go to Lazard, the bankers took with them many confidential investor profiles, which Merrill claimed had been painstakingly assembled over many years and contained valuable information about the leading investors in private-equity and hedge funds, how they made their investment decisions, and what funds they had invested in--in sum, the very essence of proprietary information.

  "As part of their anticompetitive scheme," the suit alleged, "between about 6:28 a.m. and 6:46 a.m. on January 28, 2003, just days before resigning en masse, respondent [Robert] White [Jr., a Merrill vice president in London] sent eight e-mails containing numerous files in a compressed 'zip' format to respondent [Scott A.] Church [a sixteen-year Merrill managing director in London], to himself at an off-site e-mail address, and to Jessica White, who is White's wife. Those files that White downloaded and e-mailed to himself, his wife and to Church at off-site e-mail locations contained not less than 246 Investor Profiles" of investors globally who invest in such funds. Merrill claimed White would have had no reason to download these files but for "a scheme to steal the business" of the Merrill group they were leaving. The files were then copied to Lazard's computers. Merrill even claimed that Bruce himself had met with a potential client looking to hire a banker to raise a new fund and told the client that Merrill could no longer perform that function but Lazard could since it had recently hired the fourteen bankers from Merrill.

  Resolution came swiftly enough, at the end of April. First, a New York state judge ordered that Lazard return to Merrill the computer files that the former employees had lifted, although the judge did not bar Lazard from using the information contained in them if that information could be remembered. To settle the arbitration case, Bruce was said to have gone to see Stan O'Neal, Merrill's CEO, to have apologized to him directly, and to have had Lazard pay Merrill a "seven-figure" dollar amount. Lazard viewed the settlement as the cost of doing business. "So what?" one Lazard partner said of the suit. "There are lawsuits all the time when you hire people." He said the business has been a good one for Lazard and the firm should have been in it far earlier.

  Bruce kept
on hiring. On the same day the judge ordered Lazard to return Merrill's electronic files, Bruce announced the hiring of another Wasserstein Perella alumnus, Gary Parr, then forty-six and a highly respected financial institutions banker at Morgan Stanley. Hiring Parr was a coup for Bruce. Parr was a true rainmaker in his industry and would help make up for the departure five years earlier of Ken Wilson to Goldman. Indeed, Lazard had been after Parr for years, but until Bruce gave him thirty-six million reasons to say yes to a Lazard offer, he had always said no.

  He wasted little time in making Bruce look smart. In September, alongside his old firm Morgan Stanley, Parr advised John Hancock Financial Services on its $10 billion sale to Manulife Financial, one of the largest deals of 2003. Hancock insisted that Parr be added to the advisory team, regardless of where he happened to work. "I'm very appreciative that Hancock wanted my advice," Parr said at the time. Also in April, Bruce hired another old friend, Mike Biondi, to come to Lazard as chairman of investment banking. Just as he did at Wasserstein Perella, Bruce was handing out titles like straws. Lazard also hired Kevin McGrath from Deutsche Bank as a managing director in its new private fund advisory group. To help ensure that he got his side of the story out, Bruce hired, in September 2003, Rich Silverman as global head of corporate communications--another position Lazard never had before. Silverman reported directly to Bruce.