by Guy Lawson
Of course he had traded illegally. But he showed them his trading records. He was always buying and selling huge pieces of Columbia Pictures. How the hell were they going to prove that he had inside information? He traded so much, they couldn’t keep up with what he was doing. They didn’t understand that there was a method to Freddy’s madness.”
After Ratner retired, Sam took over as Graber’s eyes and ears on the #oor of the exchange. Even armed with all of Graber’s inside information, Sam needed to hedge risk on his behalf. That meant short selling, which would protect Graber if the price of a stock went down. Israel aimed to make himself Graber’s short-position trader. It was a way to be useful to Graber, as it was a kind of trading his boss didn’t understand particularly well. “From the beginning, I was fascinated by the short side, not the long,”
Sam said. “That meant I was looking for stocks that were going to go down in price, not up. In those days, the public wasn’t sophisticated about the markets. People thought that when the market went down everyone lost money. I knew that wasn’t true.”
Sam also started to bet his own money on short selling. As a short, Sam didn’t buy stock, he purchased a “put” or borrowed the stock to sell to the buyer. Shorting was not for the risk averse. Because there was no limit on how high a stock could rise, in theory losses could be in"nite. Sam was trading on margin, so he was betting with borrowed money he would eventually have to come up with if he lost. More than a few traders had taken enough rope to hang themselves by short selling.
Because of the hazards and complexities, short sellers enjoyed a certain mystique.
The aura was part of the attraction for Sam. He had developed a mantra for himself. If there were one hundred people playing the market in one direction, Sam wanted to be the one guy who made money while the other ninety-nine were losing their shirts. The notion was based entirely on ego—or hubris. After two years on Wall Street, the education of Sam Israel was well under way. So was the growth of his cynicism. “Under Freddy I learned that Wall Street was an illusion,” Sam recalled. “There were di!erent magicians using di!erent tricks in di!erent ways. But everyone cheated. It shocked me so much in the beginning. I admired those people. And they cheated.”
CHAPTER THREE
Front-Running
In 1984, Israel asked his high school sweetheart to marry him. Janice McKergan was a pretty and clever Irish Catholic girl from Yonkers who had followed Sam to Tulane University, where she graduated with an accounting degree. “Janice was a girl I could love,” Sam remembered. “She was blond, with blue eyes, very attractive, very athletic.
She came from a lower-middle-class family. Her father worked in a bank. Her mother was raising six kids. There was never anything extra in her family, so Janice worked for everything she got. Janice was a cheerleader and I played linebacker on the football team. She was a straight-A student. She was stable. I was the fuckup. I was the bad boy.
I took drugs and fooled around and didn’t take anything seriously.”
Janice agreed to marry Sam—provided Sam got his !nancial a"airs in order. Despite his apprenticeship in the art of running money, Sam’s life was in chaos when it came to his !nances. Sam’s days were spent obsessing over money, but he had adopted Freddy Graber’s strangely passive-aggressive attitude to it. Money was everything to a Wall Street trader: a way to keep score, accumulate possessions, assert status. But money was also a matter of indi"erence to a great trader. The small people of this world—accountants, regulators, losers—sweated the details. Not men like Freddy and Sam. In fact, Sam hadn’t paid income tax in four years, and his credit card statements and bank accounts were a mess. Janice had just returned to New York to take a position as an accountant with Price Waterhouse. She was fastidious and well organized when it came to paying bills. Sam was shambolic, adopting the pretense that the ability to summon money out of thin air by trading negated the need to take care of petty issues like debt or taxes.
Then there was the matter of the lifestyle of a trader. Graber was concerned that the sweet and innocent young woman who was going to marry Sam didn’t understand the nature of Sam’s business. “When Janice and I got engaged, Freddy said he wanted to talk to my !ancée,” Israel recalled. “She came by the o#ce one day after work. Freddy sat her down next to his big marble desk. He said to her, ‘I’ve been doing this for twenty years now. I’m tired. I’m raising a family. I need to go home at night. So Sam is going to go out every night for me. He’s going to be with these brokers getting drunk. He’s going to be out late and he’s going to get up early and he’s going to work his ass o".
I’ve already talked to Sam about this. If you can’t accept it, don’t marry him. Because you’ll be divorced.’ I think Janice respected Freddy for saying that.”
On the eve of the wedding, Graber took him out for a night on the town. To Israel’s surprise, they went to the same high-end whorehouse the broker had taken him to a year earlier. “I didn’t tell him I’d been there before,” Sam recalled. “He said I could go crazy. The place was packed with beautiful women—each one prettier than the last. I said, ‘Could I have two?’ He said I could have three girls if I wanted. So I got two. It was the best thing ever.”
Newly married, Sam and Janice moved to a small prefab town house in Bronxville.
With Phil Ratner retired, Sam was now responsible for doling out Graber’s commissions, so the modest Israel home quickly became packed with the gifts from brokers trying to get into Sam’s good graces—cases of Chateau La!te Rothschild wine, antique clocks and maps, Ti"any glassware. “They would try to get me to go out with them as much as possible,” Israel said. “Janice wanted nothing to do with Wall Street. She hated the traders and brokers with their drinking and drugs and cheating on their wives. She knew I had to go out, but she kept her distance. The brokers wanted me to owe them.
They wanted me to walk into work the next morning and feel like I should give them the business because they’d shown me a good time.
“I knew this broker named Eddie. I was smoking dope with him at his apartment one night when he said something about ‘soft dollars.’ I’d never heard the term before. He explained it to me, saying it was the biggest scam ever—and it was totally legal. It was basically a kickback brokers would pay traders to get their business. In the early eighties, brokers were cutting commissions. Trading volumes were going up really fast because of computers. I remember the !rst day a hundred million shares were traded in a day. People thought the system couldn’t take it.
“So brokers began to o"er $at rates, like eight cents a share. The way soft dollars worked was that the broker would charge us eight cents a share to make a trade. Then the broker would pay four cents back to us to pay for all the stu" we needed to trade—telephones, IBM computers, o#ce space. That was how it started. Brokers would cover the legitimate expenses of their customers as a way to attract business. But then brokers started to pay traders for other things. Like country club memberships. Then cars and trips to Europe and home renovations. It was called ‘soft dollars,’ but really it was a form of bribery. After a while soft dollars would pay for a private plane full of traders to go to Tahiti for a party. That was why Wall Street was so lavish in the eighties.”
When Israel explained the ruse to Graber, he was amazed and delighted. Graber moved a hunk of his business to Eddie and began to reap the rewards. Whatever concert or Broadway show Freddy or Sam wanted to see, the best tickets were at the ready. Graber would take Sam to Knicks and Rangers games and have an entire executive box reserved for the two of them, simply because Graber didn’t like being around crowds. Trips to Las Vegas to gamble were taken in ultra-luxe style, often at a moment’s notice.
“Freddy would go to Petrossian and order caviar,” Sam said. “Not the little itty-bitty servings most people ordered. He got four or !ve big bowls. He didn’t bother with putting the caviar on a piece of toast, or in one of the fancy shells they gave you. He scooped out huge spoonfuls. He woul
d order a bottle of vodka, two bottles of Cristal champagne. It was excessive. There were no limits.”
During the mideighties, the Dow rose to more than 2000 and kept climbing. Graber started to commute from the suburbs to Wall Street in a private helicopter. Sam traveled with him as they swooped through the sky above the snarled tra#c below. The views were breathtaking—and so was the excitement.
“In those years, I became an asshole,” Israel said. “I was making seventy grand, plus getting handed a bonus of a hundred grand by Freddy, plus there was the money I was making on my own account. When I started out, my ambition was to make a hundred grand a year, and I was already beating that. I went from a low-key considerate kid to this rich kid who was a complete jerk. All of a sudden I had to have the best cars. If I was traveling someplace I had to be $ying !rst class. If it wasn’t !rst class, I wasn’t fucking going. I would only stay in !ve-star hotels. I would throw money away, just like Freddy would throw money away. My moral education from Freddy consisted of learning how to keep secrets and spend money. I started acting like Freddy. My mother said she didn’t know who I was becoming. My ego was out of control.”
Sam’s hair was thinning prematurely, as it did for most of the men in the Israel clan, making him look older than his age. But he worked out regularly, preparing to run in a marathon and keep in shape for the grueling nights on the town. Maintaining a boyish sense of humor, Sam developed an alter ego he called Captain Proton, a fearless superhero whose special powers were infused by vodka and cocaine. When Sam inhabited the character, he would turn an umbrella into his sword and a curtain into his cape as he set about crusading through the bars and clubs of Manhattan.
“We were hedge fund heroes,” Israel recalled. “There were only !fty or so hedge funds that traded a lot at the time. As Freddy’s protégé I was in the thick of it. Everyone called me ‘the kid.’ I was out of my mind having fun. I would get shitfaced and do outrageous things. I didn’t give a fuck. I would get my ear pierced on a dare. I would pull the tablecloth out from a table !lled with plates and glasses like I was a magician —only everything would go $ying. I used to jump out of limousines at intersections and start directing tra#c on a big street in midtown Manhattan. But the downside was that always I wanted to please people. I had a horrible time saying no. I would get invited out to dinner by two brokers, and I would say yes to both because I didn’t want to hurt their feelings. Then I would find an excuse for one at the last second. I wanted people to like me too much.”
At the height of the takeover craze, Graber’s methods were increasingly ingenious and devious. Grooming his charge, Graber began to trust Sam with some of his most sensitive sources, introducing him as his right-hand man and vouching for his reliability and discretion. “Gradually Freddy showed me the ropes with the real insiders,” Israel said. “There were the Jewish guys who went to Michael’s and Smith and Wollensky.
The Italian guys went to Tiro a Segno, which was a restaurant with a gun club in the basement in the West Village. There was the Mayflower set at the Harvard and Yale clubs. We moved inside all the circles. His best contact was a guy named Alan Jacobs—Jake, as he was known. He ran a boutique investment bank advisory company. Jake’s clients were investment banks and accounting !rms trying to !gure out the value of companies that were targets for takeovers. On virtually every big deal in the eighties, Jake was hired by one of the players to assess the merits of the transaction. It made him the perfect insider. I knew Freddy had someone but I didn’t know who it was. By then I’d seen a lot and said nothing about it. One day Freddy said, ‘Tonight, you’re going to meet our guy.’ He was letting me in on his biggest secret. It was like I was a wiseguy getting made by the gang—getting sworn into the secret circle.
“Jake held court at a bar called Michael’s Too. He sat at the far left end of the bar.
The place would be packed with Wall Streeters watching basketball. It didn’t look like it, but Jake’s circle was exclusive. That was how things worked. The lines and boundaries were invisible. The guys at the left end of the bar looked like a few guys unwinding after work. Jake didn’t look rich. He didn’t act rich. He looked like a drone —an accountant, a corporate lawyer. He sat there getting drunk. Which became one of my jobs—getting drunk with Jake.
“The !rst time I went with Freddy I kept quiet and watched. Jake wouldn’t come out directly and say things. But he would give you enough circumstantial hints that you could !gure it out. Like Shell Oil getting bought out in 1984. Then the airlines happened. Then computers. Jake did every fucking one of these deals. Jake was doing the analysis. Or he knew the guy that knew the guy. It was an incestuous world. That was how people put things together. Jake was just one piece of the puzzle. If Salomon was backing the deal, we had someone at Salomon. If it was Goldman Sachs, we had an in there. That bar was where the real money was being made.
“Freddy had a thing he called the brother-in-law rule. He believed there was no such thing as a secret. If a deal was coming, there was always a way of !nding out about it !rst. Everyone inevitably talked to their wife or cousin or brother-in-law to let them in on the deal. We got a lot of information in ways that avoided making a guy come right out and tell you things. I would call up Freddy’s guy in the M&A department at Morgan Stanley. I would shoot the shit for a little while, give him something he could use—a tip or a lead. Then I would say I’d heard they were working on a deal. I’d name the deal.
But I didn’t put him on the spot. He had to be able to say under oath that he never told anyone about the deal. So I’d say, ‘You don’t have to tell me anything. I know you’re backing the Shell deal. Is it still going through in the next two weeks? I’m going to count to four. Hang up before I get there if there’s something going on.’ Then I would count. ‘One. Two.’ Click. The guy hangs up. Now I know Shell is in play.
“These were people I knew. These were people I was in business with. I wasn’t talking to strangers. They expected payment in kind. Some guys wanted Yankee seats.
Some guys wanted to go to the opera. Some wanted cash. We’d get one of our brokers to hire that !rm and use the money from our commissions to pay them. There were schemes upon schemes upon schemes. There were layers of layers.”
BY THE MIDEIGHTIES, it was evident to Sam that a paradigm shift was occurring on Wall Street that would alter the de!nition of what it meant to be a trader. The introduction of computers was radically transforming the entire securities industry.
When Sam had started, there were no desktop computers, and teams of secretaries were required to enter data to create primitive trading charts. The !rst Bridge Data machines were so large they had to be shipped in trucks and wheeled onto trading $oors on mover’s dollies.
Over time, the technology began to evolve, slowly at !rst and then quickly. There were still position traders, men like George Soros or Warren Bu"ett who were concerned with large economic trends and the underlying value of companies. In the hierarchy of the business, position traders imagined themselves to be the elite. But high-velocity traders like Graber were moving from the periphery of Wall Street to the center of the business. The big players were gradually coming to understand that the tiny sums of money Graber accumulated by exploiting the cracks on Wall Street could add up to billions if the volumes were large enough. It was impossible for humans to trade at the necessary speed, but computers were able to trade in vastly larger amounts and at exponentially faster speeds. By the middle of the decade, Goldman Sachs had scores of young techies working on their secret proprietary trading programs. More independent hedge funds were also trying to create programs that would quantify and digitize what Graber did the old-fashioned way. The machines were able to process much more information than was otherwise possible, providing an incredible edge to the possessor of the fastest, most sophisticated systems.
The term quant was coined to describe traders who used mathematics and algorithmic analysis. Sam didn’t have the education or technical expertise to bec
ome a quant. But he was convinced of the importance of computer trading. A friend of Sam’s named Stanley Patrick was also interested. Patrick was a southerner, like Israel, who ridiculed the conformist conventions of Wall Street, preferring the self-image of the eccentric oddball. Obsessed with catching lobster on Long Island Sound in his spare time, Patrick wore brightly colored rubber !shing boots with his suits, not as a lark but as his daily attire; it was a way of thumbing his nose at the men dressed in Gucci and Brooks Brothers.
“I loved Stanley from the day he walked into Freddy’s o#ce,” Israel said. “We were kindred spirits, even though he was !fteen years older than me. He’d been a trader with some of the biggest !rms on Wall Street—Goldman Sachs, Dean Witter, Morgan Stanley, the biggest players. He was regarded as exceptionally bright and exceptionally $aky, and that was kind of how I thought of myself. He’d make the most insane trades, take the hugest risks—but he made the positions work. He would go on coke jags and disappear for days. He was much more successful than I was at the time, but we were very close.”
For years Patrick had tra#cked in insider information, like most everyone else. Now Patrick was trying to make himself expert at the new computer trading systems.
Working as a trader for a hedge fund that specialized in technical analysis, Patrick attempted to create programs that would detect trading patterns in speci!c stocks. The hope was to develop triggers that would track the $ow of money in and out of stocks.
The computer calculated spreads, premiums, volumes, and price, enabling a trader to have a matrix of data inputs to enable fast, precise, and pro!table trades at low risk. In theory. The reality was far more complicated.
Israel was mesmerized by Patrick’s work. He quizzed Patrick incessantly about computer programming. Sam watched as the handwritten ticket was gradually replaced by digital transactions on the $oor of the exchange, threatening to make his position with Graber obsolete. The human element of trading had always been fundamental to the market. Information had been the most valuable asset. But Graber’s skill set started to matter less and less. A strategy emerged called “program trading.” The premise of program trading was that computers could be trained to automatically make trades once predetermined conditions were met, such as a drop in a specific stock index.