Serpent on the Rock

by Kurt Eichenwald

  The situation at Bache was dire. Silver delivered by the Hunts began to be piled in stacks in a back hallway by the firm’s metals department. The SEC had halted trading in the firm’s stock. Examiners from the New York Stock Exchange had swooped down in the morning to pore through the firm’s books to see if it still met the minimum capital rules to stay in business. By midday, officials from the SEC began telephoning Bache competitors, asking whether they would be willing to take over some of the firm’s branch offices. The planned dismantling of Bache had begun.

  That night, Bache held the most critical board meeting in its history. Depending on the price of silver the next day, Bache could go out of business. Jacobs looked haggard as he watched executives calculate to the penny how far silver could fall without killing the firm. The answer was grim—Bache would be in violation of the minimum capital rules if silver dropped another $2.80 an ounce. If it fell $4, all its capital would be wiped out. In disbelief, the board members discussed plans for shutting Bache’s doors for good.

  As the talks dragged on, a secretary called Wyser-Pratte, the head of arbitrage, out of the meeting. A Belgian investment-banking firm was calling him. The Belgian firm represented a large film company, Wyser-Pratte was told, which needed silver for its business. Would Bache be interested in selling the entire Hunt silver inventory to that company? Wyser-Pratte caught his breath—the bid they offered was high enough to let Bache stay open the next day.

  Wyser-Pratte sprinted back to the boardroom, exclaiming, “Hey, we got a bid on the whole block.”

  Everyone visibly relaxed. Demand was returning to the silver market. The metal’s price had hit its floor. Rejuvenated, the board rejected the Belgian bid and decided to seek higher offers. The silver market would not be putting Bache out of business.

  But the firm was still in danger. After several weeks, the banks returned to Bache. They wanted more assets pledged to their loans. In an all-night session, the bankers and Bache lawyers hammered out an agreement for additional collateral. Under the deal, Bache would pledge a large portion of its own capital to secure the loans. In effect, the bankers would have the power to potentially take over the firm. The lawyers sent for a Bache executive to sign the deal.

  Virgil Sherrill walked into the conference room and sat down at the table to read the documents. The disheveled bankers and lawyers, with a day’s beard growth on their faces and their ties askew, watched as the meticulously clad Sherrill calmly examined each of the pieces of paper that would endanger the firm’s independence.

  Finally Sherrill put the documents back on the table and stood up. “Gentlemen, when you made these loans, you received collateral, and that collateral was in silver bullion,” he said. “It was the only collateral you received on these loans and it will be the only collateral you will ever receive on these loans. Have a wonderful day.”

  With that, Sherrill strode out of the room, leaving behind the stunned army of bankers and lawyers.

  Bache survived the silver crisis. Miraculously, it escaped without losing any money, largely because of the skills of Frederick Horn, an unflappable, chain-smoking commodities trader who liquidated the Hunts’ silver. By the time he was done, Bache could actually report a small profit in the quarter of the silver crisis.

  For the Hunts, the silver crisis ended the family’s decades of financial secrecy. To make good on some obligations, the brothers shed assets, such as an interest in some Canadian oil properties. As collateral for more than $1 billion in loans, the Hunts put much of their personal fortune in hock, mortgaging oil and gas leases, coal leases, real estate, cattle, and antiques— even a Rolex watch and a Mercedes-Benz were put up.

  But what would happen with their huge stake in Bache? For months, Jacobs and other executives endlessly discussed theories about where the 6.5 percent of the firm would go. In late November, they knew the answer. A filing with the SEC disclosed that the Hunts had sold much of their stake to an outfit called First City Financial. Bache executives knew the name well: First City was the centerpiece of the Belzberg empire.

  The enemy had returned. Now the Belzbergs controlled 15.5 percent of Bache. Sam Belzberg rattled his saber a little louder, demanding to see Jacobs. His secret weapon gone, Jacobs agreed to the meeting with Belzberg at La Guardia. The firm stood almost defenseless. If the Belzbergs launched a takeover, the chances Jacobs would prevail were slim.

  The last thing Bache could afford at that moment was the disclosure of another scandal.

  CHAPTER 3

  JOHN D’ELISA PUT HIS right leg forward and leaned into it, pushing his body as low to the ground as he could. He breathed out as he held the position for an instant, feeling his hamstrings stretch. D’Elisa always spent a lot of time limbering up before he ran, scrupulously following each step of the little routine he developed years before. It was a great time of solitude, one that made him feel relaxed and ready to run.

  As he stretched in the cool evening air, D’Elisa absentmindedly watched some of the hundreds of people standing with him on Liberty Street in the shadow of the World Trade Center. Normally, by 6:30 in the evening, the financial district in downtown Manhattan would be mostly deserted. But on this night, September 23, 1980, that small part of the city surrounding Wall Street teemed with life. Hundreds of runners from more than sixty brokerage firms and investment banks were there, preparing for the second annual five-kilometer Securities Industry/United Way Challenge Race. Some of them were engrossed in their own warm-up exercises. Others just walked about eager to start the race.

  Even though this was only the second year the race had been held, the competition was intense: The team with the best time won the right to keep the Challenge Cup until next year’s race. D’Elisa ran for Bache, where he worked in the tax shelter department. He wore a white T-shirt with the firm’s name emblazoned on the front in stark, blue lettering.

  Nearby, D’Elisa saw Bill Pittman limbering up. Pittman, a volatile former stockbroker, had been hired by Steve Blank years before to handle the department’s administrative duties, from organizing paperwork to keeping the supply cabinet stocked. But since Darr had taken over ten months earlier, Pittman’s fortunes had changed. Darr gave him the chance to work as a tax shelter marketer. Few members of the department could understand why Darr did it. Pittman was barely qualified for the job: He seemed to know little about tax shelters and had received his undergraduate degree from a night school only a few years before.

  Still, there was no doubt that Pittman was a hell of a runner. With him in the race, D’Elisa thought, Bache might actually have a chance of doing well this year.

  D’Elisa kept stretching as he watched a tall, thin man walk through the crowd. During the day, no one would have noticed the man; nothing about him would have seemed remarkable. But on this evening, he seemed oddly out of place. He was dressed in a suit, white shirt, and tie with his dark hair slicked back. Among the runners in their brightly colored shorts and shirts, he looked almost shadowy. The man’s eyes locked on D’Elisa, and he strode purposefully toward him. D’Elisa stood up as the man came to a stop directly in front of him.

  “Hi,” the man said. “I’m Neil Sinclair.”

  D’Elisa nodded a greeting. He had never heard the name before.

  “I used to work with Jim Darr at Josephthal,” Sinclair said. “I understand that Jim is now with you at Bache, running your department.”

  “Yes?”

  “I just want to tell you to watch yourself,” Sinclair said. “Jim is on the take.”

  D’Elisa just stared at Sinclair. He didn’t quite know how to respond. “All right,” he finally said. “I appreciate the information.”

  Sinclair nodded and turned away. D’Elisa watched as the stranger walked off, disappearing again into the crowd, then returned to his stretching, without mentioning the odd encounter to his teammates. At 7:00 P.M. sharp, the race began. D’Elisa’s encounter with Sinclair did not throw off his running performance—he ran all five kilometers in twenty
-six minutes, placing eighth on the Bache team.

  But the whole time, and for days afterward, Sinclair’s words rang in D’Elisa’s head. It wasn’t what he’d heard that disturbed him the most. After working with Darr for almost a year, D’Elisa was more bothered by his own reaction.

  He wasn’t shocked at all.

  Jerry Leach, the head of Smith Barney’s partnership division, peered across a conference table in the squat Oklahoma City headquarters of Seneca Oil Company. Never before had he seen Curtis Henry, his old friend from Bache, appear closer to bursting a blood vessel. Henry wanted to strike a deal so that Bache and Smith Barney could jointly sell Seneca’s next tax shelter. But as Seneca managers looked on at the September 1980 meeting, Leach gave no ground. Repeatedly he dismissed Henry’s proposals with a wave, saying that Smith Barney did not need a partner.

  This type of cautious mating dance between two brokerage firms was standard fare in the business. Almost every corporation has multiple Wall Street relationships, and eventually, those different firms can come together on a deal too large for just one to handle. That spreads the fees and gives the client assurance that the deal will get done. Seneca’s planned $15 million partnership seemed perfect for such a combination between Smith Barney and Bache. Both firms had relationships with the company, with Smith Barney selling its past partnerships and Bache handling other investment-banking work. But Smith Barney had never handled a tax shelter this large; Henry could not understand Leach’s refusal to let Bache sell half the deal. He kept telling Leach that Smith Barney could never sell the deal by itself.

  Leach knew Henry was right. He doubted his brokers would be able to move even one-third of the deal alone. To get it sold, he would have to bring in another brokerage firm. But he would never allow Smith Barney to work with Bache. Not anymore. Not since the firm hired Jim Darr, his old colleague from Merrill. Leach had heard about what had happened at Josephthal and thought Darr was dirty.

  More than a year earlier, Leach had rejected Darr’s proposal to have Smith Barney sell an oil deal he was packaging. If Bache was foolish enough to put a person like that in charge, Leach thought, so be it. But he would not bend his position: No department he controlled would do business with Darr.

  Leach didn’t want to embarrass Henry, so he refused to cite his real objections to Bache in front of Seneca’s management. He hoped Henry would recognize that stubbornness was not his style and back down. But Henry didn’t understand the unspoken message. Leach’s chorus of nos made him too angry to think.

  Finally Leach pushed his chair back from the conference table. “Curtis,” he said, “why don’t you and I go take a walk outside, and just talk by ourselves a little bit.”

  Henry liked the suggestion. Now they could talk turkey without worrying about what the client thought. By the time they got back, he figured he would have half the deal in his back pocket. Both men stood up and told the Seneca executives they would be right back. With Henry following, Leach left the conference room and headed out the company’s front door. He didn’t stop until he reached a street corner, where Henry sidled up beside him. They both stood silently for an instant, watching the cars drive by. Leach seemed to be gathering his thoughts.

  At last, he turned to Henry. “I’ve got problems, Curtis. I can’t do a joint deal with you.”

  Henry felt flustered. Finally he sputtered, “Well, why not?”

  “I can’t do a joint deal with you as long as Jim Darr is in charge of your department at Bache.”

  Confused, Henry looked at Leach. He himself disliked Darr and made no effort to hide his contempt for his boss’s arrogance and bullying behavior. But Leach’s reaction seemed extreme.

  “Well,” he replied, “he’s kind of rough to get along with, but why does that mean you can’t do business with us?”

  Leach looked around. No one was there. He decided to stop dancing around the topic and asked Henry if he knew what had happened to Darr at Josephthal. Henry shook his head.

  “He got caught with his hand in the cookie jar,” Leach said. Darr, he said, got caught taking money from clients.

  Somewhere in his heart, Henry knew he should have felt stunned. But he didn’t. “That wouldn’t surprise me,” he said.

  “I don’t know how Darr got out of it,” Leach said. “But you need to be very, very leery of your new boss.”

  Henry muttered something. Everything was happening too fast.

  “I cannot and will not recommend doing any joint business as long as that guy is your boss,” Leach continued. “Now this conversation is at an end. I can either go in there and withdraw, or you can. Which one of us is going to be the gentleman?”

  Henry’s head was spinning. He wanted this deal badly, but he knew the right answer. “I’ll go in and withdraw,” he said, defeated. “I’ll be the gentleman.”

  Leach thanked him, and they returned to the conference room. Henry wound it down quickly, muttering that it looked like Smith Barney might be able to handle the deal alone after all. Everyone stood up and shook hands. Henry left the room and walked out the building’s front door, still feeling unnerved.

  He had never simply walked away from a deal before. He had no idea how he would explain what had just happened back at Bache. How could he say that Smith Barney shunned the firm because Leach thought the new boss was crooked? Nobody would believe him—everyone knew he didn’t like Darr. If he said anything, he could be out on the street looking for a job, with his former boss a sworn enemy. But if he kept quiet, and Leach was right, there was no telling what might happen at Bache. No matter what he decided to do, Henry knew it wouldn’t be the right choice. There wasn’t one.

  Oh, my God, he thought. What am I going to do now?

  When Jim Darr first arrived at Bache’s tax shelter department, his reputation among his new staff was already sour. For some, it was the things he said during the job interviews that did it. For others, it was the conditions they knew he must have accepted to get hired.

  Early on, Henry felt uncomfortable about whoever Blank’s potential replacement would be after someone he respected walked away from the job. Henry had recommended an old associate, Lee Roeder, who established himself in tax shelters at Paine Webber. But shortly after his interview with Lee Paton at Bache, Roeder called Henry to say thanks, but no thanks.

  “I can tell you right now, I’m not interested in the job, and I doubt very seriously if they are going to offer it to me,” Roeder said.

  “Why?” Henry asked.

  “Their idea of the size of that department and the growth they want out of it are crazy,” he replied. “In no uncertain terms I told them that there were not enough quality deals available to get the department to the size they wanted.” There was only one way, Roeder said, to reach Bache’s goal: start selling lots of junk deals.

  Great, Henry thought in disgust. Paton and all those others had no idea what the tax shelter business was about. You couldn’t just create good deals out of thin air—quality properties managed by quality general partners were tough to find. But in typical Wall Street fashion, these guys saw a business booming and wanted to push it further. All they considered, Henry suspected, was that E. F. Hutton had been building its tax shelter business exponentially in the past year. Under the leadership of George Ball, Hutton’s go-go president, the firm was hiring new staff and selling tax shelters at a rapid clip. But already, the quality of some Hutton deals was being viewed on the Street as suspect. Too many lousy shelters were being sold too fast. Just because Hutton and Ball wanted to risk their clients’ money to build an empire didn’t mean Bache had to follow them into the gutter. Whoever accepted the job on those terms, Henry felt sure, was not going to be someone he liked.

  Months later, the first person in the department to meet Darr was David Hayes, the longest-surviving member of Bache’s tax shelter business. Over the years, Hayes had cultivated a reputation for honesty, at times going so far as criticizing Bache deals to brokers. By 1979, he had more
credibility with brokers than anyone else in the department. So, in selecting a new boss for the department, it made political sense to try to win Hayes’s support. Paton telephoned him in Washington, asking him to come to New York to meet a candidate for the job named Jim Darr. Hayes agreed; he had never heard the name before.

  Hayes almost immediately took a dislike to Darr. Everything about Darr’s manner screamed that he was obsessed with control and had a self-important air of superiority. More times than Hayes could count, Darr started his comments with the phrase “I’ll tell you how to do it.” The entire time they spoke, Darr stared directly at Hayes, never moving his eyes. He’s trying to intimidate me, Hayes thought.

  The meeting came to an end, and after shaking hands, Hayes headed out the door, feeling enormously uneasy. From the way Paton acted, it was clear to Hayes that Darr already had the job in his back pocket. Hayes could not believe he would be working with the guy.

  The next month, Darr hit the department like a hurricane. Since Steve Blank’s dismissal, things had been drifting. Open positions went unfilled. Follow-up on some deals was missed. Morale suffered, and Paton made it worse by holding back some bonuses he thought were too high, even though they had been promised by Blank.

  Darr tackled all those problems with gusto. He had enormous energy and spoke forcefully about the need to transform the department into one of the biggest and best on Wall Street. Darr described, in military detail, his strategy: He had learned the game plan at Merrill Lynch. Their structure of product managers and other marketing specialists was the one to emulate.

  From almost his first day on the job, Darr’s new hires were given jobs prescribed in the Merrill playbook. One of his first hires was Wally Allen, his old friend from his training days at Merrill. Allen had since left Wall Street and was working at a southern coal company. But Darr thought he would be the perfect person to help bring a little bit of Merrill into the department. Within months of Darr’s arrival, Allen was working at Bache in the new job of product manager.