Eagle on the Street

  Cox was oblivious to the controversy inside the SEC about his office. He was enlivened by the mission Shad had laid out for him—to analyze, quantify, and document the chairman’s free market views on the most important regulatory issues of the day. Corporate takeovers were an ideal issue for Cox to tackle first. With controversy over the Martin Marietta affair raging and calls for reform mounting, Shad wanted to quickly quantify the costs and benefits of takeovers. He wanted a clear economic analysis—based, of course, on Shad’s own free market assumptions about economics—of the impact of any proposed changes in the rules that governed the merger game. Shad’s gut told him that takeovers were good and that tampering with the regulatory system to control them would create more problems than it would solve. Now he had an economist who could crunch the numbers to support his views.

  That would be no intellectual compromise for Cox, who had received his doctorate in economics from the University of Chicago. Cox was one of the university’s true believers—the graduate students and economists who flocked to Washington to change the way government worked. To them, the political changes inaugurated by Ronald Reagan offered a chance to implement a radically conservative version of the Marxist concept of praxis—the melding of revolutionary theory and practice. Cox subscribed fervently to the view that free, unfettered markets offered a more efficient and effective means to solve society’s problems than government did.

  He and Shad hit it off from the start. In their first conversation before Cox was hired at the SEC, they talked about how economic analysis could play a role in decision making at the commission. They agreed that the SEC staff was generally too reluctant to quantify the economic impact of regulatory decisions. The more they could quantify, Shad and Cox agreed, the better their decisions would be. Of course, since it was typically much easier to quantify the cost of a proposed rule or regulation than it was to quantify its benefits—which might include abstract ideas such as the quality of life or the safety and soundness of the financial system—there were some at the SEC who saw the new emphasis on numbers as a disguised effort to reduce the commission’s regulatory role.

  With Cox in place as chief economist, Shad had implemented an important institutional mechanism that he hoped would transform the SEC. Shad was at last firmly pushing the commission bureaucracy in a new direction. Fedders had won international renown for the agency’s campaign against insider trading; the biggest overhaul in history of the SEC rules governing how corporations raised money from investors was well under way; Cox was ready to draft papers declaring that takeover fights like the one that rocked the country in August merely represented the invisible, albeit indelicate, hand of capitalism at work; and Shad even succeeded in pushing his first bill through Congress. On October 13, President Reagan signed amendments to the securities laws that resolved the turf battle between the Securities and Exchange Commission and the Commodity Futures Trading Commission, thereby permitting new stock futures to come into existence. This was the deal struck by Shad and CFTC Chairman Philip Johnson, over lunch at the Monocle restaurant on Capitol Hill. In Shad’s view, the bill was tantamount to an emancipation proclamation for shareholders, who were free now to trade a panoply of new financial instruments without undue regulatory interference.

  Finally, too, the withering battle with Dingell began to ease. About two weeks after Jack Hewitt returned from Los Angeles to report on his interrogation of Michael Milken, Shad received a letter from Dingell’s office. “It is the staff’s conclusion that there was no wrongdoing in the method of disposition of the Hutton securities or in the transfer of the proceeds thereof to your trust,” Dingell wrote. “While the transactions were complex, they appeared to satisfy all existing statutory and regulatory requirements.” It was exactly the letter of exoneration Shad had requested when the investigation into his finances began—or as close to a letter of exoneration as John Dingell knew how to write.

  Before Shad moved from Wall Street to Washington, Nicholas F. Brady, an executive at the Dillon, Read investment house and a former senator from New Jersey, warned him about capital politics. You come to Washington with a fine reputation and you want to be sure you leave with it, Brady had said. And when Dingell had come after him, it was Brady who suggested that Shad hire Joseph Califano to fend him off. It irritated Shad enormously that he had to pay Califano $70,000 in fees and that his personal integrity had been questioned publicly. Yet, that November, Shad adopted a moderate tone in the public statement he released to the press along with the Dingell letter. “It has taken seven months and $70,000 in personal legal fees, but I am glad to get it over with,” Shad said.

  He had survived his initiation into Washington’s partisan rituals. He had established his authority over the SEC’s staff, partly through compromise. He had put in place new mechanisms through which to translate some of his free market views into federal policies. What remained was for John Shad to put broadly into practice the ideas about economics and government he shared with Ronald Reagan and the conservatives who had come to Washington to change the relationship between government and business.

  Shad sincerely believed that such a program—he refused to call it deregulation, partly because that was a word the Democrats used to bludgeon the Reagan administration—would lead the United States toward growth, prosperity, and strength. He believed adamantly that such a readjustment of priorities in favor of unfettered markets would work, because he shared his president’s sunny optimism about American business and American businessmen. The dark suspicions about venality and greed in corporate boardrooms that seemed to underlie the SEC’s enforcement program before his arrival seemed to Shad an overreaction, an essential misreading of Wall Street’s moral turpitude. He was prepared to stake his tenure as SEC chairman on his conviction that most everybody in American high finance—and, for that matter, at the commission—was honest.

  7

  The Chicago School

  In mid-February 1983, a heavy snow blanketed the capital, clogging roads and paralyzing traffic. SEC enforcement chief John Fedders was trapped at his spacious home in Potomac, amid rolling hills and horse farms and white rail fences, unable to navigate by car the narrow roads that led into the city. Snow in Washington was rare and much resented by the local populace, but in the wealthy Maryland suburbs along the river, it transformed pedestrian suburban tracts into winter landscapes of bright, manorial splendor.

  At Fedders’s house the mood was not bucolic. His marriage was deteriorating quickly, and for weeks he had offered little but silence to his wife, Charlotte. When the snow fell, it seemed to Charlotte that her husband became immediately angry and frustrated. Like a drill sergeant, he ordered the five boys to shovel the driveway clear. When they finished, Fedders climbed above the garage to clean the drain and inadvertently loosened a small avalanche of snow from the roof onto the drive. Though the boys were now inside, resting, he insisted that they return with their shovels. Charlotte began to scream, and she threw a wooden toy at him. Fedders smacked her so hard that he broke her glasses and blackened her eye.

  A few weeks earlier, confounded by his silence, Charlotte had written the SEC’s enforcement chief a note: “Do you realize the responsibility you have to find out what your problems are to help your children now and in the future? Do you realize you are more likely to succeed further (i.e., cabinet position, etc.) if your problem is taken care of now by counseling and/or medication than if your neighbors and friends and coworkers begin talking to investigative agents about your bizarre treatment of your family?… I know you are a good and decent man when you are healthy.”

  Now she decided to act. She dropped the boys with a friend, had her bruise photographed, and drove to the Rockville police station. They said all they could do was arrest him if she swore out a warrant. She said she didn’t want him to go to jail, and went home. A few days later, Fedders left for Florida on SEC business. He didn’t tell her where, or when he would return.

  The telephone rang one afte
rnoon while she was home alone with the boys. It was John Shad. Charlotte had met him a few times, once at a commission Christmas party she and Fedders hosted in Potomac. As Charlotte recalled:

  “Do you know when he’s coming home?” Shad asked.

  “I don’t know and I really don’t care. He has just given me a black eye.”

  “I’m sorry, but he has been under a lot of pressure lately,” Shad said.

  Perhaps Shad was thinking of Dingell’s investigations. The congressman’s probes of Shad had ended, but Fedders was the target of several continuing, politically motivated investigations. They would eventually come to nothing, but they put pressure on Fedders and kept his name in the newspaper.

  “No,” Charlotte replied. “It’s been happening since the beginning of the marriage.”

  “I’m really sorry,” Shad said. She was convinced he meant it. Shad said later that Charlotte hadn’t mentioned a black eye.

  When Shad saw Fedders the next week, he told him, “Get away and relax. Spend time with Charlotte and the kids.”

  “Yes, yes, but—” was Fedders’s reply.

  “I mean it, John,” Shad said.

  That was a suggestion Charlotte Fedders might have found frightening, but Shad thought that many marital problems were caused by stress faced by the husband at work, and that the problems could be eased if the stress was reduced and the husband spent more time at home. In his days on Wall Street, Shad had seen that sort of thing often enough. He did not discipline Fedders, nor demand that he seek professional help, nor did he investigate Charlotte Fedders’s condition—whether she and her children were in imminent danger, whether they needed assistance. Shad felt that he didn’t know the facts about the Fedderses’ marriage, and in any event, he was reluctant to get involved with what he viewed as a personal family matter, even one that involved the top law enforcement official at the SEC.

  Charlotte Fedders wasn’t sure why she had told Shad; never before had she talked to one of her husband’s colleagues about the violence. Later, when Fedders came home from Florida and she asked him to move out of the house, she told him that Shad knew that he was “a wife beater.”

  After that moment, Charlotte said later, her husband never spoke to her again until he moved in July to his own apartment on Massachusetts Avenue in Washington. To Fedders, Charlotte thought, talking to Shad about the beatings was her ultimate betrayal. In any event, as a cry for help, it was useless.

  At one level, Shad seemed not to comprehend the magnitude of the secret he was harboring. This was a trait with which Shad’s senior staff at the commission had grown familiar. Shad often justified his free market policies at the SEC in strong moral terms. He described his own life decisions in the same language of right and wrong. And yet at times his own views of ethics and morality seemed sharply at odds with those of his colleagues or the public.

  A stunning example of this gap in ethical perceptions had been a closed SEC meeting two weeks before Shad’s call to Charlotte Fedders. At the meeting, the commission was to consider a controversial investigation into allegedly improper accounting practices at Aetna Life & Casualty Company, the insurance giant. Senior SEC staff wanted to file public charges, but the insurer had lobbied vigorously in its own defense, arguing through written briefs that the practices questioned by the SEC were generally accepted in its industry. As the climactic decision by the SEC approached, Aetna retained Joe Flom, the Wall Street takeover lawyer Shad had invited onto an SEC takeover advisory panel, to press its case at the commission. At stake was $203 million in profits that Aetna would have to wipe off its books if the SEC decided against it. Flom flew to Washington with Aetna’s chief executive in an effort to make a personal presentation to Shad and the other commissioners. To the amazement of the SEC staff, Shad invited Flom into a closed commission meeting and allowed him to make an oral argument on Aetna’s behalf. No outsider had been permitted into a closed commission meeting for more than a decade. That Flom was Shad’s old friend from Wall Street compounded the transgression in the eyes of some senior commission staff, who were convinced Aetna had hired Flom because of his personal relationship with Shad. One commissioner vocally objected to Flom’s appearance at the closed meeting, and the vote went against Aetna. Afterward, what appalled many of the SEC staff involved was Shad’s obliviousness to the implications of his actions. He didn’t understand that he had violated sacred SEC tradition and offended some who took that tradition seriously. Nor did he understand that such favoritism to an old friend from Wall Street looked bad politically, inside the commission and out. What would John Dingell do if he found out about Flom’s appearance?

  But there were no embarrassing hearings on the matter, because Dingell never found out. Secrecy, of course, was one of the commission’s most cherished traits. It was a credit to the commission’s culture of secrecy, and to the personal affection Shad was beginning to earn from the staff, that the partisan investigators on John Dingell’s staff never learned what happened in the Aetna case. Though it had merit in some instances and was a sign of the intense loyalty felt by the SEC staff to the agency, the uses of secrecy at the commission also highlighted some of the worst tendencies of bureaucracies and bureaucrats in Washington. Most importantly, secrecy protected the symbiotic relationship between the agency and the corporations and Wall Street firms it regulated. Secrecy had its legitimate functions—protecting the right to privacy of innocent people under investigation and enhancing the commission’s ability to conduct many of its sensitive probes. And both sides felt they benefited from the fact that neither the public nor the Congress knew what was happening. SEC officials felt they benefited from secrecy in part because no one could second-guess their votes or examine the evidence on which they based their decisions. The corporate and individual defendants in commission cases avoided the costs and embarrassment of publicity and full disclosure. On another level, though, the agency’s obsession with secrecy was replete with hypocrisy. The SEC pushed corporations and Wall Street firms to disclose all material information to investors, but it disclosed relatively little of the agency’s own most crucial dealings, making it difficult for the public to evaluate enforcement settlements and other issues. There was a way, too, in which the culture of secrecy percolated into the personal and professional attitudes of SEC officials. They became endowed with prestige and power. It was exciting to work on a secret case, one that could be resolved only in the revered privacy of a closed SEC meeting.

  Some of the commission staff lawyers had decided that either Shad didn’t care about how Flom’s appearance at a closed meeting looked or else he didn’t understand, and truthfully, they weren’t sure which it was. As the truth of Shad’s knowledge about the dark secret of Fedders’s marriage eventually spread, these staffers felt the same puzzlement. Despite Shad’s expressions of sympathy to Charlotte Fedders on the telephone, he took no action. The irony was that among officials of his rank in the Reagan administration, there were few who grappled more regularly with ethical questions or who described their work in moral terms more articulately than Shad. The commission’s charter demanded it—the agency’s job in part was to develop and enforce rules about fair dealing and ethical conduct on Wall Street. Shad’s argument for the crackdown on insider trading led by Fedders was as much moral as economic. Insider trading was just wrong—it was unfair—he kept saying, and it must not be allowed to undermine the integrity of the stock market. Away from the SEC, so often had Shad repeated to his friends his Mormon grandmother’s precept that a person should spend one third of his life learning, one third earning, and one third serving, that it had become a kind of cliché among them when the topic of Shad’s character arose. How many Wall Street millionaires had prefaced their careers by fasting in an attempt to induce a religious revelation? Yet the conflicts within Shad were obvious to those who knew him well, or who saw him operate inside the commission. His competitiveness, his love of wagering, his chain-smoking, his dedication to family and work, the
way he drove cars and boats too fast—at times the only thread binding his impulses seemed to be his absolute intensity.

  On a boat in the Pacific in the 1940s, Shad had declared himself an agnostic, but at the commission he was sometimes seen as a true believer, not about God but about free market economics. The first impulse of commissioners and staff who tried to assess Shad’s ideology was to lump him in with the “Chicago School” conservative theorists so prevalent among the Reagan appointees. That was easy to do, since Shad was attracted to economic theorizing generally and to the work of the Chicago professors specifically—his recruitment of Charles Cox to head the commission’s new office of the chief economist emphasized the point. By early 1983, though, it was becoming clear that Shad’s approach was not so coldly utilitarian as that of the hard-line Chicago intellectuals, who tended to think that every aspect of human life could be measured and assessed in terms of the free market. The Chicago economists’ laissez-faire attitude about markets had a libertarian corollary in their approach to social issues. Just as the government should keep away from the nation’s financial exchanges, it should stay out of the country’s bedrooms, too.

  Though Shad believed in free markets more fervently than almost anything else, his vision of the ideal society included—in fact, demanded—a prominent place for human trust and benevolence. The Chicago economists who had never tried to make a living on Wall Street thought free markets worked because, abstractly, they provided the best system in which individuals could make choices about their self-interest. The amalgamation of self-interested choices would protect and promote the collective interest. Shad thought that was correct as far as it went, but that the theory didn’t take account of the environment of personal trust that was essential for the markets to work fairly.