Eagle on the Street

  I don’t understand how a firm the size of Merrill Lynch—one with tens of thousands of employees and offices all around the world—can be held responsible for the actions of one rogue account executive in San Francisco, Shad declared when the debate began. Shad was convinced there were a thousand other situations that were handled properly by the firm. How could charging the firm be fair?

  The facts show that there were serious violations over a period of years, Lawyer argued.

  Formal and restrained, Lawyer sat stiffly at the table. His manner contrasted sharply with the way he usually conducted SEC depositions, where he liked to put his feet up on the table and didn’t mind addressing a witness with a simple assertion such as “That’s bullshit.” There was none of his usual bravado, and certainly no profanity, as he responded to Shad.

  “This wasn’t a systemic breakdown,” the chairman said.

  Lawyer fired back. Merrill Lynch had only one system for compliance with the securities laws. And in this case, that system hadn’t worked. The failure was systemic.

  The San Francisco staff had assumed coming into the meeting that Shad was against them, while commissioners Peters and Treadway would probably support their position. But they had no idea which way commissioners Marinaccio and Cox would go. Cox initially was seen by liberal staff lawyers as a lackey of Chairman Shad, who had engineered his appointment to the commission. (The views of many early critics of Cox changed over time, and he earned respect as an independent commissioner.) If Lawyer and Lapidus were to prevail, they needed one vote from either Cox or Marinaccio.

  “You’ve got three votes,” Fedders said to Bobby Lawyer some ten or fifteen minutes into the meeting, after Cox made a comment indicating that he was in favor of naming Merrill Lynch as a defendant. It was clear to Lawyer and his supporters in the room that Fedders, too, was behind him. The tension among the staff lawyers eased.

  The final vote was 4 to 1; an attorney present recalled Shad acknowledging at one point that he was beginning to “feel a little bit lonely on this.” When the tally was called, no attempt was made to distinguish between the question of whether to charge Merrill Lynch with fraud or whether to name three of its employees—the discharged Matl, and San Francisco officials Louis Trujillo and Robert Fisher—as defendants. It seemed from his comments that Shad had no objection to filing charges against the individuals, but since he didn’t make that clear when he voiced his vote, he cast his ballot technically against filing the entire case. In a later interview, Shad clarified his vote, saying, “I have a basic visceral reaction to sanctioning the firm for one bad account executive,” but adding that any individual stockbroker who abused his customers “should be prosecuted to the full extent of the law.”*

  Some of the commission attorneys who supported Lawyer’s fight for charges against Merrill Lynch considered his victory Pyrrhic. To them, it was absurd that so much energy had to be expended arguing about a case where the facts seemed so strong, the violations so egregious. It wasn’t a question of whether Merrill Lynch’s top executives had consciously engaged in fraud—the evidence showed they had not. The point was, if those executives were not held publicly accountable for serious breakdowns in discipline within their firms, what message would that send to Wall Street about the SEC’s attitude toward fraud and misconduct? If it had taken that much effort for Bobby Lawyer to prevail against Shad in a case where the facts were mostly undisputed and relatively easy to prove in court, what would happen to all the other cases against Wall Street firms where the evidence was convincing but less clear-cut?

  Still, for Bobby Lawyer and his supporters in the enforcement division, the victory at the table was a moment to savor and a boost to morale. For as 1985 began, the enforcement division became embroiled in a distracting and demoralizing scandal that would attract far more attention than the Merrill Lynch case.

  Some of the SEC’s own unsavory secrets were soon to be exposed.

  * SEC records do not reflect Matl’s response to these specific complaints, but Matl said on several occasions that he was authorized to make the trades that customers were complaining about.

  * On September 11, 1985, Merrill Lynch settled proceedings with the SEC by accepting a public censure without admitting or denying wrongdoing. Robert Fisher, chief of the firm’s San Francisco office, accepted a two-month suspension from the securities business, also without admitting or denying wrongdoing.

  A second manager in the San Francisco office, Louis Trujillo, chose to fight SEC charges in an administrative proceeding. The Trujillo case showed that the commission’s internal process for conducting civil trials was slow and sometimes ineffectual. The lawsuit lasted more than three years, consuming thousands of man-hours and tens of thousands of dollars in fees and expenses. In early, confidential settlement negotiations with the SEC, Merrill Lynch insisted that Trujillo deserved no more than a public censure. SEC lawyers initially held out for a suspension, but then agreed to recommend a censure to the full commission. At a closed SEC meeting attended by Shad, Peters, and Cox, the latter two commissioners toed a hard line, insisting that Trujillo deserved a suspension, not the censure recommended by staff. Shad supported a censure but was outvoted, 2 to 1. After a drawn-out trial, an SEC administrative judge ruled, in April 1987, that Trujillo deserved a censure. Trujillo appealed to the full commission, of which Cox was still a member. At a closed meeting in 1989, the SEC voted to exonerate Trujillo entirely.

  Victor Matl settled SEC charges without admitting or denying wrongdoing and was barred permanently from the regulated securities business.

  Merrill Lynch said in a statement that it was “committed to the highest standards of professional and personal ethical conduct,” that its systems of employee supervision are “second to none” and that Matl’s productivity as a salesman did not influence how the company handled the complaints against him. The firm added that “while the Matl situation was a unique one, we believe our firm acted reasonably and responsibly in dealing with it based on what was known at the time.”

  Smith Barney settled SEC proceedings on March 5, 1985, accepting a public censure without admitting or denying wrongdoing in connection with the Rhinelander naked options case. Denny Herrmann and his boss in Rhinelander, Robert Heck, also settled cases against them and accepted brief suspensions. Herrmann was fired by Smith Barney, and as the 1980s closed, he was working as a stockbroker with another firm in northern Wisconsin. He said in an interview that he believed he had been treated unfairly by his former employer. Smith Barney officials declined to make any comment about the case.

  14

  Testing a Friendship

  On the wintry morning in 1985 when the story broke, the reporters gathered like a pack of hounds in the lobby of the commission’s headquarters, television cameras slung over their shoulders, wires snaking outside to vans parked along Fifth Street, microphones poised to jab and thrust at any SEC official who tried to run the gauntlet. Shad happened by at one point, and they pounced. The chairman muttered that he would not comment on John Fedders’s personal life, that he had not asked for Fedders’s resignation, nor had the enforcement chief volunteered to quit.

  John Fedders has done “an outstanding job” at the commission and had assembled “an excellent staff” to prosecute securities fraud cases, especially those involving insider trading, Shad told the reporters.

  Upstairs, on the fourth floor, Fedders—visibly engulfed by emotional pain—moved between his office and those of his senior colleagues in the enforcement division, talking about the story in that morning’s Wall Street Journal. His secret was exposed. His career and all it meant to him seemed about to collapse.

  Several of the enforcement lawyers who had worked with him closely since 1981—including Gary Lynch, the associate director, Bill McLucas, an assistant director, and Michael Mann, a young attorney who had worked side-by-side with Fedders during the Swiss-bank secrecy negotiations and related insider trading cases—sympathized with Fedders’s angui
sh. To one degree or another, and especially in recent days, they had heard about Fedders’s troubled marriage, including the report that he had physically beaten Charlotte at least half a dozen times. They did not condone what Fedders had done, but they knew that he regretted it, that his relationship with Charlotte was complex, that he had been separated from her for more than a year, and that his performance at the SEC had seemed unaffected by the secrets he kept at home. To Fedders and some of his friends and colleagues at the commission, the story about his tenure as enforcement chief and his marital problems in the Wall Street Journal that Monday, February 25, 1985, seemed brutal and unfair. And they did not understand why virtually every media outlet in the capital had been stirred into a frenzy by disclosure of details about Fedders’s private life.

  “The path through the capital’s revolving door—whirling into government service for a while and then back into the private sector at a big salary—is a heavily traveled one,” began the story on the front page of the Journal, which has the largest daily circulation of any national newspaper in the country. “But it has turned into a bumpy road for John Fedders.…” The story, authored by investigative reporter Brooks Jackson, then listed in specially indented paragraphs four “troubles” that had placed Fedders at the “storm center.” The news that Fedders beat his wife was buried beneath the disclosure that he was “strapped for cash and can’t meet expenses,” and above a description of Fedders’s previously reported role as a lawyer in a criminal corporate-bribery case that predated his arrival at the SEC, a case in which he was never charged with any wrongdoing. It was as if the Journal’s editors had been sufficiently uncomfortable with the raw disclosure of Fedders’s marital violence that they had found it necessary to create a larger context in which to report their startling scoop. (Newspaper reporters and editors frequently wrestle with whether to report the personal problems of public officials, guided in part by how the problems relate to on-the-job performance.) And yet, predictably, that Monday it was the news that John Fedders had beaten his wife while working as the top cop at the SEC that galvanized the Journal’s competitors and caused a sometimes-unruly pack of print and television reporters to assemble in the commission’s headquarters lobby.

  Up on the fourth floor, some of Fedders’s senior colleagues in the enforcement division were asking a question about the Journal’s story: Was it, in part, an act of institutional retribution against the SEC for the insider trading prosecution the commission had recently mounted against R. Foster Winans, a fired Journal reporter?

  Fedders thought this was possible. Winans had been the author of the Journal’s widely read “Heard on the Street” column about the stock market. Over a period of months, he had leaked advance word of his column’s contents to a stockbroker at the Wall Street firm Kidder, Peabody & Company, and had profited from stock trading the broker handled. When Winans was about to write favorably about a company, they bought the company’s stock before his column was published. After Winans was caught, the SEC and the Manhattan U.S. attorney’s office launched investigations that caused embarrassment at the Wall Street Journal.

  The notion that the Winans case had led the Journal to take revenge on Fedders by digging up the details of his marital violence was appealing to some of the senior enforcement staff, but it illustrated that they, like Jack Shad earlier, seemed unable to comprehend the central anomaly of Fedders’s secret. The leading law enforcement officer at the commission, a six-foot ten-inch disciplinarian and the arbiter of right and wrong on Wall Street, committed battery against his wife in the privacy of his Potomac home. It was outrage about that contradiction and the power of such an anomaly to become sensational news that lay behind the Journal’s story and the ferocious scramble of other newspapers and the television networks that Monday to catch up.

  Fedders wasn’t sure what would happen. No decision about his future had been made by Shad or the White House that day. Fedders had talked about his marriage with Shad and White House counsel Fred Fielding earlier that February, after two days of testimony in his divorce trial in a small courtroom in suburban Rockville, Maryland. On the witness stand, Fedders had admitted in open court that he struck his wife during their marriage and said that he felt “tremendous remorse.” The Journal’s Jackson had attended the trial and identified himself as a reporter, so Fedders knew a story was likely. In the several weeks it took Jackson to prepare his piece, Fedders’s personal lawyer had negotiated with the Journal’s managing editor, Norman Pearlstein, in an attempt to forestall publication. On Sunday night, Fedders learned that the effort had failed, although he had no inkling until Monday morning of the length and prominence and details of the story. Shad, too, knew a story was coming, but not that it would be long and graphically detailed.

  Fedders wanted to go home that Monday night to the apartment he had rented on Massachusetts Avenue after the separation from Charlotte, but he didn’t want to push his way through the reporters in the lobby. Many of the enforcement lawyers on the fourth floor that evening were angry at the media. One or two reporters had snuck around commission security and tried to prowl the hallways, looking for Fedders. The enforcement staff thought this was outrageous and unprofessional. They felt besieged. Lynch, Mann, McLucas, and other enforcement staff told Fedders they wanted to help, and they said they had a plan.

  Fedders had parked his car in a garage across the street from the SEC. Mann took the keys and went to retrieve it. Another staff lawyer escorted Fedders onto the elevator, rode with him to the commission garage below the lobby, and helped him into a different car. They slipped unnoticed out of the driveway and met Mann at a prearranged rendezvous several blocks from the commission.

  For most of the evening, Fedders stayed at Gary Lynch’s house in Chevy Chase, Maryland, just over the district line, talking with Lynch and Lynch’s wife about Charlotte and his sons and his future. Around 11:00 P.M., he said he wanted to go home, and he drove off. As he neared his apartment building, SEC staff lawyers who had been waiting for him flagged his car down. The press had staked out his apartment lobby, Fedders was told. The gangly enforcement chief clambered out, walked down the block, and snuck into his building through the garage while the enforcement lawyers parked his car out on the street.

  The next day it ended. Fedders managed to duck into SEC headquarters in the morning. He spoke with Shad.

  Everyone has concluded that it would be best if you resigned, Shad said.

  By that, it was clear, the chairman was referring to the Reagan White House.

  I’ve come to the same conclusion myself, Fedders replied.

  Others in the Reagan administration had been suspected of wife-beating and had not resigned. But the difference in Fedders’s case, Shad agreed, was that the enforcement chief had admitted the violence in open court.

  In his office, Fedders drafted a letter.

  “Dear Mr. Chairman,” he wrote to Shad. “Newspaper reports of yesterday and today have focused on my marriage and my pending divorce trial in Maryland. Those reports have exaggerated allegations in the divorce trial and have unfairly described occasionally highly regrettable episodes in our marriage. On seven occasions during more than 18 years of marriage, marital disputes between us resulted in violence, for which I feel, and have expressed, great remorse. Those isolated events do not, however, justify the extreme characterizations made in the press.

  “Although I am thoroughly satisfied that my private difficulties have in no way affected the execution of my duties as director of the division of enforcement of the Securities and Exchange Commission and would not do so in the future if I remained in office, the glare of publicity on my private life threatens to undermine the effectiveness of the division and of the Commission.… I must now regretfully tender my resignation as of the close of business today.”

  At 5:30 P.M., the SEC announced officially that John Fedders had quit.

  Shortly thereafter, on the CBS evening news, Washington reporter Leslie Stahl said, “Whi
te House officials insist that there was no pressure on Mr. Fedders to resign, although they admit that, given President Reagan’s emphasis on family values, the Fedders case, if allowed to linger on, could have been politically damaging.”

  The fall of John Fedders set the stage for a quiet change inside the commission that would contribute, just a year later, to the biggest crackdown on Wall Street corruption in SEC history: Gary Lynch came to power as enforcement chief.

  In those first weeks, he wanted more than anything to avoid making a serious, public mistake. Lynch was one of Fedders’s closest friends and he felt bad about what had happened, but there was no question, either, that he wanted the job of enforcement chief now that Fedders was gone. Among the commissioners and the senior staff, there was little doubt that if Shad decided to hire from within, Lynch would be selected—he had no serious rivals among his colleagues at senior levels of the division. The question, though, was whether Shad would go outside to hire from among his former associates on Wall Street, in an effort, perhaps, to restore the enforcement division’s credibility by attracting a well-known leader of the securities bar. On the Monday following Fedders’s resignation, Shad named Lynch as the interim enforcement chief, but Lynch knew the chairman was continuing to talk with prominent lawyers in private practice about the job.

  Fedders’s abrupt resignation and Lynch’s uncertain status left its mark on the enforcement division. Wall Street raced ahead—extravagant and seemingly abusive takeover deals sprang up, led by a wild fight for Phillips Petroleum involving Ivan Boesky, Boone Pickens, and Michael Milken; insider trading in advance of merger announcements grew; stock prices were buffeted by new, computerized trading strategies—and the SEC’s vaunted enforcement division seemed uncharacteristically weak. Crises erupted one after the next. Less than a month after Fedders’s resignation and the chaos that attended it, an official of the Federal Reserve Board, which monitored interest rates and helped to ensure the safety and soundness of the banking system, telephoned Lynch at home.