House of Cards (49 page)

Cayne then negotiated with Meriwether what the clearance arrangement would be. Cayne told him that regardless of how much money Merrill raised for LTCM, the minute the fund's net asset value fell below $500 million, Bear Stearns would no longer clear trades for the fund. “That will be in our clearance agreement,” Cayne told Meriwether. “He said, ‘We can't live with that.' I say, “You got to live with that.' He said, ‘We can't live with that.' I said, ‘Well, then you can't have a clearance agreement. But we can have an institutional-client relationship, where I'm going to enforce the $500 million level.' He said, ‘Okay, maybe we can talk you out of that over time.' They never could.”

Cayne personally invested $10 million in LTCM, one of about eighty Wall Street heavyweights who were allowed to invest individually. He figured LTCM would make so much money the high fees being charged would not matter. In February 1994, the firm opened for business with
$1.25 billion of investors' money. But from day one, LTCM wanted to be treated differently from other clients. They did not want to put up initial margin for their trades, which required a cash deposit equal to around 5 percent of the value of the securities being bought or sold. LTCM did not want to put down any initial margin at all. Bear's derivatives desk called Cayne and told him this news. “What?” Cayne said. “The Bank of England puts up initial margin. They don't put up initial margin?” Cayne felt he had been snookered but was willing to put up with making “razor-thin” profits from LTCM and “pulled out the red carpet” for the firm “because (a) it was a great assignment, (b) it was prestigious, and (c) whatever flow there was, you're going to be able to see the flow”—meaning that Wall Street firms could piggyback LTCM trades since they were able to see in advance the supposedly brilliant trades LTCM wanted to make and could then just copy them. “Let's not kid ourselves,” Cayne said. “That's part of Wall Street.” But, Cayne said, Bear Stearns did not piggyback on the LTCM trades. “We never even saw their flow,” he said. “We never saw their swaps. We never saw any of it. We're just clearing. We march along in life, clearing.” Bear Stearns made $30 million a year clearing trades for LTCM.

As has been well documented in Roger Lowenstein's bestseller,
When Genius Failed,
LTCM combined all of Meriwether's supposed trading expertise with the technical expertise of Nobel Prize—winning economists Robert Merton and Myron Scholes (the latter one-half of the duo that devised the widely used Black-Scholes option-pricing model)— and with the regulatory expertise of David Mullins, the vice chairman of the Federal Reserve Board, who resigned his position to join LTCM. It was a partnership designed to maximize the seduction of potential investors. Needless to say, LTCM was the envy of Wall Street—in the days before hedge funds were a dime a dozen—and firms rushed to do business with the hedge fund. LTCM's computer-driven investment strategy was to make so-called convergence trades, involving securities that were mispriced relative to one another, taking long positions on the inexpensive side of a trade and a short position on the expensive side of a trade. For the first two years, the strategy worked splendidly. Investor returns were around 40 percent during that period and the assets under management swelled to $7 billion. The original partners and investors were getting even richer.

Bear Stearns, too, was performing well as the markets improved in the mid-1990s, having recovered its balance in its fiscal year ended June 1996: Net income more than doubled, to $490.6 million, and the bonus pool for the top five executives reached a stunning $81.3 million. Cayne's pay more than doubled, to $20.4 million, as did the pay of Spector ($19.5
million) and Greenberg ($19 million). Schwartz's compensation nearly tripled, to $14.6 million. Siconolfi, writing about the management's windfall in the
Wall Street Journal,
noticed that the top five starters at Bear Stearns earned $23.3 million more in compensation than the entire twelve-man roster of the NBA champion Chicago Bulls. “Which goes to show, perhaps,” he wrote, “that even in today's record-setting market, the Bears sometimes can beat the Bulls.” At the firm's annual meeting for shareholders, in November, Greenberg extended Siconolfi's basketball metaphor. When asked by one shareholder whether there was any “ceiling” on management's compensation, Greenberg replied there was not. “Do you know how much Shaquille O'Neal makes?” he asked, referring to the then star center of the Los Angeles Lakers. “And the Lakers don't make any money.” After the meeting, Greenberg pointed out that the two shareholders who had questioned the management compensation packages had been assuaged by his explanation of how it worked and “seemed very, very satisfied.” He also noted that 91 percent of the non-employee voting shareholders approved of the pay plan. The next year, Bear's top five executives split between them even more money—$87.8 million— with Cayne once again walking off with the lion's share, $23.2 million.

B
UT AS 1997
came to a close, cracks were beginning to appear in Bear's façade. First came a lengthy broadside in
Forbes,
written by Gretchen Morgenson (who would later move to the
Times
), questioning the firm's role in the demise of a small “bucket shop” brokerage by the name of A. R. Baron & Co. In the language of Wall Street a “bucket shop” was considered to be a shady brokerage firm that used aggressive telephone sales tactics to sell securities that the brokerage owned and wanted to get rid of—typically inferior investment opportunities or penny stocks—and were not particularly concerned with the consequences. Morgenson wrote how the failure of the diminutive Baron, in July 1996, had cost its customers some $22 million and, more important, had “laid bare a corner of the securities industry that is rarely seen but hugely profitable: processing trades for other firms.” In delicious detail, Morgenson documented numerous nefarious allegations about the firm's clearing division, which was run by Richard Harriton, then sixty-one years old, and cleared more than a hundred thousand trades a day at that time. According to Morgenson, Harriton used to introduce himself to potential customers by saying, “I run the most profitable division of Bear Stearns and I'm the most powerful man on Wall Street in clearing.” She described a number of the shady clients Bear cleared for in addition to A. R. Baron, including Rooney, Pace (closed down by regulators in 1987), D. Blech & Co. (the investment
firm that went out of business in 1994, leaving investors with $200 million in losses), and Stratton Oakmont (closed by regulators in early 1997). “Right now,” she wrote, “Bear Stearns is the clearing firm for at least 15 brokerages that are, if not full-fledged bucket shops, close to it.”

Morgenson suggested that Bear Stearns kept Baron alive for more than a year after the firm was kaput, causing investors to lose millions on shady deals. She wrote that Harriton agreed to clear for Baron—after once kicking it out of Bear Stearns in 1992—as a favor to a Bear Stearns brokerage client with “sizable accounts” at the firm and who also had an investment in Baron. Baron's president, Andrew Bressman, used to take Harriton to New York Knicks basketball games, where they would sit together in his front-row seats next to film director Spike Lee. Morgenson also implied—using an anonymous source—that Harriton was receiving kickbacks from Baron in the form of proceeds from the sale of Baron's hot IPOs. Hannah Burns, a spokeswoman for Bear, said the firm would not comment for the story because of pending litigation. “Clearing is a very, very proprietary business for us, and we don't want the public knowing about it.” Summed up Morgenson: “The whole situation stinks.” A few months after the
Forbes
article appeared, on May 13, 1997, the Manhattan District Attorney's Office indicted Baron “on charges of being a criminal enterprise that used lies, unauthorized trades and theft to defraud investors of at least $75 million from 1991 to 1996, according to the
New York Times
. The DA's office arrested thirteen Baron executives, all of whom either pleaded guilty to charges or were found guilty at trial. Bear Stearns and Harriton quickly found itself caught up in the Baron litigation and the myriad of derivative lawsuits associated with it. The DA's office, under the auspices of Assistant District Attorney John W. Moscow, also opened a two-year grand jury investigation into Harriton's behavior as head of the clearing business, and the SEC began an investigation into Bear's role in the Baron debacle. As with several other incidents over the years, the Baron litigation and the SEC's investigation would give Cayne another chance to showcase his skills of macho confrontation.

B
UT IF THE
Baron matter showed Cayne at his toughest and most intransigent, he was also capable of great charm, nuance, and negotiating skill in an effort to obtain a coveted prize. Nowhere were these Cayne attributes on finer display than in his two-year quest to wrest control of the square block of land at 383 Madison Avenue, between 46th and 47th Streets, in Manhattan—just down the street from Bear's headquarters at 245 Park Avenue—upon which he would erect what he thought would be
a monument to the firm he was guiding to higher and higher profitability and importance on Wall Street. In the end, the building was simply a gold-plated monument to Cayne's ego.

By 1997, Bear Stearns was busting out of its headquarters at 245 Park. The firm had 8,300 employees in June 1997, up 32 percent from June 1993. Its lease was up in 2002, and its recent addition of another 100,000 square feet of space at 245 Park was merely an interim solution. The firm also had smaller offices in the area, including one at 575 Lexington Avenue. Cayne had made it known in real estate circles that he was looking to build a new headquarters building in midtown, although the other options included staying at a revamped 245 Park or finding another existing office building.

Bear had several different locations under consideration for constructing a new building. But 383 Madison, right in the heart of Manhattan and owned in a partnership by First Boston, the investment bank, and Saudi Arabia's powerful al-Babtain family, was the best site. “It's filled with homeless crackheads and whatever,” Cayne said. “It's a blight. But it's perfect.” At one point, the British developer Howard Ronson had had an option on the site, but his option ran out before he could find an anchor tenant, and so First Boston gave Bear Stearns a call. “I'd been spending a lot of time with Jimmy and we were sort of like comrades in arms in a way because he was becoming obsessed about this whole real estate thing now,” explained Tom Flexner, a Bear vice chairman and head of its real estate group. “So maybe it was beginning to turn into his monument. I mean that respectfully. So we start negotiating with First Boston and I think we negotiated this $53 million price to buy the site.” The idea was to tear down the Manhattan Savings Bank building that was there and put up a skyscraper that had been designed by Skidmore, Owings & Merrill. Cayne called up Allen Wheat, the CEO of First Boston, to negotiate a deal. “Look, I'm not in the real estate business,” Cayne told Wheat. “I don't think you're in the real estate business, but I understand you have a property for sale. I understand that you have an interest in selling it at $53 million. Are you still interested?” Wheat said he was interested in selling. “So we can do this?” Cayne asked. They shook on a deal at $53 million.

Cayne then called up Flexner and told him the news.

“How much did you pay for it?” Flexner asked.

“How much did I pay for it?” Cayne replied. “You told me $53.”

“Yeah, but Jimmy—” Flexner began.

Cayne interrupted. “Oh, I get your question,” he said. “Could I have done it at $51.9? Could I have really scored? No. You gave me a number, I did the number. We're done.”

At the end of the negotiations, First Boston had mentioned that the Saudis had a right of first refusal on the property, but assured Bear that the Saudis wouldn't exercise it because “they wanted out—they had been feeding this thing for years, and they wanted out.” But the Saudis exercised their option in February 1996 and paid First Boston its share of the $53 million exercise price. That would have been the end of it, except that Cayne latched on to a clever idea. He and Flexner somehow figured out that the Saudis had not obtained the air rights over nearby Grand Central Station that would be needed for them to build a skyscraper on the site. So Bear Stearns bought an option on the air rights from billionaire Carl Lindner for around $10 million contingent on Bear Stearns getting control of the site. “This was the true mutual assured destruction kind of deal because if you buy the air rights and you can never cut a deal with the owner of the building, then you've just lost 100 percent of whatever you paid for the air rights because they're only good for that building,” Flexner explained. “But they weren't that expensive and we could get an option on them for a few weeks or months or something. We could use that as leverage.”