House of Cards (52 page)

For many at Bear Stearns at that time, Cayne's machismo in the LTCM crisis was a moment that defined the remainder of the firm's existence. “I think the hubristic moment for him, the turning point from which he couldn't go back, was LTCM,” explained one Bear Stearns senior executive. “It was the moment where he felt like he had outwitted all these CEOs of Wall Street. That was the no-turning-back moment where his set of virtues—in his mind—were embedded in concrete.” He observed that Cayne himself had no real understanding of risk per se, or of how much risk was too much risk, since he had only ever been a broker and an executive manager. Instead, Greenberg's approach to risk heavily
influenced Cayne's views on the subject. “Some of those virtues, I think, are Ace's virtues that bled into him over time,” he said. “I mean, Ace wouldn't risk a nickel for anybody.” The key to unlocking what happened at Bear Stearns after LTCM was gaining an understanding of the lineage that ran from Greenberg through Cayne to Warren Spector. Added a former longtime partner of the firm: “Warren and Jimmy decided that they weren't going to share in the burden with the rest of the Street. Then those guys [on Wall Street] had a perpetual erection for them. Especially for Jimmy, because he's an arrogant son of a bitch. He's a world-class bridge player. Everything he does is like he's playing a hand of bridge.”

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o celebrate Greenberg's fiftieth anniversary of joining Bear Stearns, there was the requisite article in the
Journal,
by Charlie Gasparino, that briefly delineated the touchstones of his career and pointed out that in 1998, with total compensation of $18.5 million, he earned in eleven and a half minutes what it had taken him a full year to earn when he was starting out as a clerk putting pushpins in a map of oil and gas wells. The secret to his long career on Wall Street was simple: “I bring in money,” he told Gasparino. Greenberg also appeared on Neil Cavuto's business show on Fox News. Among other things, Cavuto asked Greenberg why he had been so obsessed with cutting costs during his reign at the top of Wall Street. “I just think that you should set a tone on how business should be run,” he said. “As Mark Twain said, I think fish stink from the head, and if people up top are watching expenses, it permeates the whole organization. And I believe in it very strongly.”

Public relations aside, if Twain was right about how a fish rots, there were some strange smells starting to emanate from Bear Stearns. In August 1999, the firm's litigation involving the “bucket shop” A. R. Baron—which had begun more than two years earlier, following the publication of Gretchen Morgenson's article in
Forbes
—came to a head. For some two years, a Manhattan grand jury had been investigating whether Richard Harriton, the head of Bear's clearing business, had been engaged in criminal activity involving Baron and its CEO, Andrew Bressman. John
Moscow, then the assistant district attorney on the case, had aggressively pursued Harriton, in part by pressuring his co-workers and even his ex-wife to testify against him. In the end, the grand jury did not indict Harriton. But by this time, Moscow had started cooperating with the SEC on its civil suits against both Bear Stearns and Harriton. The SEC was trying through this litigation and a parallel rule change to make Wall Street's clearing businesses accountable for the questionable behavior of its clients. One Bear executive said he occasionally urged the firm not to clear for certain unsavory customers. At one such meeting, he said of one particular client, “I think he takes an unwholesome interest in the aftermarket performance of the deals he does. I would avoid him.” But that recommendation fell on deaf ears. “I was taken outside and they said, ‘Look, does a hotel have responsibility for what goes on its rooms?’” he recalled. “And I said, ‘If enough of it goes on, the hotel gets a reputation and people don't want to stay there. But are you asking me do they have a legal liability for what goes on? The answer is probably not. But if you're asking me are there consequences? There probably are consequences.’”

At various times during the SEC's investigation, the SEC offered to settle the lititgation with Bear Stearns for amounts that ranged between $5 million and $10 million. Explained one Bear Stearns executive: “But Jimmy Cayne, the ultimate bridge player, refused to settle for anything above $1 million.” On August 5, Bear Stearns decided to settle with the SEC. This time, Cayne's gamble had backfired. The cost of the settlement was an eye-popping $38.5 million, which included a fine, the establishment of restitution funds to settle customer claims, payments to the Manhattan District Attorney's office, and payments of $1 million each to New York City and New York State. The SEC found that Bear's clearance business “caused violations of the antifraud provisions of the federal securities laws in connection with its clearing relations with” A. R. Baron. Specifically, the SEC found that “although Bear Stearns was aware that Baron was engaging in unauthorized trading in customer accounts, Bear Stearns charged unauthorized trades to Baron customers instead of to Baron; Bear Stearns took money and securities from customer accounts to pay for the unauthorized trades; and Bear Stearns refused to return the customer property it took, even after Baron admitted that certain trades were unauthorized.” The SEC also found that Bear Stearns “assisted Baron in staying in business when it knew that Baron lacked required capital to operate and was engaging in an ongoing fraud. By charging to customers unauthorized trades that should have been liabilities to Baron, Bear Stearns helped Baron hide its continuing capital deficiency.” Suspected a senior Bear Stearns executive about the A. R. Baron
clearing arrangement: “Jimmy knew everything that was going on. There were plenty of meetings in his office about all that.”

Richard Walker, the SEC's enforcement director, hammered home the SEC's view that clearing firms would be held accountable for the actions of their clients: “Bear Stearns took actions that directly facilitated Baron's widespread fraudulent activity. A firm's status as a clearing broker does not immunize it from the consequences of participating in a fraud. To the contrary, a clearing firm, or any other market participant, that engages in conduct enabling a boiler room like Baron to defraud investors of millions of dollars is fully responsible for its actions.” Cayne said that at first Moscow and Robert Morgenthau, the Manhattan District Attorney, concocted “conspiracy theories that Bear Stearns and Citibank were out to fuck A. R. Baron customers” and wanted “$700 million” from Bear Stearns and Citibank. “I had a whole group of lawyers,” Cayne said. “They went down to see Morgenthau and his staff. They came back and gave me a report and I said, ‘Now, we have grades that we give out here for everything. You guys don't even get a grade. This result is so poor that you don't get a grade.' And I walked out.” In the end, Cayne said the A. R. Baron settlement was like “arguing with the umpire. The videotape shows you slid in and that you're safe, except the umpire says you're out. That's it.” The SEC gave Bear Stearns one night to consider the settlement offer. Bear signed it.

The Baron incident showed that the firm did not have proper oversight of the clearance business. The real issue with Baron, one executive said, “was more like if you lie down with dogs you get up with fleas. And these were less than wholesome people. They did not represent any significant part of the business. They represented a tremendous aspect of the liability of the business. They represented no money. I think setting some guidelines on maybe less than 1 percent of the customers would have saved the firm a fortune. But Bear didn't tend to micromanage successful producers.”

At first, Greenberg encouraged Harriton, his old friend, to fight the SEC charges. There was an issue of the potential conflict of interest because of Richard Lindsey, the former SEC official hired to replace Harriton. But, in the end, some eight months later, in April 2000, Harriton settled the case with the SEC. As usual, he did not admit or deny his culpability, but the SEC's nineteen-page settlement order laid many transgressions at his doorstep. He agreed to pay a $1 million fine and to be barred from the securities industry for two years. Harriton never returned to Wall Street.

On the heels of the Baron debacle, Bear Stearns found itself part of
the two major Wall Street scandals after the bursting of the Internet bubble in and around March 2000 revealed any number of systemic abuses on Wall Street. The first involved the conflict that arose between the equity research departments and the investment banking departments on Wall Street, in that investment bankers put pressure on research analysts to write favorable reports about their clients in the hope of winning future underwriting and M&A business. Since at that time research analysts were paid in part from the investment banking revenues they helped to generate, the bankers were able to lean on the analysts to write favorable reports. Obviously, this conflict did not serve investors well, since they could no longer be sure whether a report reflected the analyst's true judgment about a company or a coerced judgment.

This kind of behavior, yet another example of unrestrained greed overwhelming ethics, occurred all across Wall Street, including at Bear Stearns, and showed that as Wall Street firms became bigger and bigger they became harder to control and manage. In a typical example of how the research abuse occurred, Bear Stearns was a co-manager of the IPO and secondary offerings for the emerging telecommunications company Digital River in August and December 1998, respectively. Bear Stearns, via three successive analysts, rated the stock a “Buy” from the IPO until April 2002. On April 1, 2002, the research analyst covering Digital River wrote the Digital River banker the following e-mail: “I have to tell you, I feel a bit compromised today. I have told every client on the phone that they should avoid or short the stock over the last few months. I have been fairly hands-off on DRIV [the Digital River stock symbol], primarily because of the banking prospect that you and [another banker] have noted. Today, clearly the stock is down a lot. The artificial Buy rating on the stock, while artificial, still makes me look bad. In the future, I'd like to have more leeway with the ratings, even for companies like Digital River, where we have a relationship on the banking side. I trust it would benefit all of us.”

As part of the global $1.435 billion settlement, Bear Stearns agreed to pay $80 million. Cayne had no choice but to settle, and the firm got off relatively lightly (Salomon Smith Barney paid $400 million and Merrill Lynch paid $200 million). Cayne also felt he had little choice but to settle—for $250 million—the SEC's securities fraud charges against the firm for “facilitating unlawful late trading and deceptive market timing of mutual funds by its customers and customers of its introducing brokers” from 1999 through September 2003. “Bear Stearns provided technology, advice and deceptive devices that enabled its market timing customers and introducing brokers to late trade and to evade detection by mutual
funds.” By late trading, Bear and its customers were able to effectively have tomorrow's
Wall Street Journal
today, enabling them to make money by making trades even though the market had closed. “The truth is I settled a lot,” Cayne said. “I settled most of the time. I very rarely fought. I pretend to fight. I'd really rather settle.”