House of Cards (53 page)

T
HE TRUTH WAS
that Cayne mostly fought litigation, in keeping with his pugilistic instincts. One case that he fought for years and eventually won on appeal involved a Polish refugee from the Nazis named Henry de Kwiatkowski (or as Cayne called him, “Henry de K”), who was heavily involved in currency trading. In less than five months, beginning at the end of 1994, de Kwiatkowski, a Bear Stearns brokerage client, made and lost hundreds of millions of dollars betting on the U.S. dollar by trading in currency futures. In January 1991, he transferred 4,000 Swiss franc short contracts from a Bank Leu account in Israel to Bear Stearns—after signing all the requisite forms acknowledging a multitude of risks—in part because, he claimed, Bear executive Albert Sabini had “extolled the capacity of Bear Stearns to provide him the full services and resources he needed for large-scale foreign currency trading.” De Kwiatkowski's primary bet was that the dollar would rise in value against other currencies. “He was a bettor on the dollar,” Cayne said. “He never had a trade. He just had a position. And the position was long [on] the dollar against five currencies.”

In September 1992, de Kwiatkowski met with Larry Kudlow, then Bear's chief economist, and Kudlow encouraged him in this view. He then made big currency bets. When he closed his position, in January 1993, de Kwiatkowski had made $219 million of profit in four months. He made no new bets on the direction of the dollar until October 1994, when Sabini called him and told him “this is the time to buy the dollar” and that “this time the dollar will do what [Kwiatkowski] always believed it would do.” As of December 21, 1994, less than two months after he resumed currency speculation at Bear, Kwiatkowski had made a profit of $228 million. Cayne said that at one point Henry de K was up $500 million. When Cayne called Henry de K and asked him to increase his margin in the account to $250 million, de Kwiatkowski responded, “No problem. I can send in $500 million if you want.”

When the dollar fell a week later, de Kwiatkowski lost $112 million in a single day (December 28). When the dollar fell again, on January 9, 1995, de Kwiatkowski lost another $98 million. Ten days later, on January 19, he lost $70 million more. Still, even after absorbing these losses, de Kwiatkowski was ahead $34 million on his trades since October 28,
1994. He continued losing money through the winter. Finally, on March 5, 1996, he liquidated all of his positions, after having lost tens of millions in the preceding few days. When his spree was over, he was still up $25 million overall, although he had lost hundreds of millions of dollars from the peak. “He was always in compliance [with the terms of his margin account],” Cayne said. “We couldn't have gotten him out even if we wanted to because he was in compliance. We warned him a thousand times. I personally talked to him a thousand times.” In fact, when Cayne saw the losses in the account mount and saw one day there was a $2 million shortfall, he told the Bear broker that the money would come out of the broker's hide if Henry de K didn't make good on it. But he did. “And now it's over,” Cayne said. “It's like a trip. It's gone from zero to $500 million to $25 million. That was his trip.”

Nevertheless, de Kwiatkowski blamed Bear Stearns and Sabini for his losses. In June 1996, he sued them both (and several other Bear entities), alleging negligence and breach of fiduciary duty. In May 2000, a jury in a federal courthouse in downtown Manhattan agreed with de Kwiatkowski that Bear Stearns had been negligent, and awarded him $111.5 million, one of the largest single awards won by a brokerage client from a Wall Street firm. After the verdict, Bear Stearns filed a series of motions with the district court arguing that de Kwiatkowski's brokerage account had been a “nondiscretionary” account that required de Kwiatkowski's approval before any actions were taken and that, as a matter of law, Bear Stearns had none of the advisory duties to de Kwiatkowski that the jury found Bear Stearns had breached. As in the A. R. Baron case, Bear was arguing against what seemed to be a new legal precedent on Wall Street that would have required firms to be held responsible for the behavior of their clients.

On December 29, 2000, the district court ruled against Bear Stearns, finding that “the unique facts and circumstances of the parties' relationship permitted the jury reasonably to find that Bear undertook to provide Kwiatkowski with services beyond those that are usual for nondiscretionary accounts, and that there was evidence sufficient to find that Bear provided those services negligently.” The court then applied the
coup de grâce
by adding another
$53
million to the jury's damages award for prejudgment interest dating back to March 6, 1995. Now Bear Stearns owed Henry de K $164.5 million. “When I got the initial verdict that we had lost,” Cayne said, “I think I got a call like four-fifteen in the afternoon from Mark Lehman [the firm's general counsel]. I sat at my desk for two hours and didn't move, literally, like I was dumbstruck, like I was tromped
on. How could you lose? How could you lose this case? This is ridiculous. The most open-and-shut case in the history of the world.”

Not surprisingly, Cayne decided to appeal the district court's decision to the United States Court of Appeals for the Second Circuit. “This was another little thing that took place inside of the executive committee,” Cayne said. “They said to me, ‘You're going to settle it, aren't you?' And I said, ‘No. No settlement.’” The executive committee, as usual, went along with Cayne's desire to appeal the case without settling.

As in the district court trial, Cayne was actively involved in the January 7, 2002, hearing before the appeals court. “Their lead lawyer turned out to be about a 300-pound fag from Long Island,” Cayne said, “a really irritating guy who had cross-examined me and tried to kick the shit out of me in the lower court trial. Now when we walk into the courtroom for the appeal, they're arguing another case and we have to wait until they're finished. And I stopped this guy. I had to take a piss. I went into the bathroom to take a piss and came back and sat down. Then I see my blood enemy stand up and he's going to the bathroom. So I wait till he passes and then I follow him in and then it's just he and I in the bathroom. And I said to him, ‘Today you're going to get your ass kicked, big.' He ran out of the room. He thought I might have wanted to start it right there and then.”

The appeals court ruled on September 19. “I get the thing delivered to me, the final appeal thing,” Cayne said. “I still have it.
And we reverse.
That was great. I was in my office. I went nuts. I just started jumping up and down. I was totally vindicated. And also the money wasn't unimportant.”

B
Y THIS TIME
, there was no longer any question who was in charge at Bear Stearns—it was Jimmy Cayne. Greenberg still showed up every day at his raised desk on the trading floor, barking out orders and trading for his clients. He also continued to chair the risk committee and was chairman of the board of directors. But there was now little doubt that Cayne and his two deputies—Warren Spector and Alan Schwartz, who also were nominated for seats on the firm's nine-member board—were in control. It was evident enough in compensation, the most important Wall Street scorecard. For the fiscal year ended June 1999, Greenberg, then seventy-two years old, took a 30 percent pay cut, to $13 million for the year, down from $18.5 million a year earlier. Cayne was paid $21.4 million in 1999, up around 8 percent from $19.9 million the year earlier. Spector was paid $20.4 million, up from $19 million, and Schwartz received $17 million.
Such was Spector's belief in the firm's prospects that he chose to take $20.2 million of his pay in the form of Bear Stearns stock, as permitted by the firm's so-called capital accumulation plan, or CAP, making his stock ownership in the firm, at 2.36 percent, second only to Cayne's, at 4.2 percent. The CAP, started in 1990, was a way for rising stars at the firm to accumulate meaningful ownership stakes. Executives had the option of deferring for five years 100 percent of their total compensation into the firm's stock, purchased effectively at a small discount to market value.

The end of the decade and the beginning of the new millennium were periods of substantial change on Wall Street, perhaps even its Golden Age. Firms were making money hand over fist—Bear had a net income of $709 million in 1999, Morgan Stanley earned $5.5 billion, Merrill Lynch earned $3.3 billion, and Goldman Sachs earned $3 billion. And their stocks were trading at or near all-time highs and at price-to-earnings multiples—nineteen times earnings for Morgan Stanley, seventeen times for Goldman Sachs, sixteen times for Merrill Lynch—that propelled the value of these firms and the net worths of their senior executives skyward. Goldman, Merrill, and Morgan Stanley each came close to being worth $100 billion. Even though the market penalized Bear Stearns for its lack of a diversified revenue stream, all of the men on the executive committee were becoming wealthy. Cayne's 4 percent of the company was worth around $360 million, Spector's stake was worth about $200 million, and Greenberg's stake was worth $90 million, in addition to all the cash they took out every year. And assuming Cayne and the other top executives could make progress in building the firm's investment banking business (still relatively tiny), its presence in Europe (still negligible at best), and its asset management business (with about $15 billion of assets under management, a peanut compared to around $600 billion of assets under management at Merrill Lynch), there appeared to be a fair amount of upside potential in the earning power of the firm, assuming markets stayed favorable and the management could execute. That potential helped explain Spector's decision to convert most of his compensation into the firm's stock.

And then in early 2000—just after everyone recovered from the specter of Y2K damaging Wall Street computers—the game of consolidation on Wall Street took a quantum leap forward. At first the deals were relatively small. In September 1999, Chase Manhattan Bank bought Hambrecht & Quist, a technology investment bank in San Francisco, for $1.3 billion as a way to try to participate in the Internet underwriting boom. In January 2000, Citigroup bought Schroeder's investment banking
business for $2.2 billion. Then, in April, Chase bought Robert Fleming Holdings, in Hong Kong, for $6.9 billion, and a few weeks later, PaineWebber bought regional broker J. C. Bradford for $620 million. Alliance Capital, the money manager, bought Sanford C. Bernstein & Co. for $3.5 billion in June. Then, on July 13, UBS, the giant Swiss bank, announced it was buying PaineWebber for around $12 billion.

Soon enough, speculation was rife about whether Bear Stearns would be caught up in the consolidation craze. Neither Greenberg nor Cayne had ever given any indication the firm was for sale, other than the predictable noises about having to exercise a fiduciary duty to public shareholders if a serious offer for the company came along. This was not particularly surprising given the firm's quirkiness. Yes, it had been extremely profitable for a very long time and the executives who worked there made yearly bonanzas, but the firm made so much of its money from the unglamorous businesses of trading and clearing, as opposed to investment banking, that it was not an attractive target to any foreign acquirer looking to enter the United States investment banking market nor to any domestic firm, with the possible exception of Chase Manhattan. Not many people believed that Bear Stearns and Chase Manhattan would make much of a cultural marriage, the secret sauce of most mergers.

“Bear didn't have that much of an equity franchise,” explained Guy Moszkowski, then a research analyst at Salomon Smith Barney, covering the financial services industry. “They were still driven very much by fixed income.” In the days after UBS announced its deal for PaineWebber, as part of his job covering the financial services industry, Moszkowski went to see Cayne in his office at 245 Park. “Him, me, and the motorcycle,” he said. He had been wondering about whether Cayne had any plan for how to deal with the changing dynamics on Wall Street. “This is an environment in which the markets have started to slow down a little bit,” he said to Cayne. “You're seeing some deals happen at some very high prices. Given that you don't have international and you don't have equities, wouldn't you consider merging with another player that could really use what you have and create something bigger?” (In retrospect, Moszkowski noted, “What I was leaving aside of course was all the cultural issues that people always said would impede a transaction.”) Then Cayne said, “This is not our market because it's all about equities right now and it's all about M&A and we're okay with those businesses but they're not a big deal for us. But trust me, the time will come when all that stuff is less important than it has been these last eighteen months, two years, during this bubble”—which was in the process of being pricked. “Fixed income
will be back. We will do better and we will use the earnings from that relative strength to invest, to build out some of the other stuff.”

Cayne said he was happy to remain independent. “I don't have any pressure on me to sell,” he told Moszkowski. “I may not be producing the returns on equity that Goldman Sachs is right here, 25 percent or whatever.” Bear's ROE was around 15 percent at this time. “But it's what we do, it's acceptable for shareholders. It's more consistent over the cycle, and we don't see any reason to give up our independence. On the other hand, I'm not crazy. I have to represent shareholders and I have to be a fiduciary, and if someone comes along and offers the right price, something that we really think is much better than what we can produce for shareholders over the long haul, of course I'll consider it.” Moszkowski couldn't help asking Cayne what his price was. “I don't know,” Cayne told him. “What'd you say PaineWebber was going for?”