House of Cards (58 page)

y 2004, there was no question that the businesses at the firm that reported to Warren Spector—fixed income, institutional equities, and asset management—were driving the growth of the firm. Particularly important was the exponential growth of the fixed-income business, which was without question Spector's fiefdom. Fixed-income revenue in 2004 was $3.1 billion—nearly 45 percent of the firm's overall revenue of $6.8 billion—and had increased some 63 percent, from $1.9 billion in revenues, since 2002. “These businesses benefited from the low level of interest rates, a steep yield curve and narrowing of corporate credit spreads,” the firm reported in its SEC filings. “Mortgage-backed securities revenues increased significantly as residential mortgage refinancing activity reached record levels during the year, driving record new issue
activity, and demand for high-quality fixed income investments continued.” The firm did not break out separately the profitability of Spector's fixed-income division, but the overall grouping of investment banking (Schwartz's bailiwick), institutional equities, and fixed income had increased its pretax income to $2 billion in 2004, from $1.3 billion in 2002, and it would be safe to say that much of the increase in the pretax income came from the growth in the fixed-income division.

Slowly but surely the market and the press began to naturally assume that Spector was Cayne's heir apparent, since he ran such a substantial portion of the firm's businesses. But Cayne was careful to leave the question of his succession plenty ambiguous. He paid both Spector and Schwartz virtually the same amount year after year. In 2004, each made $18.7 million. In 2003, they made $20.5 million each, and in 2002, each made $17.2 million. He was also careful to pay them around 95 percent of what he made in any given year as a way to head off any nascent movement for a coup d'état against him. But the impression remained, fostered in part by Spector himself, that he was the likely successor to Cayne, though Cayne denied that Spector had the position wrapped up, despite his business and bridge acumen. Besides, Cayne had no intention of going anywhere. “Spector was a major, major, major, major disappointment because he was extremely smart and capable,” Cayne said. “The attitudinal issue of him being an elitist with his own people was clear. There were always reports about him being an unpleasant boss to work for. But he was a favored son in the eyes of the firm. He never was told by me he was my successor. He asked for it many times. And I never said yes, never. Not out of any malice. In fact, if I had to choose—like you're dying and you've got to choose a successor—it would not have been him. Here's a guy that was right a lot of the time. His personal faults were simply bearable. The package was worthwhile.”

The Oedipal quality of their relationship was becoming increasingly obvious. Ironically, though, it was Spector's careful reading of the firm's CAP—the internal mechanism created for the sole purpose of creating sufficient long-term wealth for Bear Stearns's senior management to dissuade them from leaving the firm—that created the first of many fissures in the complicated relationship between Cayne and Spector. The way the CAP worked was that an executive could choose what percentage—up to 100 percent—of his annual compensation he wanted to invest in the company's stock through the plan. The day the election was made was the day the stock would be purchased at whatever the market price of the stock was at the time. There was no discount. But there was an opaque benefit to the plan, whereby each year the CAP participant
would get an additional number of shares based on the firm's earnings and the firm's stock price. Over time, it became clear that this benefit worked out to between 7 percent and 8 percent extra a year, in some years even more. Over the five-year life of each CAP, an investment in 100 shares could be turned into 140 shares simply by compounding that 7 percent annual return. This was before any increase in the firm's stock price, which throughout this period was increasing rapidly. The chance to triple one's initial investment was not unreasonable.

Spector was one of the very few senior executives at the firm to take the time to read and fully comprehend the nuances of the CAP. He figured out how lucrative the plan could be, as long as the firm's earnings and stock price were increasing. He routinely decided to invest 100 percent of his annual compensation into the CAP. What's more, as was permitted by the terms of the CAP, Spector had elected to defer the investment, including all of its tax-deferred compounding, until he retired. Since Spector was in his mid-forties at this time, and the firm obviously had never enforced a retirement age, the size of the firm's potential liability to Spector could be enormous. As was required, disclosure of the growing payments and liabilities to the senior management of the firm started to appear in the annual proxy statements. This, in turn, caught the attention of investors and the research analysts who covered the company, which in turn made the magnitude of the problem seem all the more severe. As a result of the CAP, the firm's proxy statements started to include a column for “all other compensation,” which accounted for “preferential earnings paid in the form of CAP Units pursuant to the CAP Plan that exceed cash dividends paid on the equivalent shares of Common Stock.” In other words, this column represented the value of additional annual 7 percent compounding on the stock in the CAP over and above what the common stock dividend would be.

Since Spector owned more stock through the CAP than anyone else, the numbers in the proxy related to his “other compensation” were getting increasingly large and were making it appear to the outside world that Spector was making more money than Cayne. For instance, the firm's 2003 proxy statement showed that Cayne owned 4.8 million shares of common stock and another 2.4 million shares through the CAP. The amount of his “other compensation” related to the CAP for 2002 was $10.2 million, and his total compensation, including that related to the CAP, was $28.4 million. Spector, meanwhile, owned 789,482 shares of common stock and another 3.5 million shares through the CAP. His “other compensation” in 2002 related to those CAP shares was $13.9 million, bringing his total compensation in 2002 to $31.2 million. In
2003, the gap between Spector's total compensation, $38.5 million, and Cayne's, of $33.9 million, grew wider.

T
HE FACT THAT
Spector appeared to be making more money than Cayne irked the boss. After Sam Molinaro, the firm's CFO, and Steve Begleiter, the firm's head of strategy, walked Cayne through the growing magnitude of the problem, Cayne decided to force the participants in the CAP to sell their stock. Begleiter and Molinaro tried to fashion a compromise with Cayne about how to unwind the plan, but Cayne decided just to end the plan and compel the sale of the stock in it. He was well within his rights to end the plan at his sole discretion. “In the CAP plan language was a little codicil,” Cayne explained. “The codicil said that anytime the company wants to call this off—this good-till-retirement thing—it may. Sam and Steve Begleiter came to me at some point and said, ‘Jimmy, you don't know it, but if the stock price does this'”—stays relatively flat— “‘there's no harm, no foul. But if the stock price goes like this'”—continued its upward trend—“‘then Warren does just fine to the tune of $300 to $400 million over a period of four to five years and the company gets killed.' Because we pay it. We pay him as if the stock was still up. So it became imperative from a fiduciary standpoint to call it off.”

Spector was livid. He suspected, correctly, that Cayne's decision to terminate the CAP was directed at him personally. “He fought it like a tiger,” Cayne said of Spector. “But it's like fighting death. If I tell you you've got terminal cancer, you can fight all you want, you're not winning. He took it all the way to every board member. All he had to do was just talk to one board member”—Cayne—“and he would have told you you're wasting your time. The company has to call it off. The company will be derelict in its responsibility if they don't call it off.” Cayne made the decision in September 2003, and by November, Cayne, Greenberg, Schwartz, and Spector had sold some $263 million worth of stock at a price of around $74 per share. Spector sold $74 million worth of stock; Schwartz sold $74.5 million worth of stock. In the years following Cayne's decision, as the price of Bear's stock continued to increase, the depth of Spector's ire at Cayne only grew.

Cayne saw this as a breaking point not only in their relationship but also in Spector's attitude toward the firm. “That blew his brain, basically,” Cayne said. “He stopped digging in. He became a caretaker of the inventory of the mortgage department as opposed to a manager of the inventory. That became, I believe, the prime mover for his dissent from the standpoint of responsibility. The hedge fund thing became totally him. He put a real fence around Cioffi. He didn't let the credit people in. He
didn't let the repo people in. He became a one-man show with Bear Stearns Asset Management, which was doing great. Remember, Cioffi's results for forty months were sensational. After the fact, it's very easy to say, ‘Well, you didn't think there was something wrong with that?' No. I didn't think there was anything wrong with it. I saw a win every month. Why, am I smarter than them?”

As is not atypical on Wall Street as wealth swells, Spector became increasingly captivated by presidential politics. He was a supporter of Bill Clinton, whom he would occasionally see on Martha's Vineyard, where the Spectors had a large home in southwest Chilmark. The Clintons would stay regularly at the compound of Dick Friedman, a Boston developer. Friedman and Spector were friendly. Tom Flexner, Spector's partner at Bear Stearns, used to rent one of the homes on the Friedmans' property before he decided to buy a home on the island, too.

During one of the Clintons' visits to Martha's Vineyard, Flexner arranged for Spector—who was a club champion golfer—to play with Clinton and with Barry Sternlicht, one of Flexner's clients and then CEO of Starwood Hotels & Resorts. “This was a brand-new experience for both Barry and Warren,” Flexner said. “They'd never played with the leader.” Flexner also arranged to play with Spector another time on the Vineyard along with the CEO of a private equity firm. “Warren is very focused, whether it's business, golf, bridge—whatever he does,” Flexner said. “We did a reasonable amount of business with this firm, and I briefed Warren on that. We're on one of the greens and Warren's out—it's his putt—and the CEO has his back to Warren and whatever is going through the CEO's mind, he forgets that maybe Warren's on the verge of putting, and he says something to me out loud—not screaming—at the exact moment that Warren is making his thirty-foot putt. He missed the hole by about that much. Warren goes up to the CEO and says, ‘Don't you know it's rude to talk when somebody else is putting?' and he was serious. Now, I later called him on that. Warren said, ‘Oh, my God. I did that? I was that rude? I've got to call him and apologize.' He genuinely wanted to apologize. I don't think Warren is an evil, malicious, vengeful type of guy.”

Following the nasty business of Cayne dissolving the CAP, Spector's next run-in with his boss came a few months later, in July 2004, following Spector's decision to participate in a July 8 conference call—along with other corporate executives—to support the Democratic presidential campaign of Senator John Kerry. On the call, according to press reports, Spector, who had given around $65,000 to Democratic Party candidates and causes, criticized the Bush administration for its “very short-term, narrow-minded policies” while also observing that Kerry's economic policies
were “fiscally responsible.” Cayne, an avid Republican supporter of Bush, was not happy about Spector's public comments. For twelve days, Cayne said nothing about Spector's comments about Kerry. The two men had been together in New York at the annual Spingold Knockout national championship bridge tournament from July 12 to July 18. “Cayne and his crack squadron of veteran bridgies were knocked out in the quarterfinals,” the
Wall Street Letter
reported in August 2004, “while Spector guided his band of tournament rookies to the finals” on July 18. Two days later, on July 20, Cayne e-mailed a memorandum to the firm while Spector was out of town. He wrote of Spector: “His comments were made in such a way as to be viewed as being attributed to Bear Stearns as a whole. Such attributions should not have been made, his views were his own, as a private individual, and not those of the firm. If any of you were upset or offended by these press reports, please accept both his and my apology…. Free speech should not be confused with directly or indirectly using the company to endorse political views or agendas.” According to the
Wall Street Letter,
a “bridge source” noted that some “people have suggested this [firm-wide memo against Spector] was a little bit of sour grapes” on Cayne's part at having been surpassed by Spector's team in the Spingold Knockout.