The last tycoons: the secret history of Lazard Frères & Co (22 page)

By the beginning of August, having failed to find a solution on his own, Felix turned to Andre, who was at his house in Crans-sur-Sierre, to see if he had any clever ideas. That was when Andre hit upon the idea of having ITT sell the stock to Mediobanca. He knew Cuccia could make a decision quickly, and Felix had also taken Cuccia to meet with Geneen a month earlier in New York. Felix later testified to the SEC that Andre chose Mediobanca because "he thought they had the size, to my recollection, and that Dr. Cuccia was intelligent and aggressive and wanted to build up a relationship with ITT." Left unsaid by all was the belief--alas, unprovable--of some Lazard partners that Andre and his friends together owned a controlling chunk of Mediobanca beyond the 10 percent stake owned by Lazard in New York, making Mediobanca's help in this matter inevitable and personally profitable.

Throughout August, Felix sent Andre a number of telexes, some typographically very difficult to read, that outlined the proposed deal. Andre suggested that three representatives of ITT meet with Cuccia in the Paris office of Lazard on August 28, 1969. Andre attended this meeting. His recollections about what happened in Paris in August 1969 came years later, in 1974 and 1975, as a result of any number of lawsuits that ended up being filed against Lazard for its role in the ITT-Hartford merger. By the time of his testimony, he wanted to distance himself from the deal. He said he provided no advice to Cuccia about how to conduct himself with the ITT executives because "Dr. Cuccia is a very cold blooded man and very clear and very realistic."

The day after the Paris meeting, Felix sent a telex (through ITT World Communications) to Andre in Paris. "Have talked to both Geneen and Howard Aibel and believe that the economic features of transaction are okay but that the lawyers cannot sign until draft agreement has been cleared with Internal Revenue," he conveyed. "Believe it would be unwise and probably impossible to close transaction with Cuccia subject to reversal in November if subsequent problems with Internal Revenue Service but believe we should have IRS ruling as well as clearance of this transaction within framework of IRS ruling by September 15. ITT lawyers are therefore being instructed to get text that is acceptable to Cuccia and which in their best judgment would be consistent with IRS and bring it back here for clearance with IRS. Geneen most grateful for your efforts. Warm regards, Felix." Despite his obvious involvement in the deal, Felix would later seek to distance himself from it as well, giving life to the old Wall Street adage that success has many fathers and failure is an orphan.

Finally, on October 13, 1969, the IRS ruled that the ITT-Hartford merger would be treated as a tax-free combination as long as ITT "unconditionally" disposed of all of its Hartford shares. On October 14, John Seath, ITT's vice president and director of taxes, wrote to the IRS and asked if it would find ITT's selling the shares to Mediobanca a satisfactory fulfillment of its requirement. Seath insisted that the proposed sale would be "unconditional," "as required by your ruling," and further elaborated: "There are no conditions on Mediobanca's ownership of the Hartford shares. It can hold the Hartford shares; it can give them away; it can sell them to ITT's competitors; it can vote as it wishes on any matter on which shareholders vote." Seath's characterization of the arrangement would later be determined to be misleading at best, when the whole transaction came under intense legal scrutiny for duping the IRS into providing the tax-free treatment. Seath also conveniently left unsaid whether Mediobanca intended to take any actual economic risk by purchasing the shares. Felix would later testify that he believed "Mediobanca had the option to make it riskless." Whereas the IRS took six months to issue its first ruling, with the heat ratcheted up and the clock ticking, it ruled one
week
later, on October 21, that the proposed deal with Mediobanca would "constitute an unconditional disposition of stock for purposes" of satisfying its October 13 ruling.

On October 28, 1969, Tom Mullarkey, Lazard's in-house counsel, called the ITT legal department to say that he had just returned from Milan with word that Cuccia had finally signed off on the October 7, 1969, version of the ITT deal--the very version that the IRS had signed off on a week earlier. He also said that Mediobanca was now awaiting payment of a commitment fee equal to .765 cents per Hartford share, or a total of $1,332,131.22. The payment to Mediobanca was approved and money wired the next day to Les Fils Dreyfus, in Basel, to pay such funds to "Lazard Freres & Co. for the account of Mediobanca."

The soon-to-be-infamous October 7 seven-page document memorializing the agreement between ITT and Mediobanca raised circularity and obfuscation to an art form. There was a technical requirement that Mediobanca sell any shares through Lazard after first notifying Lazard in writing of its desire to do so. Lazard had also been authorized, if asked, to provide a minimum price at which Mediobanca could sell the shares to a third party, which was a mechanism designed to prevent Mediobanca from simply dumping the shares on the market to get rid of them at any price. Lazard sought, and received, an indemnification from ITT for the work it was to perform under the ITT-Mediobanca contract.

In his "Memorandum to the File" regarding the closing, Samuel Simmons, ITT's European general counsel, acknowledged being told by Cuccia that Mediobanca had selected a third-party resale option in the contract; this meant that Mediobanca, with Lazard's help, would hold on to the shares until it found third-party buyers willing to pay more for them than ITT had. Mediobanca never intended to take any risk itself with regard to the shares and would simply pay over to ITT whatever price it got for them, less any fees and sales commission it was entitled to. Per the agreement, any profit or loss on the shares would be remitted to ITT. But this is hardly the same as an actual sale. The contract's convoluted and murky language--and its implications--would subsequently subject ITT, Mediobanca, and Lazard to a massive, decade-long legal battle and the attendant fiasco of negative publicity. Critics charged that ITT, with Lazard's help, was simply placing the stock with Mediobanca--to comply with the IRS requirement--and in the process, while receiving large, no-risk fees for themselves, buying more time for the Hartford stock price to recover sufficiently to avoid a loss on the original purchase, which is exactly what happened.

This was the sum and substance of the IRS's March 1974 conclusion about the matter. As immoral as that scheme may have been, Cuccia's letter to Lazard choosing the third-party sale held one more nugget of impropriety: to wit (in keeping with Lazard's private new arrangement with Mediobanca), "as consideration for all your [Lazard's] services, including the safekeeping of such Shares, you shall, on the completion of the sale of all of such Shares," receive
half
of the profit, if any, as well as half of the up-front fee--the $1,332,131.22--or more than the $660,000 that Mediobanca received for doing the deal in the first place. So Lazard not only received a $1 million fee for advising ITT on the merger and handling the exchange offer for the Hartford shares; it also had cut a separate, undisclosed fee deal with Mediobanca. Lazard also received a $500,000 fee for brokering ITT's original purchase of the 1.7 million Hartford shares. On November 5, 1969, Walter Fried, on behalf of Lazard, signed the Cuccia letter and returned it to him. Lazard did not--at this time anyway--disclose to ITT its fee-splitting deal with Mediobanca. Felix would later say that he had forgotten about this fee-splitting arrangement during his early discussions with Geneen about the potential deal with Mediobanca.

On November 10, in all of twenty-three minutes, in Hartford, the Hartford shareholders approved by a vote of 80.37 percent to 2.78 percent what was, to that moment, the largest merger in corporate history. Felix had a full day of meetings, although none of them apparently concerned ITT. He managed to find time for a meeting with a reporter from
Institutional Investor
magazine before heading up to see his client Steve Ross.

BUT THE FIGHT was not over, not by a long shot. On May 27, 1970, the Justice Department renewed its vow to proceed with its efforts to block the merger on antitrust grounds if the two companies were actually combined. The trial in the case was scheduled to start in November.

While in the fall of 1970 Felix and Geneen set out to try to negotiate a settlement with McLaren that would allow ITT to hold on to the Hartford, Mediobanca quietly set about reselling its new ITT "N" shares (which in the interim Mediobanca had exchanged for the Hartford stock when the deal closed) on ITT's behalf. What IRS and SEC investigators would later discover about these sales--but no one knew at the time--was that each one contained a highly convoluted, quid-pro-quo benefit for the purchasers, all of whom had ties to Lazard, Mediobanca, or ITT. In sum, Mediobanca had sold all of its "N" shares for close to $113 million and remitted that sum--less fees for itself and for Lazard--back to ITT, turning an almost certain loss on the sale of the shares into a $24 million gain, the difference between the value of the shares at the closing of the scheme with Mediobanca ($112.7 million) and Mediobanca's provisional cost ($88.8 million).

In Washington, negotiations between ITT, its counsel, and the Justice Department were accelerating furiously in an effort by ITT to retain ownership of the Hartford. Felix would be a leading participant in the negotiations with McLaren and his boss, Richard Kleindienst. Attorney General John Mitchell had supposedly recused himself from the ITT settlement discussions because he had previously, in private practice, provided legal counsel to an ITT subsidiary. This did not stop Mitchell from having an important role in the matter, but for the record, anyway, his recusal put Kleindienst, the deputy attorney general, in charge.

In August 1970, Geneen met with Mitchell in Washington. Supposedly, the two men discussed only "conglomerate policy" generally, although three of the Justice Department's four pending antitrust lawsuits involved ITT. ITT's attorneys did try to negotiate with McLaren a few times during the next year or so, and they conveyed a willingness to divest some of ITT's extensive holdings if it could keep the Hartford.

On April 16, 1971, Lawrence E. Walsh, a partner at Davis Polk & Wardwell, a top New York law firm, wrote an astonishing letter to Kleindienst at the request of his client Harold Geneen, urging Kleindienst
not
to appeal any of the ITT antitrust matters to the Supreme Court. He said he had been asked by Geneen to make a presentation to Kleindienst "urging that the Department of Justice not advocate any position before the Supreme Court which would be tantamount to barring such mergers without a full study of the economic consequences of such a step." Walsh wrote that he was afraid that the Supreme Court's record regarding antitrust matters did not bode well for ITT. "To us this is not a question of the conduct of litigation in a narrow sense," he wrote. "Looking back at the results of government antitrust cases in the Supreme Court, one must realize that if the government urges an expanded interpretation of the vague language of the Clayton Act, there is a high probability that it will succeed. Indeed, the court has at times adopted a position more extreme than that urged by the Department." Here was Walsh, whose firm, Davis Polk, had been ITT's outside counsel for more than fifty years, asking the government's top antitrust official not to bring a case to the Supreme Court involving his client that Walsh thought the government would
win.
Walsh knew what he was talking about, too, having served as deputy attorney general--Kleindienst's job--from 1958 to 1960 and as a U.S. district judge in Manhattan from 1954 to 1957. He joined Davis Polk in 1961.

Geneen's choice of Walsh to send the letter to Kleindienst was a clever one for two other reasons as well, despite Davis Polk having had no previous role in the ITT antitrust cases: First, Walsh had been Nixon's deputy chief negotiator at the Paris peace talks in 1969, and even more important, he was the chairman of the American Bar Association Committee on the Federal Judiciary--and so Nixon's federal judgeship appointees had to be signed off on by Walsh. Since part of Kleindienst's job was to appoint federal judges, the two men had become quite close. "It was, I am afraid a rather elliptical observation that meant regardless of the merits of these cases if you look at the record of the Department of Justice in the Supreme Court in any antitrust case, you have to be concerned with the probability of Government success," Walsh would later say. Indeed, from 1960 to 1972, the government won twenty of twenty-one antitrust cases brought before the Supreme Court. Walsh wrote in his letter that "it is our understanding that the Secretary of the Treasury"--John Connally--"the Secretary of Commerce"--Maurice Stans--and "the Chairman of the President's Council of Economic Advisors"--Pete Peterson--"all have some views with respect to the question under consideration. Ordinarily I would have first seen Dick McLaren, but I understand that you, as Acting Attorney General, have already been consulted with respect to the ITT problem and the Solicitor General also has under consideration the perfection of an appeal from the District Court decision in the ITT-Grinnell case." McLaren had lost the Grinnell antitrust case at the district court level and had appealed the result to the Supreme Court. The letter from Walsh, who later became a special prosecutor in the Iran-contra scandal during the Reagan administration, would soon put Kleindienst in a very difficult position indeed. Walsh was asking for a delay in the government's procedural filing that had to be stamped no later than four days from the time of his letter. Kleindienst, in fact, agreed to delay the procedural filing until May 17, but not without first playing some high-stakes Washington poker.