The last tycoons: the secret history of Lazard Frères & Co (87 page)

As part of getting that understanding, Steve asked Golub to undertake an internal audit of the new real estate fund--the $1.5 billion LF Strategic Realty Investors II Fund. As an investor, Steve had received a notice from the fund stating that after the first nine months, the returns were 29.07 percent. He remembered thinking how odd it was that the number was so precise. His curiosity was piqued, and the audit revealed that Solomon had "revalued the portfolio based on his own whim of what he thought it was worth," Steve said. "It turned out to be a house of cards. The whole thing was jerry-rigged." Golub discovered that the fund had lost nearly $400 million--Solomon disputed this finding--after a number of investments in assisted-living centers had fallen precipitously in value.

Solomon was using the fund to buy control of
companies--
for instance, he invested $200 million in ARV Assisted Living Inc.--rather than just buying real property. ARV's stock plunged 80 percent at the time. He also used the fund to make a bid--as principal--for a large movie theater chain at the same time Steve was representing KKR, the buyout firm, in a bid for the same company. There had been no internal coordination. Steve struggled to imagine how he would have explained to Henry Kravis why Lazard's real estate fund had been bidding on the property at the same time as KKR, but fortunately it never came to that. Steve was not happy. As a result of these infractions, he fired two of Solomon's colleagues and demoted Solomon to nonexecutive chairman of the real estate group. Solomon was not one to go quietly. He organized a meeting in early April 1999 between Steve and several of the large investors in the Lazard real estate funds, but he neglected to tell Steve the investors were coming. Solomon had invited Tom Dobrowski of the GM Investment Management Corporation; John Lane of the Pennsylvania Public School Employees Retirement System; and Barbara Cambon, an influential pension fund investment adviser.

Once the investors had assembled in a conference room, Solomon invited Steve to join. It was an ambush, and the investors demanded to know from Steve just what was going on with their money and the leadership of the funds, now that Solomon had been demoted and his two deputies fired. "We never would have invested had we known there were such troubles at Lazard," one of the investors said. Steve asked them to give him a few days to review the situation and invited Solomon to his office as the guests were leaving. Once there, Steve fired Solomon "for cause." Solomon responded by hiring Stanley Arkin, the white-collar litigator, and by filing a fiery arbitration suit "crafted in tabloid-ready prose" accusing Lazard of "breach of contract, defamation and other juicy charges." In legal papers filed with the New York Stock Exchange, Solomon said his "ouster from overseeing the funds that he has so carefully cultivated and groomed over the past decade is nothing short of a high-class hijacking." He also branded Steve a "journalist-cum-investment banker" whose "unbridled personal ambition and elbows-up demeanor" had resulted in a flood of senior-level departures from the firm.

A number of employees who worked for Solomon, though, wondered why he had been able to hang on for so long at Lazard. "We couldn't believe it didn't happen sooner," said a former member of Lazard's real estate department. Damon Mezzacappa applauded Steve for "cleaning up the whole real estate thing" because "these guys, these guys were just over the edge, in terms of ethics, over the edge." But he added that Steve had paid a price, too, because the Solomon firing really upset Michel. "Michel took great umbrage," he said. "But Michel was dead wrong. But he was really upset that we had basically fired these guys."

Lazard settled the suit with Solomon out of court in June 1999 for (once again) $11 million, one of the largest payments ever by a Wall Street firm to an employee. "It was really just awful," Steve said. "It was a consequence of there being no management." The immediate other consequence of the blowup of the real estate fund was that Lazard's effort to raise a separate, more generalized private-equity fund was totally derailed. The placement agent told Steve the real estate mess had badly damaged the firm's reputation for managing capital.

While he was grappling with the Art Solomon debacle, Steve got it in his head that all the so-called side deals that Michel had entered into with various partners had to be revealed, too. This would be part of the general thawing, even though both his own lucrative undisclosed arrangement with Michel about the firm's work for Providence Media(8.25 percent of the override in addition to his $900,000 annual salary and 4.75 percent of the firm's pretax profits) and that of his chief ally Damon Mezzacappa (3 percent of the pretax profits of capital markets plus his $900,000 annual salary and 3 percent of the firm's pretax profits) would all be disinfected by the sunlight, as the Supreme Court justice Louis Brandeis would say.

There were some startling revelations, especially among the non-banking partners. For instance, Norm Eig and Herb Gullquist--who together ran the asset management business--had contracts with Michel and the firm that paid each 15 percent of the net profits of their department. They received $15.8 million
each
in 1998. The contract called for them to continue to receive 15 percent of the net profits for the three years after their retirement. Jack Doyle and Dave Tashjian, who together ran Lazard's fledgling high-yield debt business, each had 16.5 percent of the high-yield profit pool of $4.826 million in 1998--about $800,000--in addition to their salaries and their percentage stakes in the pretax profits of the firm. Harlan Batrus, who ran the lackluster but consistently profitable corporate bond desk, had a deal whereby he received 20.2 percent of the corporate bond profit pool of $5 million--just over $1 million--in addition to his salary and percentage stake in the firm's pretax profits. Even Art Solomon had a deal with Michel to receive 3 percent of the gross real estate advisory fees and 33.3 percent of the real estate fund department profit pool, net of bonuses paid to others, as well as a 15 percent share of the override from Lazard's first real estate investment fund. In 1998, this totaled, for Solomon, $8.235 million.

In sum, Rattner's investigations revealed some twenty of these side arrangements. Partners well below the radar, whose contributions were considered modest at best, had been paid millions and millions. "Steve made all that stuff transparent," a former partner said. "There were no more private deals." Ironically, as Michel had always maintained, the M&A bankers for the most part had no side deals with him. "The reality of the side deals was not as bad as the perception of the side deals," Steve said. "There were some but not as many as people feared. Part of the problem was the opaqueness. My approach was to be transparent. If I can't look you in the eye and tell you why banker X is getting a $20 million bonus, then he shouldn't be getting it. In other words, if he's entitled to it, then I should be able to defend it to you or any other partner who asks me." Steve also convinced Michel to reduce his personal take of the annual New York profits to 10 percent, from his traditional 15 percent, the idea being that in addition to the obvious symbolism, the extra five points could be used to recruit new partners or reward highly performing ones. He also convinced Michel to reduce the profit percentages for some of the other "capitalists" as well and established a policy for how to treat the older, limited partners whereby they would be paid a $75,000 salary, have an office and a secretary, and receive some small sliver of the profits. Steve said of Michel, "He didn't care that much about the money, up to a point. It was all about his pride, his place, and his power. Michel had many wonderful expressions. One of these great expressions was that 'all Americans care about is money; all the English care about is their lifestyle. And all the French care about is their pride.'"

Steve preached teamwork. He participated with Michel in determining partner compensation. He instituted weekly meetings of the management committee. He presided over substantive weekly partner meetings with reviews of actual deal pipelines and prospects. He instituted call reports to track whether bankers were making efforts to see their clients. He organized periodic dinners between bankers of specific industry groups and partners on the management committee. Steve insisted that partners have lunch together on a daily basis to try to warm the notoriously frosty partner relationships.

Previously, partners had had trays delivered to their offices, a lovely and simple Lazard tradition where one of the two full-time female French chefs whipped up an individually prepared meal of, say,
salade nicoise
with Dijon vinaigrette. Dressed in dark, conservative uniforms, the chefs, sequestered away in a cubby on the thirty-second floor (when the firm was at One Rock; the kitchen moved to its own
floor
at 30 Rock), would deliver the trays to each partner in his office at lunchtime, assuming he was not going out, a fact that would be ascertained sometime during the morning. It was not uncommon for partners to be chomping away on this little slice of a Parisian brasserie while vice presidents sat across from them without a morsel, taking down the latest deal directive. A rare treat indeed was to be invited into a partner's office to dine with him, and having one's
own
tray.

Steve also considerably dialed down his public persona as "a self-promoting guy in a hurry." Of that image of him in the mid-1990s, he said later, "There was some reality to it, and there was some perception. But the reality doesn't matter, because when it comes to image, perception is reality." He realized that to lead the generational succession at Lazard, he himself had to change. "It was very, very clear to me that I had to do two things," he said in 2001. "I had to really, to the best of my ability, lower my own profile way below the horizon, which I've tried my hardest to do for the last several years. Second, if I was going to succeed in making Lazard the kind of collegial environment that I wanted it to be, then I had to also lead by example.... The only way I had a chance of making all that work would be if I--to some considerable degree--changed my own style."

Steve's first year in charge in New York had been a whirlwind of activity, with many changes instituted and many more promised. The firm remained immensely profitable, making some $415 million worldwide in 1997. But Lazard's position in the closely watched M&A league tables had slipped to tenth worldwide in 1997, from sixth the year before, reflecting the double whammy of increasing competition from global banks and the loss of some of the firm's talent. In the press, Steve downplayed this development. "Our approach involves concentrating on high value-added business and doing quality work for our clients," he told
Fortune.
"In that context, market share is not the primary focus." Privately, though, he was more concerned. "I believed, and in retrospect I think I was completely right, the firm was living on borrowed time," he said. "It was trying to live in a new world using an old business model that didn't work anymore." He remembered seeing at that time an industry magazine ranking of Wall Street firms based on the value they provided to clients. There were a series of categories--what firm do you like for M&A, what firm do you like for financing, among others--but the only category in which Lazard placed in the top ten was for which firm do you think is most overrated. "And that's how I felt about it," he said. "That we were underinvesting in the business and living on borrowed time."

THE JUNE 1998
150th anniversary of Lazard's founding provided a convenient backdrop to assess the firm's performance in the post-Felix era. Under Steve's direction, the firm threw a huge party for itself in and around the breathtaking Temple of Dendur at the Metropolitan Museum of Art (in stark contrast to Andre's decision to basically ignore the firm's one hundredth anniversary). Hundreds of tuxedoed guests, from corporate CEOs to political and cultural leaders, were invited to dine and to toast the firm along with its partners, who had come from all over the world to New York for the celebration. Felix came back from Paris. Michel gave a speech, as did Steve. In his speech, Michel failed to thank Felix and Antoine Bernheim, the longtime Paris partner, for their help in building the firm. "Investment bankers getting up and doing that sort of stuff is cringe-making," said one man who was there. The famous soprano Jessye Norman sang, and sang. "She was sort of prancing around the place and sang rather badly for too long," remembered a partner. Some partners thought the event was wholly inappropriate, from its pageantry to its history. "It was dear old Steve Rattner at his very worst," said one. "Because it was sort of in praise of Steve Rattner, really." Some partners objected to celebrating the 150th anniversary of the dry goods store as if it were the same as the founding of the investment banking firm, which did not get established until the late 1850s (accounts differ precisely as to its origin) in Paris. London opened its doors in 1870. The New York office was not started until 1880. When some of the partners deigned to point that out, Steve reportedly said, "Don't let the history interfere with a good story." Lazard continued to propagate its legends.