Merrill Lynch: Four legs good, two legs bad

At Merrill Lynch, there was no doubt about it: Edson Mitchell was a star. Largely under his direction, the investment bank’s fixed-income division leapt from nowhere in the 1980s to become the number one global player. Using swaps and derivatives talent hired from JP Morgan and Morgan Stanley, Merrill surprised its competitors by becoming one of the most creative and innovative players on Wall Street. By 1995, the charismatic Mitchell was said to be in command of a $1 billion revenue stream – the driving force behind Merrill’s international expansion in recent years.

But last January, Merrill embarked on a strategic reorganization, and the future of Mitchell’s star status seemed to be thrown into question. He was asked to head equities, a move his superiors said was designed to broaden his management capabilities. But outsiders interpreted the reassignment as a way of breaking down Mitchell’s power base, as part of an attempt to rid Merrill of the fiefdoms they say had plagued it for years. After weeks of negotiations, Mitchell turned down the new assignment and defected in May to Deutsche Morgan Grenfell in London. He was the most senior person to leave Merrill in more than a decade.

Mitchell’s departure, followed by more than a dozen of his most gifted subordinates, dismayed many senior Merrill executives, including president David Komansky. “He was the most creative person in fixed income,” sighs Komansky. “Believe me, I wish he hadn’t gone.” 

Over the next few months, such highly-regarded Merrill executives as Grant Kvalheim, who had headed capital markets, and Henry Yordan, a managing director, joined Deutsche Morgan Grenfell in New York. Top-flight debt salesman Michael Phillips went to work with his former boss in London. Admits Komansky: “I regret losing many of them.”

It seems obvious now that Mitchell inspired deep loyalty in his division, where former employees say he fostered an incredible team spirit. For years, Merrill’s inferiority complex in investment banking was what propelled his drive. But it may also have inhibited Mitchell from extending his team spirit to many other parts of the institutional side of the firm, which former fixed-income professionals admit they viewed as mediocre and inferior. 

Under Mitchell, says one individual close to Merrill: “Fixed income was much less cooperative with other parts of the firm. They thought investment bankers didn’t add value. They wanted to do their own deals, and print their own tickets.”

To Komansky, and no doubt to many others on the Merrill executive team, that meant one thing. “Edson’s myopic drive to build his businesses” resulted in a “perception of a lack of what we call teamwork” explains the president. But, as even Komansky acknowledges, Mitchell’s defection points to one of the most difficult issues facing Wall Street in general and Merrill in particular. And that is the inevitable tension between the creative entrepreneurial spirit – with its accompanying egos – that drives the best of Wall Street, and the organizational structure needed to keep a colossus like Merrill from imploding.

Cold comfort

The record of star-based cultures in recent years does not inspire imitation. Salomon Brothers, Drexel Burnham Lambert and First Boston are a few that come to mind. But the flipside is not so attractive either. Merrill, which has struggled so long to become a top global investment bank, may be at a watershed. Those who’ve left fear that the firm is heading for a period of conformity and mediocrity, uttering with distaste the word “technocracy”. “The fact that they are losing so many people means something is not quite right,” adds a competitor in the derivatives area. “We see them as being less competitive, less aggressive.”

Komansky acknowledges that he spends a lot of time these days thinking about the tension between entrepreneurialism and management, and says there has to be room at Merrill for creative people “who don’t walk down the middle of the road. But they have to be on the reservation.” At Merrill, that means abiding by the firm’s five hallowed “principles” which are plastered all over the bank’s walls. They even flash by, item-by-item, on secretaries’ computer screen-savers: “Client focus. Respect for the individual. Teamwork. Responsible citizenship. Integrity.”

The principles are simplistic and hokey. But employees seem to take them to heart. Even an avowed cynic at Merrill says defensively: “People need a value system to subscribe to. At the end of the day, integrity and reputation are everything.” The principles, first given this capsule form in 1992, are considered a distillation of Merrill’s culture. They are what many see as one of the firm’s greatest achievements and the legacy of chairman Daniel Tully. “The culture Merrill’s been able to build is one of the firm’s unpublicized successes,” says Brian Barefoot, a senior vice-president in merchant banking who left Merrill in 1992 after 25 years. (Last year, he joined PaineWebber as an executive vice-president.)

In the eyes of Wall Street, Merrill Lynch is a blue-collar firm that has climbed the lofty pinnacle of high finance through hard work, playing by the rules and a little luck. A self-made firm, it is the embodiment of the American dream. Not only did Merrill bring Wall Street to Main Street, it has taken it to the rest of the world. “Street smarts [street wisdom] and common sense” are the characteristics one former executive attributes to chairman Tully and president Komansky, the men who run the firm. Both were raised in the working-class boroughs of New York City. Tully says this taught him to get along with other cultures. Komansky keeps a photograph on his office wall of the Brooklyn tenement where he grew up – a constant reminder of his humble roots.

There is ample contrast between that tenement the other side of the East River and the World Financial Center – the heart of Merrill’s 35-country empire – on the west side of Manhattan. The ultra-chic complex of financial institutions, shops and restaurants forms a cluster of glass-clad postmodern architecture overlooking the Hudson River. Merrill’s 1987 move into its grand 34-storey home was a sure sign of its ambitions, which were tested immediately by that year’s crash in the world equity markets. 

Today, it is the biggest Wall Street firm, with $5.8 billion in capital and an estimated $20 billion in revenues last year. It is often compared with larger, more highly-capitalized commercial banks in the US and abroad because of its size and the breadth of its business. Analysts are expecting net income to top $1 billion for 1995. In international securities business, it beats all the competition. Merrill has held the record for cross-border financings for seven years. The recent purchase of London-based market-maker Smith New Court also makes it the world’s largest equities house in terms of people.

Culture problems

So far Merrill’s stature in the markets hasn’t suffered from its recent talent drain. Many former executives, noting the strength of the franchise Merrill has built, say the depth of its talent means departures have little lasting impact. After weathering 1994 far better than its competitors, it is still the most profitable among them. Merrill remains number one in global debt and US corporate debt underwriting, with its market share virtually unchanged this year. In the international area, executives say, morale has never been higher. The firm has been climbing the rankings for M&A, the most lucrative and most prestigious of corporate business.

Nonetheless, those who recently quit suggest there is a culture problem which they predict will hurt the firm in years to come. At least in the fixed-income area, where the departures occurred, they argue that Merrill’s five principles have become a “mantra” that is used to stifle creative debate. “Teamwork” has come to mean falling in line and they add that “politicians” are replacing the stars.

“The political correctness that has developed at Merrill is a fairly recent phenomenon,” says a former executive. These Merrill refugees have a vision of utmost horror: could Merrill Lynch’s employees become versions of the very creatures they detest most – the “moonies” of Goldman Sachs? This epithet for Goldman’s drone-like culture was reputedly coined by Merrill’s own John McNiven, managing director of European capital markets in London. There’s “no chance” of such a transmogrification at Merrill, says one Merrill executive. “We’ve got a sense of humour.”

The ability not to take themselves too seriously is a positive trait and one characteristic that separates Merrill bankers from many of their competitors. But that doesn’t mean they are good humoured about the criticisms of their beloved principles. Bellows chairman Tully: “To say the principles stifle creativity – it’s BS [bullshit].” 

And Herbert Allison, the executive vice-president who oversees investment banking and equity and debt markets, also rejects the idea that a straitjacket is being put on Merrill Lynch. “The opposite is true,” he says. “We’re trying to promote more candour and encourage and reward creativity.”

Creativity, or the lack of it, is a touchy subject at Merrill, for good reason. In the past, the investment bank has often been viewed as a lumbering giant, forcing its way into markets by brawn not intellect. Many of its most creative ideas – from the retail division’s much-copied cash management account, to its state-of-the-art risk management system, to its derivatives expertise – came from hiring outsiders, whether they were consultants or Wall Street veterans from other institutions. 

But Merrill wants the institution itself to be viewed as a trendsetter. “If we allow conformity, we will not succeed,” says Jerome Kenney, the executive vice-president in charge of strategy. He is another top executive unhappy about the recent defections: “No-one is ever better off by losing more than a few good people.” Adds Komansky: “I don’t want us to become the men and women in grey flannel suits. There has to be room in this organization for people who think differently.”

World-class ambition

Merrill has largely built its investment banking business by buying talent. The purchase of the investment banking firm White Weld in 1978, followed by its purchase of some AG Becker operations in 1984, were significant steps to overcome what Merrill viewed as its deficiencies in that area. Merrill continued to upgrade its institutional image in the late 1980s and early 1990s – generally by hiring professionals from the more prestigious firms of Morgan Stanley and JP Morgan. (Mitchell, interestingly, spent almost his entire career at Merrill and was one of its few home-grown investment banking success stories.)

At the same time, Merrill built on the strengths of its highly successful retail business. The success of its two-pronged approach has been unmatched by any other financial institution. This is perhaps partly because a strong and common identity – one that can bridge asset management, investment banking and private client bases – is hard to fashion. It’s also critical that the sense of identity is maintained among its 44,000 employees in 35 countries. One way Merrill tries to do so is through the simplicity of its principles.

Now that Merrill has emerged as the premier US financial institution by a number of measures, Komansky’s ambition is to see it become his perception of a “world-class company”. By that, he doesn’t mean another Morgan Stanley or Goldman Sachs. Komansky is looking at non-bank corporations. League tables aren’t enough he notes: other criteria are client satisfaction, shareholder value and financial performance. 

“It’s an ambience, an aura,” says Komansky. “It’s difficult to quantify.” But he knows it when he sees it, as he did for example when visiting brewer Anheuser Busch last year. “From the moment the car pulled to the front of the building,” he says, “you knew it was a world-class company.” When he called on another company, which he refuses to name, and he found the receptionist eating pizza at her desk, “you knew it was not a world-class company”.

Merrill’s obsession with such matters is based on its own research on the topic of excellence. Its culture, its principles, are not unique, comments Kenney. “All successful companies have to sustain values and work together.” One critical method by which Merrill has tried to encourage teamwork on a firm-wide basis is to institute a pay system that links bonuses through stock ownership to the firm’s overall profitability. 

Merrill executives talk about how much they love to come to work and about their sense of family pride in the institution. “Cut my wrists and little bulls run out,” jokes Edward Goldberg who came up through the ranks with Tully and is now executive vice-president of operations, systems and telecommunications.

Some former executives and Merrill clients say that the tone of teamwork and cooperation is set at the most senior levels of the firm, in the executive management committee, and that it is Tully himself who is responsible for a collegial atmosphere. “I don’t allow backbiting,” Tully says. “If one of the executive vice-presidents comes to complain about someone, I say: ‘Let’s get them in here.’ I’ll create a situation where they have to speak with the other person. Then I’ll be the arbitrator. Therefore, little [backbiting] occurs.” 

Some former executives praise this technique. They say it has gone a long way towards ridding Merrill of the “brutal political” atmosphere prevalent during the late 1980s and early 1990s, before Komansky was sent from retail to head the institutional side. On the other hand, one complaint is that Tully “only likes to hear another success story. It works fine when things are going well.” (To the criticism that he doesn’t like to hear bad news, Tully retorts that he doesn’t want to hear any news like that in 1987, when rogue trader Howard Rubin lost the firm more than $300 million on mortgage-backed securities.)

In Merrill’s not so distant past, as the firm was growing beyond its wire house roots to become a global power-house, teamwork was more difficult to achieve. “Life is not a honeymoon, and we’ve certainly had our share of internal squabbling and bickering over the years,” acknowledges Komansky. Describing the political atmosphere of earlier years, former employees talk about the “battle after battle” for fee splits between the institutional and retail side for transactions that involved both. An issue known as “transfer pricing”, it involves the booking of both revenues and costs, affecting the internally calculated return on equity for the two areas. The animosity between the institutional and retail sides was common and predictable: institutional employees felt that retail ran the firm (all chairmen and presidents have had a retail background), while retail resented having institutional products pushed down its throat.

Former employees say that Komansky, who spent most of his career at Merrill on the retail side and is renowned for his people skills, was transferred to the institutional side in part to smooth things over. (In 1990 he became head of equities.) Downplaying the matter, Komansky says that while acrimony had developed about 10 years ago, by the time he arrived there was only one area of dispute left to resolve. “I didn’t think it was worth the time to be bothered about that last 5%, and that attitude began to permeate the rest of the organization.” Komansky was the director of both equity and debt markets from 1993 until he became president last year.

John Steffens, the executive vice-president who heads the powerful retail side of the business, acknowledges that there used to be some concern about products that “appealed to the institutional side but not retail”. But he says he now has veto power over any product designed by investment banking that he believes is unsuitable for his private client base. It is further evidence of the cooperative climate, says president and CEO of Merrill Lynch Asset Management, Arthur Zeikel, who is also a Merrill executive vice-president, that Steffens’ salesmen also work closely with Merrill Lynch Asset Management. Merrill Lynch Asset Management, with $180 billion in assets under management, has no marketing people, only portfolio managers. “Mutual fund sales people don’t work for me,” says Zeikel. “They work for Lonnie [Steffens]. They don’t report to me. By definition, that means we have to have strong teamwork.”

Allison’s game plan

The recent reorganization of the corporate and institutional client group, which Allison now heads, was also designed to promote cooperation between debt, equity and investment banking. “We have to have unparalleled teamwork” in order to “seize the high ground of relations of clients”, says Allison. His “game plan”, as observers call it, involves, for example, reorganizing the investment bank along global industry lines, which puts M&A bankers to work side-by-side with corporate finance specialists and analysts. 

Allison says that in order to move from low-level corporate finance to a lead-manager role and the high-end advisory business, Merrill is changing the way it pays investment bankers. Compensation will now be based on three-year performance in generating revenues and building a presence as measured by market share. Some of these changes have been in the works for a while. 

Already, Merrill’s M&A business has made significant strides. In cross-border M&A, Allison says, the firm jumped from outside the top 25 to ninth in 1994 and fourth during the first half of 1995. In addition, debt, capital markets, equity and municipal bonds have all been realigned under “global client products” reporting directly to Allison. “To increase coordination, we need to break down walls in the organization,” he says.

But those who left the firm after Allison gained more authority during the recent reorganization, complain that when Komansky held a similar position (before becoming president), fewer areas reported directly to him, and heads of divisions such as debt and capital markets had more autonomy. There’s no doubt that Allison’s star has risen under the reorganization, though a Merrill spokesperson says that it was a decision made by Tully and Komansky. With institutional business riding high, Allison seems well positioned to become the next president of Merrill, which could occur when Tully retires in 1997. Allison did the requisite stint in retail. A big plus these days is that, unlike either Tully or Komansky, he also has international experience (in Paris and the Middle East).

Having served as treasurer and chief financial officer of the firm, Allison is credited with a big role during the 1989 restructuring that cut costs and boosted Merrill’s profitability. While designing the firm-wide compensation systems calculated to foster teamwork, he came up with a stock plan known as “herbies” that has enriched almost everyone at Merrill. He is better educated than his superiors, having gone to Yale and Stanford. (Tully graduated from New York’s St John’s University, and Komansky attended the University of Miami. After becoming high level executives, they both went through Harvard Business School’s advanced management programme.)

Allison is also driven. “He’s an extremely hard worker,” says a former executive. “He is really pushing the envelope in a lot of ways, putting a lot of pressure on individuals to perform better to get more with less.” But even those who say they have a positive impression of him also say he can be hard to get on with. “He can be a very difficult guy,” says one. It’s a sharp contrast to the two men at the top of Merrill today, which is one reason his rise to power was viewed somewhat ominously by those who departed.

Allison’s style seems to rankle many of the independent-minded traders and the so-called intellectuals brought over in the late 1980s to the derivatives and swaps areas. One former Merrill trader, who left a few years ago, says: “It strikes me that the place is being run by technocrats reading McKinsey reports.” One former employee who left recently speaks of an “Animal Farm” atmosphere where the principles are trotted out to “cut off discussion and intimidate people”. “You’ll be talking about doing a transaction – whether or not you should do something for a client,” he says. “This should be about making money after all. If I said ‘I don’t think you should do that deal’, somebody would say ‘you’re not client-focused’. They tar you with saying you’re not client focused.”

Merrill senior executives deny this is the case. Kenney agrees that there’s a constant debate on the subject of client focus. “You can easily go broke offering client service,” he says, only half in jest, but adds that building relationships sometimes necessitates foregoing adequate returns. A former Merrill executive, however, insists that a lot of derivatives products that were profitable for firms like Merrill weren’t in the best interests of its clients. “Generally speaking, the battle to make money wins out over the desire to make sure the client gets the best possible deal.”

Komansky insists that is not the Merrill mind-set. As for the stifling of debate, he suggests: “There’s a difference between debate and acquiescence. If a decision is made contrary to yours, then that’s stifling – well, maybe it is.” In reality, he believes today’s environment has changed the types of transactions that can be done. There are fewer “bells and whistles”, he says, hinting at the derivatives creativity Merrill became known for.

In his defence, Allison insists he’s not trying to create a “rigid bureaucracy” but rather to foster creativity by bringing people from diverse areas to work together. “In the past, there wasn’t much candour around here,” he says. Referring to Mitchell and his team, he adds: “Individuals, through their own willpower, could impose their own views.” Even Mitchell’s admirers admit that, as one put it, “he had no small ego”. And many agree that the changes Allison has engineered were necessary.

Although Mitchell was the head of fixed income, it was his predecessor, Roger Vasey (moved aside when Komansky was brought in to head the division), who started developing the division’s power base. Both men “eliminated barriers” within fixed income, say former colleagues. “They created a culture in which teamwork did thrive,” says a former trader. “Those two guys were the glue who transformed Merrill from literally a bucket shop to the top fixed-income player on the street.”

He says that it was Mitchell and Vasey who brought investment banking business to Merrill by way of its new issues desk and risk management execution. Such blue-chip names as Kodak and PepsiCo became clients this way.

Shooting stars

One colleague says of Mitchell: “Within the framework of his responsibility, nobody was able to build a stronger team orientation.” Mitchell reputedly knew each one of the 700 people in his division by name. He was also capable of bending the rules to suit his needs, say colleagues. As an example of his fiefdom-building, one former associate reminisces how Mitchell would take over an obscure department with 100 people when a headcount freeze was instituted, then fire those working there and rehire the type of people he wanted. “It was not pernicious. He just believed he could do better. He may have known better.”

Those close to Mitchell say that asking him to head equities, an area weaker than fixed income, was forcing him sideways, if not downwards. His seniors were asking him “to throw away his street equity [his market value as a professional] and bet on Merrill 100%”, explains one former colleague. “If you’re not comfortable with those at the top – meaning Allison – it’s not a decision you want to make.”

Some say they had seen the end of the star system coming, when Vasey left the debt division in 1992. Traders’ bonuses began to decline, as part of Merrill’s policy of linking compensation to the firm’s overall results. After the bond market rout of 1994, it was no doubt an easier time to limit fixed income’s influence.

“They don’t want anybody who rocks the boat,” says a colleague of Mitchell who followed him out of the door.” To become a star, to become successful, at the end of the day you have to go out on a limb. It ruffles feathers. In the past, what was important was building the business. Now it came back to bite you.” Under the reorganization, he says, “anyone who was a star was looked at with a different view. The politicians, who were generally not the stars, were the ones who came out on top.”

With Merrill so firmly placed near the top of the heap, it may not need stars any more. At least, that’s the gamble Merrill is taking. No one individual can be bigger than the firm, says Daniel Napoli, the senior vice-president who heads risk management. That lesson, he says, was learned in the Rubin trading debacle in 1987. Napoli, who interviews traders before they are hired, says he always resists the “cocky person who always tells you his or her P&L”. At Merrill, he notes, most of the P&L “comes from the bull”.