As the markets began to crumble around Wall Street executives in late August, former Salomon Brothers chairman and chief executive officer Deryck Maughan was in a good mood. “He seemed tickled pink that he had sold the firm a year earlier,” says David Berry, an analyst at Keefe Bruyette & Woods, recalling a conversation with Maughan.
Former Salomon bankers say they know why Maughan was so happy. Given Salomon’s historical dependence on proprietary trading and the type of bond arbitrage that almost destroyed the firm run by ex-Salomon traders – Long-Term Capital Management – “Salomon would probably have been bankrupt by then,” says one who left almost as soon as the 1997 merger with Travelers Group (which owned retail brokerage Smith Barney) was announced.
By the end of October, however, Maughan wasn’t sitting so pretty. Travelers’ next merger – with Citicorp – came on the heels of disastrous third-quarter earnings at its Salomon Smith Barney investment banking unit. It made a net loss of $325 million, compared with a pro-forma profit of $508 million in the third quarter of 1997. The poor figures were largely the result of $700 million-worth of trading losses, mostly from proprietary bond trading.
Last month came the inevitable management shake-up of Citigroup’s combined investment-banking operations. Maughan still has a job, but now has less responsibility for day-to-day operations. But co-head of the unit Jamie Dimon was let go. Maughan was kicked upstairs to a vice-chairmanship and two lower-ranked executives – Michael Carpenter from Travelers and Victor Menezes from Citibank – took over the troubled operation. “Maughan’s being preserved for institutional memory,” says one former Salomon banker of Maughan’s new role. (Maughan has not returned calls for comment.)
To many of the hundreds of former Salomon Brothers bankers who either fled the firm or were purged from it after the Travelers union last year, the management shake-up was the final disgrace for Salomon. This was the firm that at one point during the 1980s earned half the profits on Wall Street. But it never seemed able to recover from the treasury-bond-rigging scandal of 1991. To others, the downfall was as inevitable as that of Long-Term Credit Management, a firm also known as “Salomon North” for its Greenwich, Connecticut, location 50 miles north of New York City.
To competitors, the recent changes are evidence that the new Citigroup won’t be much of an investment-banking powerhouse. In the US, at least, there’s no doubt that little remains of the old Salomon.
“Citigroup’s aspirations of being a top investment bank have to be questioned,” says a senior Wall Street executive. “They’ve got two CEOs who don’t love investment banking, and I’m a great believer that the top people need to believe in it for it to work.”
The most recent turmoil also suggested that wily dealmaker Sanford Weill, as chairman of Travelers, paid far too much for Salomon – $9 billion – and had made yet another misstep into the investment-banking world. Indeed, some viewed it as even worse than the disaster at American Express Shearson Lehman Brothers, another financial services giant that was created, in large part, by Weill’s dealmaking. “This may be Sandy Weill’s biggest mistake,” says a former Salomon M&A banker, referring to the purchase of Salomon. Weill could not be reached for comment.
When Weill and Maughan announced their merger in the fall of 1997, the less than two times book Travelers paid for Salomon seemed a good deal on paper. After all, other securities firms were being gobbled up for far more. But it puzzled those who had known Weill. He abhors taking trading risks, yet proprietary trading was the only thing at Salomon that consistently made money. As one former Salomon banker puts it: “There was a fixed income-trading business and oceans of red ink everywhere else.”
At the time, both top executives indicated that Salomon’s trading operation would continue unscathed. And many other Wall Street executives expected it as well. “After all, that was the jewel,” says the head of investment banking at another institution. But as soon as the deal closed, Salomon quickly began scaling back. The firm had lost $100 million on an equity-arbitrage position on the aborted merger of telecoms companies BT and MCI. Within weeks, equity arbitrage was closed. Steve Black, the Smith Barney executive named to head global equities (who recently resigned in the wake of Dimon’s departure), said that Smith Barney’s strong customer equity franchise made such trading unnecessary.
That wasn’t all. “The equities trading floor was instantly transformed into a rather low-energy, uneventful place,” says a Salomon executive who left earlier this year. “At Salomon, somebody was always trading. But when it merged with Smith Barney, they would just shut down desks at certain points in the day and people would sit around throwing paper balls up in the air.” Indeed, the firm even cut out block trading, a Salomon speciality. At Salomon, block trading consisted of buying a billion dollars in securities and selling them overnight. “They marketed the hell out of them,” he says. “But when Steve Black took over, that was the end of that. All they wanted to do was feed the retail brokerage operation.”
Just as quickly, trading everywhere else was truncated. The proprietary trading department was renamed global arbitrage the day of the merger and, says one individual who left the firm shortly afterwards, “I sort of knew that was the beginning of the end.” The global trading environment didn’t help, of course. Last year’s Asian turmoil hurt trading there. And even during the early part of 1998, US bond arbitrage, as LTCM was also discovering, was becoming less profitable. Indeed, while some former Salomon bankers mourned the demise of its proprietary trading and bond arbitrage business, others point to what happened to LTCM and say the same fate would eventually have befallen Salomon.
“Proprietary trading at Salomon Brothers was a mirror image of what was going on at LTCM,” says a former Salomon partner, who worked there during the 1980s when LTCM founder John Meriwether’s career there flourished. “It was never really profitable, but created the illusion of profitability by creating the illusion it wasn’t using much capital.” He argues that LTCM’s recent woes indicate that that firm was undercapitalized by $4 billion to $5 billion. “If they had been running the operation with $8 billion of equity, which they needed, they wouldn’t have been earning 41% returns, but more like 18% or 19%, which would have meant they did about half as well as the stock market.”
He applies the same analysis to Salomon’s trading operation: “From 1986 to when it failed in Travelers, the bond arbitrage offered a terrible return on equity, but a lot in terms of revenue.” Indeed, he believes that one of Salomon’s inherent problems was that “the people using all the equity were the arb guys”. Meriwether initially dismissed Salomon colleagues’ criticisms of the amount of capital he was using, recalls the Salomon partner. “Then he hired Myron Scholes and then Robert Merton to schill [front] for him. Basically it was a Mexican standoff.”
But just as LTCM went on to con the highest ranking executives on Wall Street, and elsewhere, so did the Salomon trading effort. “Sandy Weill didn’t understand this when he bought the firm, he was as mesmerized by those guys as Deryk Maughan was,” the banker continues.
Salomon sources say Maughan tried to protect the bond arbitrage unit this year. But after a loss in the second quarter, it too came under the knife. By summer, the entire global arbitrage operation was being dismantled, but it didn’t happen quickly enough to stave off the third quarter’s huge losses.
Meanwhile, over the course of the past year, Salomon bankers elsewhere in the organization were jumping ship. While Salomon might have had a flawed business concept, employees loved its freewheeling atmosphere. Travelers, a hodgepodge of businesses assembled by Weill, was very different. “The place didn’t have a culture,” says one former Salomon executive. “It didn’t have an esprit de corps. It was just a nameless, faceless, mediocre, gigantic company.” He argues that Weill simply built Travelers by “riding the financial services wave”.
By April this year, almost 500 out of Salomon’s 8,000 employees had fled. Some top names included co-head of M&A Michael Carr, now a partner at Goldman Sachs, Frank Yeary, a top telecommunications banker and Conrad Bringsjord, another M&A banker. A slew of top-ranked analysts also left: Diane Glossman went to Lehman Brothers, while Paul Westray and Ivy Scheider went to Credit Suisse First Boston.
When the Citigroup deal was announced, Weill, and the Travelers’ organization, were viewed as the top dogs. Reed even said he wanted to get some of the Travelers’ DNA into Citicorp.
But the difficulties at Salomon Smith Barney have shifted the balance of power. And it now appears that the Citicorp genes may dominate. Emerging markets, which Salomon hoped to operate under the brokerage unit, has reverted to Citibank’ s control, according to former Salomon bankers. And if the Salomon bankers viewed Travelers as bureaucratic, it can hardly hold a candle to the rigid structure at Citicorp, where staff functions dominate and political infighting is intense.
For example, at Salomon Smith Barney, Maughan and Dimon made hiring decisions, then notified human resources to do the paperwork. But at Citibank, the head of human resources is a powerful figure.
Weill may have hoped to cover up Salomon’s problems by selling out quickly to Citicorp. But whether he will have better luck surviving as a co-CEO of Citigroup than he did as the president at American Express is still uncertain. Travelers’ stock was one of the darlings of the bull market. But the new Citigroup has lagged competitors, and some banking analysts pulled their recommendations after Dimon’s departure.
At Salomon Smith Barney, despite the problems, the down-to-earth Dimon was better regarded by the old Salomon people than the somewhat aloof Maughan. “Deryk was sort of creepy, but people loved Jamie,” says a former Salomon banker.
Meanwhile, tension between Weill and the two new heads of investment banking have already surfaced. While Carpenter and Menezes are trying to integrate the investment banking businesses of Citibank and Salomon Smith Barney, Weill has said they will run side by side.
Integration is likely to remain elusive. Joan Zimmerman, an executive recruiter with GZ Stephens, suggests that the worst is not over. “We haven’t seen the bulk of the departures,” she reckons. Zimmerman thinks that Weill and Reed may have underestimated the difficulties of combining their two institutions. “It sounds really stupid but I’m not sure they even thought about it. When you’re looking at an acquisition you don’t necessarily ask ‘Gee, are the commercial and investment bankers going to be happy?'”
Michelle Celarier
