The Go-Go Years

by John Brooks

  Whether or not Haack knew it at the time, this was quite wide of the truth, as subsequent events would more than demonstrate. Facts were only spottily available; Wall Street was swept by confused alarms, and many firms in trouble were bald-facedly concealing the truth from the Stock Exchange. Perhaps Haack’s statement should be taken as an expression of hope. His job, he clearly felt, was to spread reassurance and to ward off panic reactions. Again, in mid-April 1970, answering an urgent query from Senator Edmund Muskie, Haack wired from Wall Street: “THE EXCHANGE’S SPECIAL TRUST FUND IS NOT NEAR DEPLETION… SITUATION WITH RESPECT TO OPERATIONAL AND FINANCIAL PROBLEMS OF NYSE MEMBER FIRMS HAS VASTLY IMPROVED.” In fact, five Stock Exchange firms were at that moment in liquidations that would end up costing the Special Trust Fund $17 million of its $25 million total; another member firm, Dempsey-Tegeler, was in its death throes, and its liquidation would eventually cost the trust fund over $20 million; and, worst of all, Hayden, Stone and Company, an eighty-four-year-old giant not far from the core of the Wall Street Establishment, with some 90,000 brokerage customers and a major share of the underwriting business, had lost nearly $11 million the previous year and was now losing money at a rate in excess of a million dollars a month. Hayden, Stone’s affairs were shortly to erupt into the first phase of the crisis that almost brought Wall Street low for good.

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  At the end of May—at just about the time of the White House dinner that got credit for turning the market around—Lasker and some of his fellow governors of the Stock Exchange decided that the time had come to form a special committee to maintain surveillance over member firms’ financial affairs. This was normally the work of the Exchange staff, and in particular of the Member Firms Department; but the governors were dissatisfied with the way that work was being done. The situation had become chaotic. It was increasingly evident that some firms were exaggerating, if not actually falsifying, their capital figures in their reports to the Exchange; at governors’ meetings there would be talk of $40 or $45 million being required from the trust fund in liquidations already under way, but nobody was sure. The figures were guesses. It was Robert L. Stott, Jr., a well-known floor specialist, who came to Lasker and suggested that a committee of governors be formed forthwith. Responding enthusiastically, Lasker appointed to the new committee—formally named the Surveillance Committee, but usually thereafter called the Crisis Committee—himself; Ralph DeNunzio, executive vice president of Kidder, Peabody and vice chairman of the Exchange; Stott; Stephen M. Peck, senior partner in Weiss, Peck and Greer; Solomon Litt, senior partner in Asiel and Company; and Felix George Rohatyn, a partner in Lazard FFelix Rohatyn réres and Company.

  The chairman of the committee was Rohatyn, and it was he and Lasker, working in tandem, who would bear the brunt of its work over the months ahead. Rohatyn had been born in Vienna in 1928, and he and his Polish-Jewish parents had arrived in the United States as refugees from Hitler in 1942, after an interim stay in France. He had graduated in 1948 from Middlebury College, in Vermont, with a B.A. in physics, gone directly to Lazard, and never left again except for a spell of military service during the Korean war. As a young acolyte making the transition from natural science to the intricate and unnatural science of corporate finance, Rohatyn at Lazard had had the good luck to become a protégé of one of the leading masters of corporate deal-making, the French-born, publicity-shy, tough old wizard of Wall Street, André Meyer. Under such Cordon Bleu tutelage, sous-chef Rohatyn flourished. A compactly built man with a pug nose, heavy brows, full lips, and a slightly receding chin, he had an eager face and easy smile that made him at forty-two seem more like a student. But his appearance was deceptive. “Nobody has a record quite as spectacular as Felix’s,” a partner in a rival investment-banking house said of him in 1970. The record consisted of having become one of Wall Street’s most ingenious experts in corporate acquisition and reorganization. That is to say, Rohatyn had become, like his mentor, a master merger-maker, and one of the firms for which he arranged intricate, multimillion-dollar acquisitions was the Lazard client International Telephone and Telegraph, on whose board of directors he sat.

  In 1972, Rohatyn would come to national prominence, of a sort, as the banker for I.T.T. who the previous year had had a series of private meetings with then Acting Attorney General Richard G. Kleindienst to argue, on public-policy grounds, for a favorable settlement of the Justice Department’s antitrust suit against I.T.T. Disclosure of those meetings involved Rohatyn in considerable controversy, since Kleindienst would later deny, for a time, that he had had anything to do with the settlement. (It was never alleged that Rohatyn had any knowledge of or involvement in the famous I.T.T. financial commitment to the Republicans for their 1972 national convention.) Whatever the facts of that matter, Rohatyn in 1970 was quite possibly the most brilliant, and certainly among the most dedicated and energetic, men in Wall Street at a time when Wall Street badly needed brains, talent, and energy to save it from its own folly. Rich enough at forty-two, married to a daughter of the well-known author and Union-with-Britain advocate Clarence Streit, beginning to be spoken of as heir apparent to Meyer as boss of Lazard Fréres, Felix Rohatyn in 1970 was riding the crest.

  The Surveillance Committee started out by meeting once a week, for lunch on Thursdays, in a committee room on the sixth floor of the Stock Exchange building. Always present, besides Rohatyn, Lasker, and their committee colleagues, were two representatives of the Exchange staff, President Haack and Executive Vice President John Cunningham. According to Rohatyn and Lasker—both of whom later talked to me at length about the committee and its work—its first job consisted chiefly of trying to exercise due diligence as to use of the trust fund in current liquidations, and of trying to set up an early warning system as to other firms that were heading for trouble. It quickly became clear that the Exchange staff men really knew remarkably little about those other firms’ financial condition. To their horror, the committee members began to see that weakness was the rule rather than the exception. Brokerage firms that the Exchange had supposed to be above reproach were revealed, under even superficial investigation, to be walking zombies, carrying assets on their books that did not exist and never had existed. “It was like a nightmare,” Rohatyn said later. “You pushed here, you pushed there, at random, and wherever you pushed, you found softness.”

  The committee revised its schedule, and began meeting formally twice a week—Tuesdays and Thursdays at eight-thirty in the morning—and putting in so many additional hours that some of its members were soon devoting most of their time to its work rather than to the affairs of their own companies. Early in June, when the committee had been in existence for only a few weeks, it faced the first of three heroic challenges: the impending collapse of Hayden, Stone and Company.

  That venerable firm had been in serious trouble since 1968, as the Exchange had ample occasion to know; in that year—a banner business year in which Hayden, Stone’s gross income was at an all-time high of $ 113 million—its record-keeping situation had become so bad that it had literally called on the Coast Guard for help, hiring members of that service to moonlight in the back office. As early as the spring of 1969, investors in Hayden, Stone were getting the message that the good days were gone, and accordingly they began withdrawing their capital in huge amounts. The firm’s attitude toward its problems at that time was vividly shown in its treatment of its treasurer, Walter Isaacson, who in the summer of 1969 began protesting that, with revenues going down, costs going up, and the capital base eroding, operations ought to be cut back drastically. Isaacson’s unpleasant warnings ceased when he was summarily fired.

  In September 1969, matters were hardly improved when the Stock Exchange backed restrictions on Hayden, Stone’s operations by fining the firm $150,000 for rule infractions during the previous year. But, shortly thereafter, the Exchange suddenly turned soft on its erring member. In October, it removed all restrictions on Hayden, Stone’s operations, and in November it made no ob
jections to an offering circular to prospective investors in which Hayden, Stone made some extravagant and dubious claims as to its future. While no explanation was offered, it may logically be assumed that the Exchange’s sudden blandness was motivated by fear that Hayden, Stone’s capital situation had become so precarious that those 90,000 customer accounts were imminently threatened. At all events, the firm started out 1970 in technical capital compliance only on the basis of such gossamer assets as a tax refund claim that, far from having been approved by the Internal Revenue Service, had not yet even been filed.

  By late May, when the Crisis Committee came into existence, Hayden, Stone was a huge black cloud on Wall Street’s horizon, a storm latent but brewing. Its roster of branch offices had shrunk from eighty at the beginning of the year to sixty-two, and its back-office expenses had been drastically curtailed through mass firings, but, even so, it continued to lose approximately $1 million a month on current operations. Meanwhile, though, its capital problems had apparently been solved, at least temporarily and technically, at a single stroke. On Friday, March 13—of all dates—a group of Oklahoma businessmen signed demand notes lending Hayden, Stone $12.4 million, pledging stock in their own companies as collateral. They included Bill Swisher of CMI corporation, who pledged 165,000 shares then worth $4,372,500; Jack E. Golsen of LSB Industries, who pledged 200,000 of his firm’s shares worth $1.2 million; and—most unfortunately, as it turned out—Jack L. Clark of Four Seasons Nursing Centers, who pledged 120,000 shares of his firm’s high-flying stock with a March market value just short of $5 million. All told, the collateral added up to $17.5 million, apparently an ample sum to cover the $12.4 million demand note and give Hayden, Stone a rosy capital future. A rosy present income for the Oklahomans was assured by an interest rate on their “money” of around 7 percent.

  However, as the reader will have no trouble discerning, something was wrong here. For one thing, Wall Street was not supposed to go knocking on the doors of little-known, unseasoned firms in Oklahoma for capital; it was supposed to be the other way around. More to the immediate point, the demand-note capital was insubstantial; the terms of the notes were such that Hayden, Stone, which so desperately needed capital to cover current operating losses, could not get its hands on a cent, unless the firm were either insolvent or in violation of Rule 325. Finally, were market fluctuations to cause the value of the loaned stock to drop below $12.4 million, the amount of Hayden, Stone’s available credit would diminish accordingly. In sum, it was a classic case of phantom capital, created by a shuffle of papers and used to maintain formal compliance with a rule of the Stock Exchange’s that the Exchange had no stomach for enforcing.

  Then the shaky structure cracked. In mid-May, the S.E.C. suddenly suspended trading in Four Seasons Nursing Centers, which shortly thereafter expired in bankruptcy. Down the drain went $5 million in Oklahoma stock value on $3.3 million of Hayden, Stone capital. And the prices of the other Oklahoma stocks were dropping—20, 30, 40 percent—along with the rest of the market. By the beginning of June, when the Crisis Committee was hardly a week old, the market value of the Oklahoma stock had declined from $17.5 million to around $9 million, and as a result Hayden, Stone was plainly in violation of the capital rule, as a routine surprise audit would confirm a few days later. Things were in a worsening mess now; but what, the committee members asked themselves, could the Stock Exchange do? Blow the whistle on Hayden, Stone and let its customers fend for themselves? The Special Trust Fund, almost gone anyway, was ludicrously inadequate to handle such a giant liquidation. On the other hand, if the Exchange looked the other way and did nothing, apparently Hayden, Stone would be unable to meet its obligations and would sooner or later be forced into bankruptcy by its creditors. As Lasker and Rohatyn saw the matter, the Exchange had only one course—to find new capital to save Hayden, Stone, or to admit to the public that Wall Street could no longer be relied upon.

  As a first step, the Exchange found some capital in a curious place. The Special Trust Fund was more than doubled by transferring into it $30 million that the Exchange had squirreled away as a building fund. No time to be thinking about new buildings now! The fund, as we have seen, was clearly intended for the single purpose of rescuing the customers of bankrupt member firms. But these were parlous times, and the language of the Special Trust Fund provisions was conveniently vague. So the Exchange’s governors, on recommendation of the Crisis Committee, now voted to lend $5 million of their constituents’ money, entrusted to them specifically to save the customers of failed firms, to Hayden, Stone to keep it in business. It was just a matter of saving the broker in order to save the customers, they rationalized. More fancifully described, it was a matter of strapped parents tapping the children’s piggy bank to prevent foreclosure of the mortgage on the homestead. Thus, on July 2, Hayden, Stone was restored to capital compliance—this time with real money, albeit money obtained in a most peculiar way.

  But the reprieve was short-lived. By now, houses were crumbling from one end of Wall Street to the other. Day after day, time and again, the Exchange’s staff would bring the Crisis Committee news of more firms that were on the brink of capital violation because of diminished business and consequent capital withdrawals. Time and again the committee would begin to probe in a new place, and find the same softness, the same imaginary assets shoring up a top-heavy facade. Several more firms, the largest of them Blair and Company, went under in June and July. In mid-August, the Exchange, through President Haack, announced for the first time the names of ten brokerage firms that were in bankruptcy or liquidation, and gave soothing reassurances that the augmented trust fund, now theoretically amounting to $55 million, was adequate to make their customers whole. Nevertheless, by the last week of August it was generally known in the Street that the fund was again depleted. And, at about the same time, there was an ominous new turn. Three more firms with in excess of ten thousand accounts among them—Robinson and Company, First Devonshire Corporation, and Charles Plohn and Company, the vehicle of our old acquaintance Two-a-Week Charlie, the garbage-stock king—were suspended for capital deficiencies and went into liquidation. For the first time, the Exchange pointedly did not commit the trust fund to the help of the customers—in the case of Robinson, on the technicality that the firm had resigned its Exchange membership back in July and was therefore not eligible for help; in the case of Plohn, because it did not believe that such help was needed; and in the case of First Devonshire, without any clear explanation. In retrospect the explanation is clear. The trust fund had been spent.

  Meanwhile, Hayden, Stone went on losing money. The Oklahomans were screaming bloody murder at what was happening to their investment, and the loudest screamer was Jack Golsen. He, like the others, had little practical reason to raise a fuss; he believed now that, because of his subordination agreement, most or all of his investment was gone whether Hayden, Stone was rescued or not. He was screaming to relieve his outraged feelings—and, moreover, on principle. The conduct of Hayden, Stone’s affairs, as it was now being gradually revealed, seemed to Golsen to be a public scandal. “In my business, if we are missing inventory, we stop everything and look for it,” he complained. “In Wall Street, if they’re missing seven million dollars, they just accept it as part of the game.” This was a double standard, he insisted: Hayden, Stone would never dream of underwriting the stock of another company that operated as it did itself. The representations that the officers of the firm had made to him, in asking for the loan, now appeared to him to have been false; it seemed to him that Hayden, Stone’s talk about its capital assets represented “dealings not in realities but in the abstract.”

  Early in August there was an attempt, prompted by the Exchange, to save Hayden, Stone through a merger with Walston and Company; but the deal fell through. The next merger candidate was Cogan, Berlind, Weill and Levitt (the same firm, with a name change, that had so profitably brokered the Leasco-Reliance merger in 1968). C.B.W.L., still doing well, was a small firm e
ager to expand, and the merger with Hayden, Stone would be a quick path to expansion. Unfortunately, it might also be a quick path to financial and operational chaos. Even apart from the difficulty attendant upon taking on a virtually bankrupt partner, one problem was that a merger would mean too much expansion; Hayden, Stone still had forty-five operating branch offices, and C.B.W.L. wanted no more than twenty of them. Knowing full well that it would have to sweeten the deal, the Stock Exchange offered $7.6 million to C.B.W.L. in exchange for its assuming the Hayden, Stone mess—a $7.6 million that the Exchange didn’t have just then, in its trust fund or anywhere else, but that it believed it could raise from its membership. And that did it. At last agreement was reached that the Hayden, Stone offices would be divided between C.B.W.L. and Walston. The surviving firm was to be named CBWL-Hayden, Stone, Inc.