PENGUIN BOOKS THE GREED MERCHANTS Philip Augar worked in investment banking for over twenty years He led NatWest’s global equity and bond business before becoming a Group Managing Director at Schroders He was a member of the team that negotiated the sale of Schroders investment bank to Citigroup in 2000 before becoming a full-time writer His first book, The Death of Gentlemanly Capitalism: The Rise and Fall of London’s Investment Banks, was published in 2000 and was a business bestseller His co-authored second book, The Rise of the Player Manager, was published by Penguin in 2002 and was one of Amazon UK’s Business Books of the Year Philip Augar speaks and broadcasts on business and management issues and has written for many publications including the Financial Times and other broadsheets He can be contacted through his website, www.philipaugar.com PHILIP AUGAR The Greed Merchants How the Investment Banks Played the Free Market Game PENGUIN BOOKS PENGUIN BOOKS Published by the Penguin Group Penguin Books Ltd, 80 Strand, London WC2R 0RL, England Penguin Group (USA) Inc., 375 Hudson Street, New York, New York 10014, USA Penguin Group (Canada), 90 Eglinton Avenue East, Suite 700, Toronto, Ontario, Canada M4P 2Y3 (a division of Pearson Penguin Canada Inc.) Penguin Ireland, 25 St Stephen’s Green, Dublin 2, Ireland (a division of Penguin Books Ltd) Penguin Group (Australia), 250 Camberwell Road, Camberwell, Victoria 3124, Australia (a division of Pearson Australia Group Pty Ltd) Penguin Books India Pvt Ltd, 11 Community Centre, Panchsheel Park, New Delhi – 110 017, India Penguin Group (NZ), cnr Airborne and Rosedale Roads, Albany, Auckland 1310, New Zealand (a division of Pearson New Zealand Ltd) Penguin Books (South Africa) (Pty) Ltd, 24 Sturdee Avenue, Rosebank, Johannesburg 2196, South Africa Penguin Books Ltd, Registered Offices: 80 Strand, London WC2R 0RL, England www.penguin.com First published by Allen Lane 2005 Published in Penguin Books 2006 Copyright © Philip Augar, 2005 All rights reserved The moral right of the author has been asserted Except in the United States of America, this book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, re-sold, hired out, or otherwise circulated without the publisher’s prior consent in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser EISBN: 978–0–141–90062–9 To the three that I admire most I have never adhered to the view that Wall Street is uniquely evil, just as I have never found it possible to accept with complete confidence the alternative view, rather more palatable in sound financial circles, that it is uniquely wise J K Galbraith1 Contents Acknowledgements Foreword to the paperback edition Preface PART 1: Introduction The Trusted Adviser Takes a Fall The Age of Deception PART 2: Is There a Cartel? The Blessing of the Leviathans Heads We Win Tails You Lose The Sound of Silence PART 3: What Really Goes On The Edge Voodoo Management The Big Squeeze PART 4: Whatever Happened to the Invisible Hand? 10 Does It Matter? 11 The Greed Merchants 12 Here’s to the Next Time Notes Index Acknowledgements This book originated in a paper I delivered at a seminar organized by the London School of Economics Financial Markets Group in September 2001 I am grateful to Sir Geoffrey Owen and John Plender for inviting me to speak there, thus getting the ball rolling I have carried out a large number of interviews with investment bankers and brokers, their corporate and institutional customers and their regulators in the United States and Britain Many of these people are still involved with the financial services industry and in most cases I have protected their identity I should like to thank them all, whether named or not, for being so generous with their time I also wish to acknowledge the Securities Industry Association for giving me permission to quote from and use their research publications and data Several experts on the financial services industry read the draft manuscript Without exception their input improved its accuracy and clarity Their comments, together with those of my editors, Stuart Proffitt in London and Adrian Zackheim in New York, have been invaluable I should also like to thank successive classes of students at Cranfield University who listened to the developing argument during my lectures and shaped it through intelligent and stimulating questions I am also appreciative of the help given by Adrian Fitz-Gerald and Stephen Sale Most of all, however, I am grateful to my immediate family, Denise, William and Rachel They provided me with support and tolerance when I became grumpy when the writing got tough, they helped with the research and production of the book and they have always been willing to act as a sounding board for ideas and text I love you all Foreword to the paperback edition Investment banking has moved at its usual hectic pace in the year since the manuscript for the hardback edition of this book was completed New products, people and protocols have emerged and they are doubtless evolving further as I write One thing that has not changed, however, is the importance of the investment banks’ integrated business model Conflict of interest – albeit better regulated and managed now – remain inherent in the model Integration also continues to give powerful investment banks a decisive advantage over other market users With this in mind, I have resisted the temptation to have a second bite at the cherry What follows is the original text, updated only for the most significant events and with certain passages moved from the present to the past tense to reflect the passage of time Philip Augar Cambridge, England, 2006 fixed commissions, abolition of 34–5 fixed income, growth of 133 free market ideology 8, 12, 20, 168–72, 173–4, 194, 197, 215 Freeman, Robert 11, 107 Friedman, Stephen 182 front running 111 Fuld, Richard 124–5 fund manager services 65–9, 133, 165, 204 fund managers 190–95, 204, 209 funds, performance of 164–5, 190 futures 77, 126 General Electric 44–5, 80 Giuliani, Rudolph 10 Gleacher, Eric 32, 38, 164 Global Crossing 82 global operations/globalization 32–3, 63, 128, 133–4 Goldman Sachs 11, 30, 32, 34, 36, 37–8, 111, 148 and conflict of interest 206 earnings, recent 61 and emerging markets crisis, 1998 130 narcissism 198 political contributions 181 prices 86 proprietary trading 114, 117 risk management 112–13 value-at-risk 117 Google IPO 44, 90, 203 governments 180–84 Gramm, Phil 183 Gramm, Wendy 183 Grasso, Richard 187 Great Crash 6–7 Greenberg, Ace 45 Greenhill, Robert 32, 38, 164 Greenspan, Alan 4, 78–9, 158, 209 Gregory, Professor Alan 170 Grubman, Jack 16, 19, 161, 195 Guinness 11 Gutfreund, John 41 Hanbury, Jim 108 hedge funds 69, 133, 160, 165, 194 Heywood, Jeremy 184 Hintz, Brad 88 history/development of investment banking 5–13, 34–6, 134, 199 HSBC 31 hubris 198 IBM 35 ICI 170 illegality see corruption/malpractice importance of investment banks 29, 32 inflation, and return on equity (ROE) 55, 56 Initial Public Offerings (IPOs) 4, 14, 69–74 analysts, role of 142–3, 144–5 and bubble 159–60 corruption/malpractice 17–18, 19, 43, 137, 144–5, 160, 196 fees 89–90, 91–3, 94–5, 96, 177, 179–80 Google 44, 90, 203 long term performance 73 offer price 70–73, 179–80 reform of system 203 regulation of 202 standards, lowering of 159–60 innovation 131–4, 208–9 insider trading 9–11 integration 22, 33, 107–8, 111, 119, 122, 168 as anti-competitive tool 145–6, 148–9, 151 and conflict of interest 22–3, 118, 206, 211–12 and corporate finance 119–21 development of 140–45 as flawed concept 151–53 and identification of profits 192–3 and regulation 22, 23, 24, 185–6 structural reform 211–15 in UK 170–71 International Swaps Dealers Association 183 internet 4, 129 stocks 4, 13, 71, 188 Investment Banking: A Tale of Three Cities 131 IT revolution, 1990s 129 J P Morgan 45, 84 J P Morgan Chase 20, 31, 37, 82–3, 178 Jeffrey, Reuben 182 Job, Sir Peter 77, 177 junk bonds 10 Kaufman, Henry 5, 118–19, 153 Kay, John 69 Kelly, Ruth 83 Kessler, Andy 18, 24, 159–60 Kianpoor, Kei 202 Kidder Peabody 34, 44 knowledge 107–8, 109–11, 113, 119–21, 122 Kuhn Loeb 34, 36 ‘laddering’ 17, 18 Lazards 31–2 leading investment banks domination of 46–8, 98–9, 103, 109–11 market positions of 36–7 overview of 29–32 Leeson, Nick 128 Lehman Brothers 30, 34, 37, 40 proprietary trading 117 return on equity (ROE) 54 risk management 112 team ethos 124–5 leveraged buy-outs 10, 76 Levin, Senator Carl 202 Levitt, Arthur 115–16, 183, 186–7, 188 Lewis, Michael 9, 41, 151, 153, 159 Liar’s Poker 9, 41, 151, 153 lobbying 183–4, 209 location of investment banks and business 32–3, 134 Lockheed 142 Long-Term Capital Management 80–81, 114, 130–31, 181 Loughran, Tim 179 Lowenstein, Roger 57–8 M&A (mergers and acquisitions) 74–7 failures 162–3, 175–6 fees 90–92, 96–7, 176–8 of investment banks 44–5 UK companies 170 Mack, John 39, 136, 137–8 malpractice see corruption/malpractice management 123–5 and corruption/malpractice 196, 197–8 cost control 134–9 recent reforms, effect of 201 risk management 111–13, 125–31 shareholder value as goal 8–9 Marconi 170 margins 52–3, 61, 88–9, 119 see also prices market concentration 46–7, 98–9 market forces, and reform 211, 212–15 market mechanism, failure of 171–2, 173–4 Markowitz, Professor Harry 129 Martin Act (1921) 15 McVeigh, Charles, III 148–9 mergers and acquisitions see M&A (mergers and acquisitions) Meriwether, John 130 Merrill Lynch 20, 30, 32, 36, 37, 39, 61, 207 cost control 136 and Enron 82–3 narcissism 198 and Parmalat 84 proprietary trading 117 risk management 112 Milken, Michael 10 monopoly 102 Morgan Stanley 25, 30, 34, 35–6, 37, 38–9, 113, 206–7 conflict of interest 22, 24, 144, 191, 205–6 cross-subsidization 147–8 integration 22 narcissism 198 and Parmalat 84 political contributions 181 proprietary trading 116, 118 return on equity (ROE) 54, 61 risk management 112 Mozer, Paul 41 Muhlemann, Lukas 137 Murray, Judge Brenda 210 Myners, Paul 209 N M Rothschild 31–2 narcissism, organizational 198 NASDAQ index 12, 13 National Association of Securities Dealers (NASD) 185, 188, 201 National City Bank 6–7 Neuer Markt 73–4 New York Stock Exchange 187–8, 201, 205 Office of Federal Home Loan Oversight 80 Office of Risk Assessment 205 O’Kelly, Gene 200–201 oligopoly 102 O’Neal, Stanley 23, 61, 135–6 Ong, Belita 11–12 options, definition of 77 output of investment banks, evaluation of 63–5, 85, 100 over-the-counter derivatives 77–8, 81, 89 Paine Webber 45 Parmalat 84, 161 Partnoy, Frank 41, 181–2, 209 Paulson, Henry 197, 206 Pecora, Judge Ferdinand 85 Perella, Joseph 43 perfect competition 102 Pitt, Harvey 187 Plender, John 208 PNC Financial 81–2 political connections 181–4, 209 prices 86–7, 97–8, 100–101, 172 advisory work 90–91, 94–5, 96–7 basis point pricing 91–3 collusion 93–8, 100–103 derivatives 88–9 and fund managers 192 negotiation, lack of 176–8, 179 under oligopoly 102 pre-announcement movements, shares 122 share trading 87–8, 89 strategic pricing 94–5, 98 underwriting 89–90, 92, 94–6 prime brokerage 133 private equity 132 privatization, UK 181 product development 131–4 product range 33 profits 51–2, 61–2 and compensation 60, 99–100 diverting attention from 95 falling, implications of 209–10 identification of 192–3 outlook for 209–10 return on equity (ROE) 54–7, 58 source of 166–7 programme trades 87, 88 proprietary trading 114–19, 192, 206, 211–12 prospect theory 180 Prudential-Bache Securities 11 Prudential plc 82 Public Company Accounting Oversight Board 200 Purcell, Philip 14, 22, 23–4, 39, 138, 205–6 Quattrone, Frank 19–20, 137–8, 151 Qwest 82 Racketeer-Influenced Corrupt Organizations law (RICO) 10, 26 recession, post-2001 13–14 Reed, John 189 regulation 7–8, 20, 81, 183, 185–90, 199 and bundling 193 integrated structure, failure to reform 22, 23, 24 and lobbying 209 recent 19, 200–203, 205, 209–10 regulatory arbitrage 185 relationship banking, demise of 35–6, 152–3, 170 research 66–7, 68, 69, 140–41, 145, 146 independent 69, 201–2, 204 internal position of 196 see also analysts Restoring Trust: Investment in the Twenty-First Century 194 returns 49–51, 61–2, 99–100, 165–6 and analysts’ recommendations 67 compensation 58–60, 99–100, 165–6 and cost of equity capital 57–8 excess, source of 166–7 falling, implications of 209–10 margins 52–3, 88–9, 119 outlook for 209–10 profits 51–2 return on equity (ROE) 54–7, 58, 61 risk management 111–13, 125–31 risk premium 55, 56 Ritter, Professor Jay 71, 89–90, 94–5, 179 Rogers, John 68 Roosevelt, President Franklin D Roye, Paul 191 Rubin, Robert 42, 182–3 salaries see compensation Salomon Brothers 11, 34, 37, 41–2, 137, 148–9 cynicism, culture of 152, 153 losses, 1994 128 and WorldCom 121 Salomon Smith Barney 17, 41, 150–51, 195 Sanford Bernstein 32 Sants, Hector 170–71, 189 Sarbanes-Oxley Act (2002) 19, 200–201, 209 Sassoon, James 184 Saunders, Ernest 11 scandals see corruption/malpractice Schapiro, Mary 188 Schroders 42 Securities and Exchange Commission (SEC) 7, 19, 21, 23, 185–7, 205 Securities Industry Association 183 securitization 78 securitized bonds 46 settlements paid by investment banks 19, 20, 23, 24, 38, 39, 42, 43, 201, 207 share prices, pre-announcement movements 122 shareholder activism 203–4 shareholder value 8–9, 63, 169 shareholders, and corporate control 163–4, 203–4 Sherman Anti-Trust Act (1890) 5–6, Smith, Adam 86, 171–2 Smith, David 171 Smith, Professor Roy 195 Smith Barney 40, 41 Southern Peru Copper Corp 91 special purpose entities/vehicles (SPEs/SPVs) 78, 82, 83 ‘specialists’ 115–16 ‘spinning’ 17–18, 43, 137, 160 Spitzer, Eliot 15, 65–6 inquiry headed by 15, 16–17, 21, 22, 24, 38, 200 whispering campaign against 23 status of investment banking 4–5, 12, 18 Stevenson, Lord 175 Stiglitz, Joseph 12, 64, 176, 182–3 stock exchanges, structural reform 212 stock markets bull market mentality 3–5, 12–13, 64, 65, 71–3 performance of 63–4 public interest in 12 stock options 176 new accounting rules 201, 209 Stonehill, Charles 147–8 structural reform 211–15 Sudarsanam, Professor Sudi 76 Summers, Lawrence 63 swaps 77, 132 Sykes, Sir Richard 210 taxation, 401K amendment team ethos 124–5 Thain, John 188, 209 Time Warner 13, 14, 76–7 Tomlinson, Lindsay 194 transaction banking 152–3, 170 transaction costs 67 Travelers 41 treasurers (company), and derivatives 80 Treasury bond scandal 41–2 ‘Triple Play’ 121 Truman, President Harry S trustees, mutual/pension funds 191–2 UBS 31, 32, 37 underwriting fees 89–90, 92, 94–6 value-at-risk (VAR) 117, 129–31 volatility of markets, and performance of investment banks 24–5, 51–2, 57–8 Wall Street Wall Street Crash 6–7 Walter, Professor Ingo 195 Wasserman, Ed 18 Wasserstein, Bruce 31, 43, 77 Weill, Sanford 195 Welch, Jack 45 Wertheim 147 Wheat, Allen 59, 137 WorldCom 17, 121, 150–51, 161 Zumwinkel, Klaus 178–9 ... through his website, www.philipaugar.com PHILIP AUGAR The Greed Merchants How the Investment Banks Played the Free Market Game PENGUIN BOOKS PENGUIN BOOKS Published by the Penguin Group Penguin Books... time in the financial news or at the large investment banks The bull market mentality prevailed and no one wanted to hear otherwise.1 The rosy economic scenario was not the only reason for the confidence,... his attention to the investment banks If the SEC – the federal agency in charge of regulating the investment banks – and the industry’s self regulatory organizations, especially the New York Stock