Tearing Their Heirs Out

Why Merrill Lynch has the urge to purge.

The recent management purge at giant investment bank Merrill Lynch is the sort of ruthless consolidation of power more commonly seen in end-stage dictatorships than in the once-cuddly firm that brought Wall Street to Main Street.

Chief Executive Officer Stanley O’Neal swung into action after learning that his erstwhile ally, Executive Vice Chairman Thomas Patrick, had been lobbying the board of directors to promote another erstwshile O’Neal ally, Arshad Zakaria, the 41-year-old head of Merrill’s investment banking unit, to president—and hence O’Neal’s heir apparent.

The reaction was swift and decisive. Patrick was asked to retire, and Zakaria voluntarily retired on Aug. 6. The skullduggery illustrates a strange dynamic that separates Wall Street from other industries. At General Electric, Jack Welch was the unchallenged ruler until the day he stepped out of office—even though he had designated an heir apparent months before. But as soon as a Wall Street all-star has one foot out the door, his longtime colleagues will hasten to slam it. And once designated, a Wall Street heir apparent becomes the most powerful person in the firm—something Stanley O’Neal knows from experience.

At first blush, it seems strange that there was even talk about naming an heir to the 51-year-old O’Neal, who had just become CEO in December 2002. But because of the peculiarities of the business, Wall Street CEOs face immense pressure to promptly identify their successors and give assurances to sensitive bankers.

Why? Because on Wall Street, the chief assets are not plants and machinery, they’re people. Compensation gobbles up about half the revenues at most big Wall Street firms. (The U.S. unit of investment bank Credit Suisse First Boston last year spent $3.04 billion of its $5.7 billion in net revenues on employee compensation and benefits.) But every night, these companies’ crown jewels leave the building. And they don’t have to come back. Your basic fortysomething division head at an industrial company doesn’t have anywhere near enough cash to retire. But most Wall Street executives with similar tenures do. Indeed, the milestone for most investment bankers and traders isn’t making their first $1 million (or their first $10 million), it’s amassing enough lucre to retire—start an art gallery, go into politics, raise horses—while still maintaining your fabulous lifestyle.

Indeed, as is the case with professional sports, Wall Street is one of the few arenas in which paid professionals can earn more than the chief executives. At many firms, bonuses are calculated based on the performance of your desk, or your unit. And so it is not uncommon for an obscure derivatives trader to earn as much as the more well-known CEO. Rise to a certain level, and you can strike your own deal. That’s how Michael Milken reportedly earned a $750 million bonus in 1987—far more than Drexel’s managing partner did. In the 1990s, Frank Quattrone, the Silicon Valley technology banker for Credit Suisse First Boston, reportedly earned $100 million a year—far more than his bosses in New York or in Switzerland.

And unlike Prince Charles, ambitious Wall Streeters won’t wait around for decades for a prospective coronation. In the mid-1990s, Jamie Dimon had been dubbed the heir apparent to Citigroup CEO Sandy Weill; by everyone, that is, except Weill. So in 1998, fortysomething Dimon retired. In March 2000, he unretired to head Chicago-based Bank One. And in the three years since, he has poached several high-ranking Citigroup executives.

In most other industries, executives can’t leave and then immediately start competing against you. The head of Federated Department Stores’ Macy’s chain can’t afford to buy a new department store chain. But on Wall Street, the barriers to entry are sufficiently low that today’s prized employee can become tomorrow’s feared competitor. A star trader can easily raise money and start his own hedge fund. Disgruntled investment bankers can set up boutique investment banking operations in a matter of days—all they need is an office and a Rolodex. In 1988, Bruce Wasserstein and Joseph Perella left First Boston and formed their own boutique firm, Wasserstein Perella, which evolved into a full-service investment bank in the 1990s. Most notably, Henry Kravis and George Roberts—two disgruntled associates at Bear, Stearns— in the 1970s joined with one of their bosses to start perhaps the most envied private equity firm, Kohlberg, Kravis & Roberts.

Add it all up, and high-ranking Wall Street executives can exercise a great deal of leverage over CEOs. So for many Wall Street bosses, the job becomes one of retention.

Designating an heir apparent a few years before you’re ready to leave would seem to solve the problem. Those who lose out in the derby—and their allies—would then either leave or reconcile themselves to the new reality. The rest would rally around the heir. That’s precisely what former Merrill CEO David Komansky thought would happen. But in his case, it backfired.

In 2001, Komansky, who planned to retire in 2004, when he would turn 65, held a sort of bake-off to choose a new president and chief operating officer (and hence heir apparent). The board unanimously ratified his choice of Stanley O’Neal in July 2001.

O’Neal set to work, overseeing a restructuring and wholesale change in top management, and forcefully directing the company’s response to Sept. 11. Within months, a newcadre of top managers had been created. But Komansky—who wasn’t part of it—was quickly marginalized.By late last year, as Merrill was grappling with the fallout of the research scandals, Komansky stepped down early and O’Neal was named CEO in December 2002.

Less then seven months into his tenure, O’Neal found himself subject to the same sort of machinations that pushed his predecessor Komansky into early retirement. Wall Street is indeed a cyclical business.