Only a few years ago, municipal bonds were one of Lazard Freres & Co.'s most prominent businesses. Now munis have been relegated to insignificance. Thus it was no surprise when the prestigious Wall Street firm told employees on Oct. 31 that it would decide by Dec. 1 whether to remain in the muni business. Many insiders believe that it will close the department.
Declining muni issuance and shrinking underwriting spreads were factors. But a major reason was an ambitious and controversial bet--uncharacteristic of staid, cautious Lazard--to build its muni business largely by hiring political clout. The strategy, begun in the late 1980s, was to put on the payroll well-connected rainmakers who could use their influence on municipalities to help win muni business. Lazard moved aggressively into underwriting muni deals, a departure from its traditional and less lucrative role as a disinterested adviser.
OUT OF CONTROL. That strategy ran into serious trouble. Much of the public attention has focused on Mark S. Ferber, a politically savvy former Lazard partner. He could face a 390-year jail term, if convicted, following an Oct. 26 indictment by a federal grand jury alleging 63 counts of fraud, accepting gratuities, and attempted extortion. Most of the charges are related to an unusual consulting contract Lazard signed with Merrill Lynch. Ferber, who set up the deal, was hired by officials to offer impartial financial advice and recommend underwriters. But Merrill paid Lazard more than $1 million a year to steer muni-swap business to Merrill, a potential conflict of interest. The indictment charges that Ferber failed to adequately disclose to clients the terms of his contract with Merrill. Lazard and Merrill settled related civil charges by agreeing to pay $12 million each, the largest ever in the muni industry, for failing to ensure adequate disclosures were made.
The indictment against Ferber describes an executive out of control, repeatedly exploiting his position for personal gain. For instance, in 1992, Ferber met a senior Merrill executive at the Harvard Club in New York and threatened to "hurt" Merrill if it did not renew its $1 million-a-year contract with him, the indictment says.
Thomas E. Dwyer Jr., Ferber's attorney, says: "Anyone who thinks Mr. Ferber will accept the nomination as the muni industry scapegoat will be sadly disappointed."
The firms neither admit nor deny guilt. Lazard says it is "the ultimate victim" of a rogue employee. "We categorically reject any suggestion that simply by entering into the muni underwriting business, we should have foreseen that one of our bankers might engage in the sort of misconduct of which Mr. Ferber is accused." The settlement agreement says Ferber "actively misled" Lazard in telling the firm that he had fully disclosed the contract to clients.
But Lazard's management bears broader responsibility for failing to adequately supervise Ferber. The settlement agreement points out that Lazard partners were well aware of the contract and knew that it "created at least a potential conflict of interest for Lazard." This being the case, it says, "Lazard did not take adequate steps to ensure that Mark Ferber met his obligations to disclose the true nature and extent of the contract."
Management also bears responsibility for creating a culture that stressed political back-scratching to win business. "They calculated that they didn't need anything but political clout and quality advice to get underwriting business, and that strategy would blow up in their face," says one former employee.
The main architect of the firm's muni political strategy was Michael J. Del Giudice, head of Lazard's muni department and Ferber's boss during the firm's expansionary period. Former Lazard employees say Del Giudice was not hired for his banking skills, but for his political connections. He had been chief of staff to former New York Governor Mario M. Cuomo and was described as "second only to the Governor in power and importance in the administration" by The New York Times.
Del Giudice was one of the biggest fundraisers for Democratic Presidential nominee Michael S. Dukakis in 1988 and a trustee of the Democratic National Committee, which means he gave a minimum $100,000. Among his many Democratic friends are Ronald H. Brown, the Commerce Secretary and former DNC chairman; and Arthur Levitt Jr., the Securities & Exchange Commission chairman. Del Giudice had little banking experience and wasn't even fully registered with the National Association of Securities Dealers to supervise muni employees until April, 1994, according to NASD records, though he ran the department from 1988 to 1993. John R. Wing, Del Giudice's lawyer, says that Lazard requested a waiver from the New York Stock Exchange for the required exam but cannot locate a copy of the Exchange's response.
QUICK BUCK. It was Del Giudice who hired Ferber and oversaw Lazard's contract with Merrill. Dwyer, Ferber's attorney, says that the contract was approved by superiors at both Merrill and Lazard and that Ferber disclosed "the substance of the agreement" to his clients. Del Giudice seems to agree, saying Lazard didn't want Ferber to disclose the exact details of the contract unless a client asked for them. In testimony before the Washington city council in January, 1994, Del Giudice stated: "I talked [to Ferber] about disclosure. We did not say disclose the full contents of the document."
The SEC investigated whether Del Giudice should be cited for not supervising Ferber, but dropped the inquiry. According to NASD records Del Giudice was the subject of an SEC investigation for "alleged failure to disclose a consulting agreement to a financial advisory client" and "alleged failure to supervise." The SEC said the Oct. 26 settlement ended its investigation of the firms and their current personnel. "Everyone who looked into it concluded Mike did nothing wrong," says Wing. He adds that Del Giudice was hired for his knowledge of government and denies his client used political influence or contributions to get muni business.
The foundation of Lazard's muni reputation was laid by Felix G. Rohatyn. He played a key role in rescuing New York City from a financial crisis in the mid-1970s. Rohatyn remains an active Democrat but has had little or nothing to do with running the muni department.
At the time, Lazard functioned as a financial adviser, proferring advice to municipalities and helping them hire other Wall Street firms for underwritings. Rohatyn, who knew Del Giudice through Cuomo, referred Del Giudice to Lazard, which hired him in 1985. Unwilling to spend for a lot of additional staff, Del Giudice recruited big producers with political clout such as Ferber. Others were Grover L. McKean, ex-aide to former California Treasurer Jesse Unruh; Norman Steisel, the former New York City sanitation commissioner, who left in 1988 to join the administration of former Mayor David Dinkins; and Richard Poirier Jr., who built the firm's Southeastern business.
This strategy created controversy within the firm. Says one former Lazard muni employee: "I left because it became clear to me the firm would squander its reputation. I knew by virtue of the hires the emphasis was on the quick buck."
Under Del Giudice, staffers wrote checks for thousands of dollars to dozens of candidates, Federal Election Commission records show. Del Giudice headed Lazard's Political Action Committee, which disbanded in early 1993.
For a time, the strategy worked. Lazard went from 30th in muni underwriting in 1990 to 10th in 1992. It kept its position as No.3 in muni advisory work in 1990 and 1992. But soon the firm was plagued by a rash of probes, including many with no connection to Ferber, from New Jersey to Los Angeles County.
Today, the firm is trying to put the whole muni mess behind it. Already, it's on the sidelines. This year to date, Lazard fell to 54th in muni underwriting and to 28th in muni advisory work, according to Securities Data Corp. The situation has deeply embarrassed the firm's investment bankers, who enjoy a pristine reputation in the corporate world. "Other than this area, they were very scrupulous," says someone with knowledge of the firm. "This is a major exception...like if you heard a bishop was going out with a prostitute." It will be a long time before Lazard attempts again to mix business and politics.
The Rise and Fall of Lazard's Muni Business
1975: Felix Rohatyn helps New York City end its fiscal crisis, which helps establish Lazard's reputation in muni market.
1985: Rohatyn hires top Mario Cuomo aide Michael Del Giudice.
1988: Del Giudice becomes head of muni department. He hires Mark Ferber and other former political aides to increase underwriting business.
1989: Ferber enters into contract with Merrill Lynch under which Merrill would split fees with Lazard when Lazard recommended clients to Merrill.
1990: Merrill contract ex- panded to include annual $800,000 retainer.
1992: Lazard's muni business hits peak.
1993: Lazard-Merrill contract becomes public; federal investigation launched. Del Giudice replaced as muni department head.
1994: Washington city council holds public hearings on Lazard-Merrill contract, where Del Giudice testifies. Merrill and Lazard agree to pay city $3.6 million to settle contract-disclosure dispute.
1995: Ferber indicted for fraud. Lazard and Merrill settle with regulators for $12 million each. Lazard underwriting ranking plummets. Lazard announces it might quit muni business.