Lehman Brothers: Free At Last

When Richard S. Fuld Jr. made his first major trip to Israel in April, he was inspired by the spirit of the people. Despite the hardships, there was a feeling of teamwork, recalls the chief executive of Lehman Brothers Inc. "It was a wonderful sense of, `We are all in it together.' That's the guts of our culture."

Just one year after Lehman Brothers was spun off by American Express Co., Fuld is mobilizing a lot of teamwork. His goal is to rebuild Lehman so that it will succeed as an independent firm. He has cut $182 million in costs so far this year, and axed 1,000 employees since early 1994. Fuld wins high marks from outsiders as a strong manager. Lehman shares have risen from 14 at the start of the year to its current 20. Fuld and his top lieutenants have been buying Lehman stock over the past few months, a vote of confidence in the firm's future.

Despite the progress, it is still far from clear whether Fuld will be able to pull it off. Lehman is still working to overcome its past, particularly its 10 years as a part of American Express and Shearson, AmEx's brokerage unit. Until a year ago, Lehman had been suffering from a series of reconfigurations and management changes, and lacked a focused strategy. Lehman does have a commanding position in the bond business, mainly trading bonds for customers. But it is still trying to develop the set of well-rounded, high-margin capabilities that are required for success in investment banking. One glaring example: While competitors aggressively expanded globally during Wall Street's fat years in the early 1990s, Lehman concentrated on domestic markets and still lacks a major presence mverseas.

HIGH STAKES. Lehman has another liability: its in-between size. Without a major presence not only in foreign markets but in some domestic markets, the firm lacks the resources and overall heft of a Merrill Lynch, Morgan Stanley, or Goldman Sachs. Yet it is saddled with costs that make it far bigger than such niche players as Donaldson, Lufkin & Jenrette, which thrive by targeting a few smaller businesses. "Without a leading position abroad or the deep pockets of some of their competitors, it remains to be seen what their comparative advantage will be," says Samuel L. Hayes III, a professor of investment banking at Harvard business school.

Fuld says Lehman's size isn't a problem since it's "not trying to be all things to all people. We want to be the premier investment bank serving our clients globally. For the clients we're targeting, we want to be their top 1 or 2 banker."

The stakes are high. If Lehman can't overcome these drawbacks, it could be caught up in the wave of financial consolidation and ironically end up right back where it was a year ago: as a division of a larger financial institution.

The old Lehman Brothers of the 1970s was one of the proudest, most powerful firms on Wall Street. Its decline began in 1984, when Lehman was ripped apart by a bitter feud between its investment bankers and traders. The traders won, but Lehman was so weakened that it sold itself to American Express. As part of AmEx, Lehman underwent a dizzying number of name changes and management crises. Shearson and Lehman first tried to combine as one unit, called Shearson Lehman Brothers Inc., later Shearson Lehman Hutton Inc. Around 1990, Lehman and Shearson were split apart, reviving the Lehman Brothers name.

From 1990 to 1993, Fuld and J. Tomilson Hill, a high-profile mergers-and-acquisitions banker, shared the CEO's job of the Lehman Brothers division. But in 1993, AmEx sold Shearson to Travelers Inc. This left Lehman abruptly shorn of its prosperous asset-management division and its 9,000 Shearson retail brokers, which were a valuable distribution system for Lehman's underwriting deals. AmEx then axed Hill and left Lehman without a CEO for months before Fuld was promoted to CEO. Finally, in May, 1994, AmEx pumped $1.1 billion into Lehman and spun it off.

There's little doubt that Lehman now has a strong management team. Fuld, 49, and President T. Christopher Pettit, 50, both Lehman veterans, have been busy reshaping the firm. Fuld, a talented bond trader who earned his MBA from New York University at night, has quickly grown into the job of chief executive. A direct, no-nonsense leader, Fuld acts as Mr. Outside. Pettit, a West Point grad, is Mr. Inside, who runs the firm day to day. Both are strongly committed to Lehman: They receive 66% of their pay in stock. And they have remained in modest offices rather than newer, more sumptuous digs that are removed from the troops. "I like the people at the top. They are high quality," says Jack J. Byrne, a Lehman advisory director and shareholder.

Lehman has avoided the compensation disputes that have plagued other firms such as Salomon Brothers Inc. One reason is that only 6% of Lehman's revenues come from proprietary trading, according to Pettit. Paying a handful of proprietary traders a chunk of their huge profits is a recipe for infighting. To keep employees focused on teamwork and help Lehman win all of a customer's business, the firm has a "one firm, one profit and loss" approach. It has a single bonus pool and shuns special pay deals with star performers. "We just can't have people paid that way here," says Pettit. "The culture has to be a team."

But Lehman is still grappling with its basic strategy. It has an enviable franchise as the No.2 underwriter of all debt issued by U.S. companies in 1994, according to Securities Data Co. It is ranked No.2 in mortgage-backed securities. But these are lower-margin, commodity businesses that need to be supplemented by higher-margin areas, such as derivatives and foreign exchange. "They are late starters in so many of these high-margin areas, it puts them at a disadvantage," says Haig J. Nargesian, a senior analyst at Moody's Investors Service Inc., which just downgraded Lehman. Fuld disagrees. "Derivatives, foreign exchange, and high yield are a huge percentage of our business," he says, adding that 20% of 1994 revenues came from derivatives alone.

NEW SPIRIT. Lehman also has to revive its equity business, where it is No.5 in global equity, according to SDC. One key to getting equity assignments is good equity research. But Lehman's equity department is in shambles. In 1994, Lehman's ranking in Institutional Investor's poll plummeted to No.9, after being No.1 three years in a row in the early 1990s. One reason: Lehman's cost cuts, which reduced the number of analysts from 71 in 1993 to 58 today. Currently, Lehman has no analyst covering major pharmaceutical companies or the media. "I keep hearing we lost the business because we couldn't offer the research coverage," says one managing director.

Part of the problem in these units is the general feeling that they are unimportant because of the firm's strong bias toward bonds, say several Lehman managing directors. The firm is tightly run by two guys, Fuld and Pettit, who spent their careers in the bond business and who have promoted their loyal fixed-income inner circle to head equity and other departments. "Equity is a stepchild. Fixed-income rules the roost," says another Lehman managing director. Fuld says the firm has "a lot of work to do" in equities--and it is not biased. "We're looking for good, talented people," Fuld insists. "Backgrounds don't matter."

It's clear that a new Lehman is slowly taking shape. Many departments are hiring senior people, who are renovating from the ground up. For example, last July, Fuld hired a Morgan Stanley & Co. veteran, Robert Lunn, to rebuild Lehman's cadre of 350 brokers who cater to the very affluent. Lunn dismissed 100 top brokers last year and hired 30 top-notch brokers from CS First Boston and Salomon Brothers in recent months. The restaffing has resulted in a rise in average annual commissions per broker from $500,000 to $1 million. Similar efforts are under way in equities, merchant banking, high yield, and in Asia.

But perhaps the best achievement is the new spirit that pervades the firm, engendered by release from what most Lehmanites considered indentured servitude at AmEx. Lehman officials say privately they are strongly opposed to a sale. Yet Lehman will have to move fast to avoid a return to what it has tried hard for so long to escape.



Lehman must build up high-margin businesses such as derivatives, high-yield bonds, and emerging-market securities.


The ranking of Lehman's once-preeminent research unit has fallen from first place to ninth.

GLOBALIZE Lehman lacks a major presence in most foreign markets.


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