"Reengineering" at Merrill Lynch

O'Neal must reverse a huge earnings slide

When Merrill Lynch & Co.'s (MER ) board met on July 23 for the announced purpose of approving the company dividend, insiders suspected that something bigger was afoot. For a month, rumors had swirled inside the largest retail brokerage in the U.S. that Chairman and CEO David H. Komansky was under pressure from the board to name his successor before his yearend deadline in order to restore "clarity" to leadership, says a senior executive.

With the firm posting a 41% decline in second-quarter earnings, to $541 million, the directors were apparently unwilling to wait that long. Komansky insists that the board didn't pressure him, but the very next day, he named head of private client services E. Stanley O'Neal as president--abruptly shoving aside Jeffrey M. Peek, head of asset management and the other top contender.

O'Neal, 49, is in line to become the first African-American CEO of a major Wall Street brokerage. O'Neal has plenty of claim to the top slot. He has mastered every job he has had in his 15-year-career at Merrill--ranging from investment banking to, more recently, running the firm's core brokerage franchise. He also helped Komansky clean up the mess left in the wake of the 1998 Russian currency crisis. "[Stan] performed spectacularly in all of those assignments," Komansky said in an interview with BusinessWeek. "I feel very confident that he is capable of making the decisions that have to be made over the next five years in this industry."

Komansky, 62, credits O'Neal with managing a dramatic shakeup of Merrill's hidebound brokerage culture, which was under siege by upstart discount brokers such as Charles Schwab Corp. (SCH ) "What [O'Neal] has been doing is reengineering a business that has basically been following the same model for many years," says Komansky.

The axman, as O'Neal is called by some in the firm, announced that he would cut 2,000 of Merrill's thundering herd of 15,000 U.S. brokers months after taking charge of them in February, 2000. Initially, O'Neal set out to beat back the likes of Schwab by matching their cheap trading fees. But he quickly raised the bar by targeting the ultrarich clients of top-drawer firms such as Goldman, Sachs & Co. (GS ) and J.P. Morgan Chase (JPM ), forcing his brokers to concentrate on clients with $1 million or more. Meanwhile, he shuffled those with more modest assets to call centers. "Merrill should focus on doing more business with their best customers rather than being all things to all people. That's the discipline that O'Neal will bring to the firm," says Henry McVey, securities industry analyst at Morgan Stanley Dean Witter.

Insiders expect O'Neal to push through similar painful makeovers at Merrill's institutional and asset management businesses. Although O'Neal is mum on specifics, he clearly thinks Merrill needs to become more sophisticated and tailor its services more closely to its clients' needs--across both its retail and institutional businesses. "We're in the first stage of an evolution," O'Neal says.

MOTIVATOR? So far, the evidence that O'Neal has improved Merrill's retail services is mixed. It has pulled in fewer assets worldwide than Schwab for three out of the past four quarters. Still, O'Neal's cost-cutting boosted pretax margins in U.S. private client services by 2% year-over-year in the second quarter. By training brokers to offer more sophisticated advice to wealthier clients, O'Neal may have laid the foundation for faster growth. "O'Neal needs to strike the right balance between cost-cutting and growing revenues," says Amy S. Butte, securities industry analyst at Bear, Stearns & Co.

He needs to motivate his troops, too. Many expect Peek and other aspirants for the top job to walk out the door, and many of his brokers are reeling from O'Neal's drastic cost-cutting. Others are critical of his "clinical," "mechanical" management style. Yet O'Neal says a recent morale survey showed that employees in private client services are happier than they have been during past downturns and in other divisions. "I would love to be able to say one can implement change and have every single individual agree with everything that has been changed. But the reality is, the world is not structured that way," he says. "I am confident we're on the right track." That may be so, but O'Neal needs to makes sure that it is also the express lane.

By Emily Thornton in New York

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