Can John Mack Be a Wall Street Reformer?

His objective: Turn CSFB into an `ethical' investment bank

The day started out painfully enough. John J. Mack, CEO of investment bank Credit Suisse First Boston (CSR ), had just learned of reports that regulators in Massachusetts had uncovered damning e-mails showing that the firm's bankers may have pressured analysts to give positive stock recommendations on investment-banking clients. On top of that, Mack had to get a cracked filling replaced. "You've caught me in a stressed position," he told BusinessWeek a few hours later on Sept. 6. "But that's O.K."

Stress is a way of life for Mack. With every passing week, federal and state regulators and Congress are turning up the heat on CSFB. When he was brought in a year ago to clean up one of Wall Street's most troubled institutions, federal authorities were cracking down on CSFB for allegedly overcharging favored investors in exchange for shares of hot initial public offerings. Mack settled that case for $100 million--and surprised many by avoiding criminal prosecution of the firm. But now legislators and regulators are back, probing to see if CSFB analysts misled investors to win investment-banking deals or if its bankers used IPO shares to curry favor with clients.

The former Morgan Stanley president isn't fighting the inquiries. Instead, Mack is launching his own assault on dubious Wall Street practices. In the 1990s, investment banks like CSFB became dominated by egomaniacal personalities who competed fiercely for deals, he argues, often at the expense of their own clients and investors. "This firm had a history of tolerating cowboys," he says. "I don't like cowboys."

Mack wants to return to a bygone era when client relationships mattered more than the pursuit of ever higher fees. To do that, he's dismantling CSFB's star system, forcing executives to adhere to strict codes of conduct, and overhauling how the company does everything--from issuing initial public offerings to trading and lending--to ensure that clients' interests come first.

In Mack's view, only those investment banks deemed trustworthy will survive the current turmoil. It's not that he thinks Wall Street's business model is fundamentally flawed. But he thinks many of today's one-stop financial giants, designed to offer an unprecedented range of services, have been very poorly managed, giving rise to endless conflicts of interest.

The breadth of advice is not nearly as important as execution, Mack argues. "The well-managed firms will survive," he says. That means shifting emphasis away from making money at all costs. And clients approve. "What's changed is that you have someone there who is saying the client counts," says Henry R. Kravis, a founder of private equity firm Kohlberg Kravis Roberts & Co. "It's just like night and day."

Indeed, for CSFB, the change is radical. For most of its history, CSFB--a subsidiary of the Zurich-based Credit Suisse Group--was arguably the Street's most freewheeling bank. When Mack took over in July, 2001, the money-losing firm was a symbol of the IPO con game. Its top tech banker, Frank Quattrone, was running his own West Coast fiefdom, overseeing corporate finance and research. CSFB bankers' lavish spending, combined with their astronomical pay packages, had gotten so out of control that the firm was facing a $1 billion loss. And when it came to execution, CSFB, known for its merger expertise, had bungled its own $12 billion purchase of rival Donaldson, Lufkin & Jenrette in 2000. Now, fewer than half of DLJ's 2,000 bankers remain. "CSFB tries to destroy itself every couple of years," says one rival banker.

Yet this distress actually played into Mack's efforts to dismantle CSFB's star system. His first target: Wall Street's penchant for overspending. To bring CSFB back from the brink, he got many of his high-priced bankers, who were pampered like movie stars, to give up 25% of their salaries. (He threw in 25% of his, too.) He also laid off some 3,000 bankers, 19% of the total, and took away even the most basic perks, including the ability to dial the phone company for information (which saved $800,000). In all, "Mack the Knife," as he's known on Wall Street, managed to slash almost $2 billion in costs and enabled the firm to post a modest $61 million net profit on $3.5 billion in revenues in the second quarter.

At the same time, Mack began to tackle his second, more difficult, goal: Making CSFB an "ethical" investment bank. He hired a cadre of compliance officers, including former Securities & Exchange Commission enforcement chief Gary G. Lynch, who oversaw investigations of junk-bond impresario Michael R. Milken and arbitrageur Ivan F. Boesky for insider trading in the 1980s, to scrutinize his bankers' deals. Those who fail to collaborate or to give clients good advice will be shown the door. He is also holding a marathon of meetings to personally tell his 25,000 employees that he wants them to "do the right thing."

But Mack will only go so far. To the surprise of many, Mack refused to sack Quattrone, a symbol of 1990s excess, arguing that the former highflier has bought into the new order. Once Quattrone agreed to Mack's terms to break up his fiefdom and accept pay cuts, then others hopped on board. "I think Frank in his heart of hearts believes in what I'm trying to do," says Mack, who had ordered an internal investigation that cleared Quattrone of any wrongdoing.

Mack is also reluctant to separate research from investment banking, though he's the only Wall Street CEO who says he will seriously consider it--if that's what it takes to restore confidence. When word got out at CSFB that Mack was willing to spin off research, analysts shuddered. "If he could replace us with a computer, he would," quips one. But Mack refuses to go it alone on this issue, continuing to send analysts on road shows and pitches.

While he says he doesn't want to use lending to woo new clients, he sees no harm in extending loans to improve relationships with existing clients. This leads some detractors to conclude that, despite Mack's best efforts, it may not be possible to have a scrupulous investment bank in an industry where conflicts of interest are a way of life.

Mack has his work cut out for him--and the stakes couldn't be higher. If he succeeds in making CSFB into a model investment bank, he may force rivals to follow suit, helping to clean up the mess on Wall Street. Clients such as KKR, General Motors, and General Electric are already throwing more business CSFB's way. Competitors are also taking notice. "We feel his presence," says Goldman, Sachs Group Inc. CEO Henry M. "Hank" Paulson Jr. "His leadership has made a big difference internally and externally, particularly with clients."

But as the firm's troubles mount, Mack faces stiff odds. For starters, if he can't turn the company around, the parent Credit Suisse Group might well hang out a for-sale sign. Indeed, the group faces deep financial woes of its own, posting a net loss of $348 million last quarter. Although Mack says a sale is unlikely, he's also aware of the possibility if he doesn't succeed in his mission: "The consequences of failure are that either this business gets very, very small or it's sold to someone."

Then there's the issue of morale. With Credit Suisse Group's stock down 52.5% since January, some of his best bankers who agreed to be paid with equity may bolt when their contracts are up at the end of the year. Others simply detest Mack's new mandates but right now have nowhere else to go.

It also doesn't help that parent CSG increasingly looks like a takeover target. "Many of us in the bank were worried that there could be a hostile takeover move for the group as a whole," says a former CSG senior executive. "I think that is still possible."

Mack is undaunted. He has dreamed for three decades of running his own investment bank. As the youngest of six sons of a Lebanese-American wholesale grocer in Mooresville, N.C., Mack, 57, has little tolerance for big shots. He attended Duke University on a football scholarship, then started working in a small brokerage in North Carolina, which led to a job as a bond salesman for Smith Barney. At the time, Duke classmate Charlie Rose, the TV host, introduced Mack to Rose's first wife at a party. Mack was impressed. "Do you have a sister?" he asked her. Four years later, when the sister, Christy, came to New York, they met--and married soon after.

Mack also caught the attention of Morgan Stanley, which recruited him to sell bonds. He worked his way up through the ranks. As head of fixed income at Morgan Stanley, he built a powerful empire so heavily guarded that people had to get permission slips just to go on the trading floor. A former master of the universe himself, Mack understood firsthand the drawbacks of the star system. In 1992, he became chief operating officer and metamorphosed into a tough cost-cutter. A year later, Mack took over as president and championed a "one-firm firm" where teamwork was in. But he still had at least one star analyst: Internet guru Mary Meeker.

His grip weakened in 1997 after he engineered a merger with Dean Witter. He left three years later after losing a bruising battle for control with CEO Philip J. Purcell. That's when Lukas Muhlemann, chairman and CEO of Credit Suisse Group, offered Mack the top job at CSFB, hoping to reverse its downward slide.

Observers both inside and outside of CSFB often wonder why Mack took on these headaches. "It's such a snake pit," says one rival banker. He certainly didn't need the work: He left Morgan Stanley with $544 million worth of the firm's stock and exercisable options. If anything, the challenges seem to have emboldened Mack. "This is his baby," says friend, Duke basketball coach Mike Krzyzewski. "He's energized."

One reason Mack has been able to make such sweeping changes is because he has brought in new blood. His chairman, Stephen R. Volk, was an outside lawyer who advised Mack on the Dean Witter merger. He also brought in several Morgan Stanley administrative managers, including Thomas R. Nides as chief administrative officer and Eileen K. Murray to head information technology. But it's not completely a Morgan Stanley takeover: Mack also brought back former CSFB merger expert Brian D. Finn to advise him on strategy, and he hired Merrill Lynch & Co.'s former head of asset management, Jeffrey M. Peek.

When he arrived at CSFB, Mack found an investment bank living on borrowed time. Employees at the money-losing firm were spending wildly. Bankers were budgeting events at $200,000 a pop to entertain clients. Now, Mack must personally approve any event costing more than $50,000. The firm was paying $10 million annually to help subsidize leases on Mercedes-Benzes and BMWs for 500 managing directors as part of its merger agreement with DLJ. "I had never seen spending like this in my life," says Mack. The firm also boasted an antique American art and furniture collection, valued in the millions, along with a three-person curator team. They were dismissed within six months.

Strategically, the firm was in a tough spot. With only a $436 billion balance sheet, it couldn't afford to throw money at clients as could Citigroup, with its $1 trillion in assets. It also lacked the coordinated brain trust of Goldman Sachs or Morgan Stanley. Many of CSFB's superstars were so wrapped up in their own worlds that they had never met each other.

To force bankers to work together, Mack quickly established radical new rules. "If you miss a big deal, and you involved everyone who could have helped you, that's O.K.," says Adebayo O. Ogunlesi, head of investment banking. "But if you win a deal, and you didn't bring in people, you're in trouble. It's worse than if you lose a deal."

Bankers who had compulsively pushed deals and even switched sides on transactions to collect a higher fee were urged to reconsider. The reason: Mack would rather lose a deal than a client's trust. Since Mack took over, CSFB has withdrawn from 47 mergers and canceled or postponed 11 equity and debt-underwriting deals--more than any other firm. "I want people to feel they're doing their job when they tell a client, `Don't do this,"' says Mack.

Case in point: Just weeks on the job, a banker asked Mack to tell GM Chief Financial Officer John M. Devine that CSFB would not help GM sell a chunk of Hughes Electronics Corp. A buyer offered to pay a higher fee than GM, and the banker wanted to switch sides. Mack disagreed. He told Devine CSFB would stick by GM. "If you don't trust your adviser, you have the wrong one," says Devine. "We respected John's decision."

Mack is also pulling the plug on ventures that could blur ethical lines. In July, CSFB spun off a private equity fund designed to invest in distressed companies even though it raised $2.2 billion. Mack felt the risk of potential conflicts was too high. That's because the fund's managers would be prevented from investing in the assets of CSFB's investment banking clients in financial distress. Investors might then be penalized from getting the best deals. "I don't want to be negotiating against my clients," Mack says.

That's where compliance comes into the picture. Codes of conduct were a low priority when Mack took charge. Mack quickly hired lawyers and former SEC officials, and put them in high-profile positions reporting directly to him. "My predecessor was two levels down from the chief financial officer, and I think that said something," says legal counsel Lynch, the former SEC enforcement director.

Now, compliance officers have a say in everything, from stopping deals to determining who gets IPO shares. As part of its January settlement with regulators, CSFB formed an IPO allocation committee made up of managing directors from the equity department and a compliance representative to make sure shares are handed out fairly. Salespeople must assure the group that clients, for example, will be long-term holders of a company's shares.

But by keeping Quattrone on the payroll, Mack could be asking for trouble. Mack asked Lynch to help him decide how he should handle Quattrone. After an internal inquiry, Lynch advised Mack that, despite appearances, Quattrone had done nothing wrong. So far, regulators have disciplined other CSFB executives. Still, many don't buy it. "It's as if [Enron Corp. finance executive] Michael Kopper got fired and [Enron CFO] Andrew S. Fastow remained in charge of finance," says Jay Ritter, professor of finance at the University of Florida. And once again, Quattrone is attracting attention from legislators and regulators on multiple fronts. They're investigating whether research analysts, who once reported directly to Quattrone, sweetened reports to gain favor with investment banking clients.

No one expected Mack to keep Quattrone around. Their relations have been notoriously strained: In 1996, Quattrone bolted Morgan Stanley with his platoon of bankers for Deutsche Bank, leaving Mack in the lurch in the middle of the tech boom. The clash had a familiar ring: Quattrone wanted to build an empire at Morgan Stanley; Mack wouldn't have it.

It may turn out to be Quattrone's biggest sales pitch yet, but Mack says he and Quattrone are now on the same philosophical page. Indeed, Mack made Quattrone an example to other CSFB highfliers of how the era of oversize bonuses has ended. He got Quattrone to rip up a contract that gave him a third of the revenues collected from every deal he landed--an agreement that made Quattrone a cool $100 million at the peak of the tech boom in 1999. Now, he is paid mostly in equity, just as Mack is. That's fine with Quattrone--especially now that the tech banking business has dried up.

Mack also redefined Quattrone's job. Although Quattrone remains head of technology banking, Mack put him on the firm's executive board. Quattrone devotes roughly 20% of his time to advising the rest of the firm. To hear Quattrone tell it, his relationship with Mack is clicking. "When we came in here and started talking about building the No. 1 firm on the planet four years ago, people looked at us like we were crazy," he says. "When John arrived, people began to embrace that idea and have set about to accomplish that goal. That's what is driving us right now."

Mack has a massive job ahead. He predicts it will take up to 18 months for the economy to rebound, and even then the industry's head count may reach only 1998 levels. He also says he has completed just one lap of what he believes will be a three-year job to transform CSFB.

There is no doubt that the firm is better off now than it was a year ago. The big test is whether he can persuade employees to "do the right thing" in the future. If he does, his cleanup efforts will be a lesson for an ailing industry. And if he can't, Washington will be happy to step in.

By Emily Thornton

With Anthony Bianco and Julia Lichtblau in New York and David Fairlamb in Frankfurt

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