(This post appeared at Credit Writedowns.)
We are now hearing former Merrill Lynch CEO Stan O’Neal’s side of the story for the first time since he resigned in October 2007. In a story by William Cohan in Fortune Magazine, O’Neal paints a picture of Merrill’s fall from grace that at once reveals O’Neal’s own deficits and foresight but that also reveals a lot about bank of America CEO Ken Lewis and Merrill Lynch’s Board of Director’s.
O’Neal approached Ken Lewis, then the CEO of Bank of America, about selling Merrill to BofA for $100 billion, according to O’Neal, in an account corroborated by other Merrill Lynch executives. Apparently O’Neal was concerned about the health of Merrill and wanted to seek a partner with a balance sheet which could weather the meltdown in subprime-related assets. He considered both Barclays and Bank of America as the two obvious bidder, eventually approaching Bank of America with an offer for sale.
Twice in 2007 O’Neal tried to negotiate deals to sell Merrill at premium prices, only to encounter crushing opposition from an unlikely source: Alberto Cribiore (pronounced Crihbe-OR-ee), a friend whom O’Neal had appointed to Merrill’s board four years earlier. Given his extensive Wall Street experience, Cribiore, a former partner at private equity firm Clayton Dubilier & Rice, wielded outsize power. He argued vociferously that O’Neal was too negative and that Merrill could address its CDO problem without having to sell the firm at a moment of weakness.
This pitched battle between the CEO and the board member, largely unexplored until now, shows how a single person was able to thwart what may have been Merrill’s salvation. And it suggests that O’Neal’s failure consisted as much of his inability to persuade his board to take necessary action as it did in his earlier cluelessness about the risks posed by the mountains of CDOs, those bundles of debt securities, many of them tied to subprime mortgages.
Whatever you think, one conclusion is inescapable: This conflict cost Merrill shareholders dearly. In the aborted 2007 negotiation, O’Neal seemed close to a deal with Bank of America to sell for about $100 billion. When Merrill was finally unloaded a year later to the same buyer, it went for half that amount. In all, the failure to sell in 2007 would cost Merrill shareholders some $50 billion.
This story is significant for a number of reasons.
First, I wrote about Ken Lewis and BofA’s board’s apparent recklessness in More reason BofA is crazy to take on Countrywide in June 2008 and in The horrible self-dealing of Ken Lewis and the principal-agent problem in April 2009. The negotiations with Stan O’Neal in 2007 confirm for me that Lewis was addicted to growth by acquisition in a way that was almost fatal for his organisation. Had he consummated a merger with Merrill Lynch in 2007 for $90 a share, the outcome would have been that much more catastrophic for BofA shareholders, both in terms of losses they never had to bear and in terms of the value of their shares.
Second, it reveals O’Neal’s lack of understanding of the complexity of the organisation he was running and the magnitude of the risks Merrill had been taking. O’Neal confesses that this dawned on him in his final days as CEO. He says:
One is the complexity of it was far beyond what I would have imagined. Second, the number of people who actually understood the aggregated view of this — not just in terms of size and scale but the potential complications associated with it — were few and far between.
While O’Neal should be commended for making a mighty about-face and looking to merge Merrill with a deep-pocketed rival, this revelation demonstrates that firms like Merrill are almost too large to run safely without extremely tight operating controls.
We have already heard similar accounts from Chuck Prince at Citigroup in his testimony before Congress and we know the same was true at Lehman given their bankruptcy. In my view, this is a pointed example of why large firms like Merrill Lynch must be broken up if regulatory reform is going to succeed.
Third, O’Neal’s account changes one’s view of Merrill’s Board of Directors, especially of board member Alberto Cribiore. In September 2008, they were successful in saving Merrill through deft negotiation. However, O’Neal had already planted the seed the year before. So the Board’s execution looks a lot less deft in light of this new information. Moreover, even more damning is the fact that O’Neal warned the Board a second time to sell Merrill after Bear Stearns collapsed despite his being a now-retired ex-CEO private citizen.
In March 2008, when rumours were swirling about the viability of Bear Stearns, O’Neal — then a private citizen with no formal ties to Merrill — sent Cribiore and other directors an e-mail to the effect that what seemed to be unfolding at Bear Stearns was exactly what he had been worried might happen to Merrill. “It’s not hard to conceive that the sequence after this is Lehman and then either Merrill or Morgan Stanley, more likely Merrill, and once it starts the progression is easy to see unfold,” he says he wrote. “You ought to think about doing something.” Cribiore thanked O’Neal and forwarded his e-mail to John Thain, who succeeded O’Neal as Merrill’s CEO in December 2007. (Cribiore favoured Thain over Larry Fink, the CEO of investment management giant BlackRock, in part because Thain had little interest in selling the firm and agreed with Cribiore that write-offs could be taken.) Thain invited O’Neal to visit and further share his views, but O’Neal declined, saying he had said all he could in his e-mail.
O’Neal sent another e-mail in early September 2008, shortly before Cribiore left Merrill’s board and Lehman Brothers imploded. Again, O’Neal says he warned that Merrill would be next. Cribiore responded that he had again passed the message on to Thain and added, “He’s in the market fighting dragons every day.” O’Neal remembers thinking, “That sounds slightly too heroic.”
Finally, after the announcement of the sale to Bank of America for stock worth $29 per Merrill share, O’Neal sent Cribiore one last e-mail: “My former friend, you should have helped me sell this business when we had the chance.”
O’Neal says Cribiore never responded.
Fourth, the denial at Merrill is mirrored by the denial chronicled in accounts of Bear Stearns and of Lehman. We shouldn’t assume that these firms were alone in their refusal to accept their firms’ vulnerability until it was too late. We can assume the same was true at all the too-big-to-fail firms in the US, the UK and elsewhere. Moreover, those firms which successfully dodged a bullet are now making the vast majority of their money in trading instead of lending. They may now feel even more immune to the risks inherent in their business model.
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