Editor’s Note: Every week, Fortune.com publishes favorite stories from the Fortune magazine archives. This one was published in the December 8, 1986 issue — after Ivan Boesky’s fall but before Michael Milken’s indictment. It was the leveraged buyout heyday, when no one on Wall Street could be trusted. Today, with the hedge fund manager Raj Rajaratnam fighting insider trading charges in a Manhattan courtroom and one of Warren Buffett’s top executives, David Sokol, resigning under suspicions about his personal trades, the lessons from the 1980s still ring true. What makes seemingly smart businesspeople lose all sense of ethics in a fleeting moment? Myron Magnet speculates: “[W]hat pushes some insider traders over the line, beyond mere greed, is a more primitive wish to flirt with danger.”
By Myron Magnet
WHAT IS THIS — the business news or the crime report? Turn over one stone and out crawls Ivan Boesky’s tipster, investment banker Dennis Levine, dirt clinging to his $12.6-million insider-trading profits. Turn over another and there’s a wriggling tangle of the same slimy creatures, from minute grubs like the Yuppie Gang to plump granddads like jailed former Deputy Defense Secretary Paul Thayer. A shovel plunged into the ground above General Electric (GE) recently disclosed a bustling colony industriously faking time sheets to overcharge the government on defense contracts. Almost everywhere you look in the business world today, from the E.F. Hutton check-kiting scheme to the Bank of Boston money-laundering scandal, you glimpse something loathsome scuttling away out of the corner of your eye.
It’s not just illegality. As if trapped by a thermal inversion, the ethical atmosphere of business, some executives mutter, is growing acrid. Says private investor and Fordham business school dean Arthur Taylor: ”I can’t do transactions on the telephone any more because people do not keep their word.” Adds leveraged-buyout panjandrum Jerome Kohlberg of Kohlberg Kravis Roberts (KKR): ”Agreements have got to be in writing, and writing is itself subject to interpretation.” Laments Merle J. Bushkin, president of an investment banking boutique bearing his name: ”I used to think that I could tell good guys from bad guys, and wouldn’t deal with people I thought dishonest or unethical. But I’ve learned that I can’t tell the difference. They look alike.”
Not that Boy Scouts have always run American business: the Robber Barons didn’t earn that name through philanthropy. But some eras are faster and looser than others, and in this one — at least in matters concerning the vast restructuring of U.S. industry now under way — the business climate has become less ethical than it was in the relatively aboveboard period from the Depression’s end until the mid-Seventies.
No place have standards dropped more vertiginously than in the investment banking trade that is presiding over this restructuring. While other areas of business are in most respects no more unethical than ever, wrongdoing in this central arena makes a crisis of business ethics seem in full swing. And with investment banking now largely manned by the young, is the erosion of ethics here an early warning of imminent trouble elsewhere in business as this generation rises to power?
Insider trading is investment banking’s most widely publicized sin, and since extrasensory perception alone doesn’t explain why the stock price of takeover targets regularly rises in advance of official announcement, doubtless plenty of insider traders besides Boesky’s confederate Levine remain uncaught. But much more pervasive, if less heralded, is the unscrupulousness that now infects relations with clients. Says Herbert A. Allen Jr., president of the Allen & Co. Inc. investment banking firm: ”A major disquieting factor is the loss of confidentiality, well short of illegality. Important clients can find out anything about other important clients.”
Formerly circumspect investment bankers now routinely trade confidential information, hoping to glean tips leading to new business. Information seeps out to other clients, too. In one example, a company preparing to go public to raise capital suddenly found itself faced with an unwelcome tender offer from another client of the investment banker arranging the stock offering.
Company chiefs are becoming understandably skittish about entrusting themselves to such leaky vessels. One divisional chief executive, hoping to buy his company out from its corporate parent, almost froze with fear when the time came to hire investment bankers to help structure the deal. If his boss discovered his plans before he could present the proposal in detail, he feared he’d be thought a traitor and get fired. ”Here I am being asked to put my life in the hands of these people,” he confided to Emory University business school professor Joseph McCann, ”and for all I know the guy on the other end of the line is Dennis Levine.”
This was no idle worry: such leaks have proven catastrophic. When management was trying to take U.S. Industries private in 1984, one of the investment bankers in the deal let out word that the company was for sale before the management group had lined up financing. The stock began to rise, and ultimately Britain’s Hanson Trust snatched the company from under its astonished managers, compounding the injury by firing most of them as an economy move. A knowledgeable insider believes that the leaky banker, fearing that management might yet back off from the deal and assured by contract that the board would pay his firm if the company was sold to anybody, deliberately put U.S. Industries in play to guarantee the fee.
Perhaps, or maybe it was just an accident. But in many instances investment bankers haven’t scrupled to work against their clients by putting them in play when that looked more profitable than working for them. A veteran of one august firm says of his colleagues: ”When they speak ethics, you’d think they’ve worn white gloves all their lives. But these days they’ll sell their clients out for a couple of million bucks in fees.” Typically, says this veteran, you look over your client list, picking out a company that appears vulnerable. Somebody’s going to put him in play, you sigh philosophically, so we’d better do it first — and accordingly you shop his company around behind his back.
A SENIOR MEMBER of a more demotic firm reports a common variation on this technique. You tell a client who has come to you for some simple bankerly service that a raider is about to put his company in play and he’d better be scared; you gallantly offer your services in his defense; and then you look for a buyer yourself. ”They take a healthy patient that walks in and make a cadaver,” says this investment banker.”It happens so quick that the victim doesn’t even know it’s going on.”
Rather than snatching a client’s company, an investment banker might merely snatch his deal. Former ITT chief Harold Geneen and ex-Norton Simon chairman David Mahoney, for instance, recently came to Drexel Burnham Lambert to get financing for their proposed purchase of a W.R. Grace retail unit. To Geneen’s outrage, another group — with close ties to Drexel and financed by the firm — ended up with the unit instead, after seeing, Geneen believes, the voluminous analysis of the unit’s value that he had prepared and given to Drexel. (FORTUNE was unable to reach Drexel for comment.)
Clients contribute to the appearance of conflict of interest that hangs over some routine investment banking practices. When they hire firms to give fairness opinions on the terms of a deal, they conventionally pay a small retainer, with the bulk payable when the fairness letter is put into the proxy statement — where only a favorable letter can appear if the deal is to succeed. Or they hire firms to advise on whether to do a particular deal and how to structure it, with the fee contingent on the successful completion of the very deal whose wisdom is at issue.
Troubling, too, in terms of the appearance of conflict of interest is the investment banker’s increasing propensity to turn up on all sides of a deal. In the pending sale of an equity stake in Western Union to Pacific Asset Holdings, Drexel not only advised the seller but also raised the financing for the buyer, an outfit, moreover, that includes among its partners Drexel junk bond star Michael Milken and other present and former Drexel employees. It’s all perfectly legal, of course.
For potential buyers, the auction process by which companies often get sold has become what one leveraged-buyout specialist calls ”a nightmare of back- room dealing.” Lucky you, you’re the high bidder for Transylvania Airlines, and the investment banker running the auction says, ”You’ve won, but you just need to sweeten your bid a little to make it totally palatable to the seller.” So you up your offer, and regardless of what he’s told you, the banker invites another high bidder to top it, and so on, all with jet speed and steam-engine pressure. ”You can’t believe anything anyone tells you in the process,” says the leveraged-buyout specialist, who, like some other former participants, refuses to play the auction game again. Sums up Lazard Freres partner Felix Rohatyn: ”The big business community views all investment bankers now as a bunch of samurais who will do anything for money.”
What happened to turn a once sedate, gentlemanly business into such a free- for-all? The takeover movement fueled the change by pouring great gouts of money into investment banking and attracting hordes of aspirants to hold their buckets under the golden shower. The huge and numerous deals in turn produced such lightning stock appreciation that some quiet trading on your insider knowledge could make you seriously rich.
CHANGES IN THE structure of the business also have eroded standards of behavior. When clients pushed investment banks to buy up whole issues of their securities for later resale, most of the major private firms of 15 years ago gained access to the needed capital by going public or selling out to big public companies. With that, each lost a measure of its distinctive character, along with the proprietary willingness to identify self-interest with the firm’s interest, a willingness that used to characterize partners and those who knew that behaving like a partner was a good way to become one. Now even bigger and more bureaucratic, firms inspire still less loyalty. ”Conscience is a fragile thing,” says Dr. Abraham Zaleznik, a psychoanalyst and Harvard Business School professor. ”It needs support from institutions, and that support is weakening.”
With hopping from firm to firm becoming common, employees often think of their mission as doing as well for themselves as they can in the three to five years they spend on average at any given place. ”These people see themselves as baseball free agents, not as belonging to anything larger than themselves that they feel a responsibility to protect,” says Samuel L. Hayes III, investment banking professor at the Harvard Business School. Most junior investment bankers don’t care what their firm’s relationship with Mega Inc. will be two years hence. Their goal is to get the Mega deal done now, without worrying how Mega, or their own firm’s reputation, will fare thereafter.
Loyalty between firms and clients has weakened no less conspicuously. Fifteen years ago, corporations still had long-term relationships with one or perhaps two investment bankers. The chief executive — often a company founder — dealt directly with the investment bank’s chief, himself often a founder of his firm and frequently a member of his client’s board. But when the SEC’s adoption of shelf registration in 1982 made it possible to issue securities almost in a rote manner, which in turn allowed clients to force investment banks to compete on price, all that began to change.
The clients’ focus moved from the relationship to the individual transaction: who could do it cheapest, and, since investment banks have different areas of expertise, who could do more complicated deals best? As had already happened with their commercial bankers, companies pushed to have loose connections with five or six investment banks, from whom they would buy particular services, depending on the particular deal. ”The ethical equation has changed, because neither the adviser nor the client sees himself committed and held to the same standards as he did when the relationship was different,” says Lazard’s Rohatyn. Of course, not just honor kept you from behaving unethically in the days of stable relationships. Says Jerome Kohlberg of the black sheep: ”Nobody would do business with you. Misconduct would hit you right in the pocketbook.”
TWENTY YEARS AGO, when investment bankers started at $9,000 a year, firms also felt less goaded to keep their new hires in perpetual motion than these days, when their numbers are legion and they start at up to $100,000. ”There weren’t the same hungry mouths needing a worm stuffed down them every day,” says Harvard’s Samuel Hayes. What’s more, the deal being done now is much likelier to be a hostile takeover than two decades ago, when aggression in takeovers was less respectable. ”Taking the gloves off,” says Hayes, ”creates an environment in which corners can be cut.”
Because investment banking has become so competitive, so dependent on innovation, it has had to open itself to talent more than in the past, when a genteel oligarchy manned it. ”The bottom quarter of the Yale class wasn’t so bright,” says Fordham’s Arthur Taylor, ”but it did share a sense of family and a sense of obligation.” One mustn’t romanticize this class’s gentlemanly code — this wasn’t a bunch of Sir Galahads, and few expansively lived out the ideals Groton or Exeter tried to teach them. But for all the oligarchy’s snobbish exclusivity, it did promote a measure of probity and honor. The recruits that investment banking has attracted to its new meritocracy truly are the talented: business is this generation’s hot career, and investment banking the hottest part of it. What they often lack is the ethic that belonged not to the business but to the class that once ran it.
They have their own ethic, and it centers on money, as is increasingly true for the ethic of the culture at large. ”Where we saw in the Sixties the notion of public service, in the Eighties money is the thing,” says Hayes. For the get-rich-quick mergers and acquisitions generation, it sometimes seems that money is the only value. ”The people with the most money are admired regardless of how they achieved it,” says James Schreiber, a New York lawyer who specializes in cases involving securities fraud. The investment banking boom gives these people their chance to be rich, and they are taking it. ”For them, it’s money now,” says one of their elders in the business. ”It’s Las Vegas.”
It’s hard to know where they would get what used to be thought of as mainstream values, given schools that strive to be so inoffensively value-neutral that they shrink from telling pupils that it was God the Pilgrims were giving thanks to, or colleges that teach — when they teach anything beyond their preprofessional curriculum — that everything is relative, or a television culture celebrating instant gratification. It’s hard to know where the new people would acquire a strong sense of responsibility for their actions when two of the chief social ideas they have been raised with are that the cause of wrongdoing is the economic or psychological environment of the wrongdoer and that it is right to hire and promote people not because of their personal merit but because they come from a particular group.
The ethic they have, half articulate but deeply felt, takes the idea of the free market and turns an economic theory into a personal moral code, making nonsense of reasonable propositions by exaggeration and distortion. ”Okay,” the rising generation says, ”the mechanism of the market insures that each individual, pursuing his own interest in his own way, will augment the wealth of the nation, thereby advancing the public interest by self-interest. That means that whatever I do in my own race for wealth — spill this company’s secrets or put that one into play or lie to a third — is fine. It is only mistaken sentimentality to say that these things are wrong.” Observes Getty Foundation chief and ex-Norton Simon C.E.O. Harold Williams: ”The concept of ‘Let the market govern’ relieves one of one’s sense of responsibility.”
Members of the post-1975 generation of investment bankers don’t sense that what they do advances the common weal only in some abstract, distant way. In fact, in their view they directly confer a vital social benefit. American industry fell behind in the Seventies, they reasonably argue, because overregulation and a national emphasis on redistribution rather than production of wealth shackled competitiveness. But then they expand this point — and pervert it. ”Rejecting talk of small is beautiful and eras of limitations,” they argue, ”our generation, stuck with this mess, rolled up its sleeves. Now, directed by investment bankers like us, and often opposed by contemptible entrenched managements whose barren stodginess and porcine presumption helped make the country uncompetitive, U.S. industry is restructuring to be lean and strong, as changed conditions require. Only the strong and realistic survive in this competitive world — and you have to be strong and realistic as a nation, a company, and an individual.”
But here the ethic turns into social Darwinism, and an appropriate tough- mindedness becomes mere hardness. ”Part of the ethic is that the strong were meant to prevail over the weak, and the strong just do not have responsibility,” says Fordham’s Taylor. They can do what they want, and their success proves they were right to do it.
And how can what they do be wrong when they work so hard, with such virtuous self-denial? For the ethic of this new generation of investment bankers retains a nub of the Protestant ethic in its emphasis on hard work and dedication, if not to a ”calling,” at least to a career. Paradoxically, that virtue can turn into a license to misbehave. The 100-hour weeks, the lack of time for social or family life, the continual pressure, all breed resentment. ”It’s an inhuman way of life. You’re at the firm’s beck and call,” says Dr. Mary Ann Goodman, a New York psychoanalyst. ”There comes to be a feeling that they owe you — there’s no way that they can repay what you’ve given up.” Adds Harvard’s Zaleznik, ”This leads to a sense of entitlement that weakens the conscience.”
This may well be part of what drives people beyond the unethical into the illegal. But psychoanalysts think that what pushes some insider traders over the line, beyond mere greed, is a more primitive wish to flirt with danger, like stunt drivers. ”As long as they’re winning, they don’t feel there’s anything to stop them,” says Goodman. ”Clinically speaking,” adds Zaleznik, ”these people are fighting off major depressions” stemming from the ”fear of being unloved, unlovable, and worthless.”
EVEN THEIR GREED isn’t always simple, as in the recent case of Kidder Peabody superbroker Peter Brant, a Great Gatsby for the Eighties. Like F. Scott Fitzgerald’s character, ne Gatz, who reinvented himself according to his own ideal, Buffalo-born Brant rejected the name Bornstein in favor of something he apparently thought evoked Cary Grant, and went on to transform himself into a millionaire Racquet Clubman and polo player of swank Locust Valley, Long Island. To protect all this when his talent for picking stocks faltered, he induced Wall Street Journal reporter R. Foster Winans to disclose, prior to publication, what that paper’s stock-tip column would be saying about individual companies, at least according to Winans’s book, Trading Secrets. Like Gatsby trying to reveal his innermost soul by throwing open his wardrobe and pouring out the profusion of his handmade shirts — the outer surface he longed to make his identity — Brant needed the money to preserve not just his possessions but the sense of self tied up in them.
Because the Eighties ethic now seems so pervasive, top executives in many businesses increasingly fear that wrongdoing could break out in their companies too. Executives worry that the industrial restructuring process could lower the standards of employee behavior by its relentless pressure to squeeze budgets and raise profits, by its fanning of fright and resentment among the survivors whenever employees are fired, and by its shredding of the corporate culture in which standards are embedded.
One of the worried is American Can Chairman William Woodside, a champion restructurer who over the last five years has sold off most of his original company and put together a new one. ”Two or three years ago,” he says, ”I thought, ‘We’re disassembling the culture we grew up in and spinning it off, and we’re acquiring a lot of different cultures, but we have not the vaguest idea of what the underpinnings of those cultures are. We don’t know how our family was brought up.’ ”
He decided to administer an ounce of prevention. Mindful that you shouldn’t buy entrepreneurial companies and force them to conform to your corporate culture, Woodside instead put every middle manager at the newly constituted enterprise through an ethics course and outfitted him with an ethics manual. Equally uneasy, scores of other chief executives have tried the same remedy, making a boomlet for ethics consultants.
BUT THE ETHICS experts who write such tomes and teach MBA students often aren’t really sure what is ethical. Listen to Vernon Henderson, a retired minister who is an ethics consultant to the Arthur D. Little consulting firm: ”Ethical behavior is always a function of a context. It is relative to a culture, an era, to the pressures exerted in a given job.” Standards, moreover, are in constant flux, he says. ”In a society like ours,” he asks, ”who’s going to decide what’s right and wrong?” One looks in vain in this kind of talk for anything that would prevent a person from pulling the lever at Auschwitz.
The result of such moral relativism is that every situation becomes a problem that every manager is expected to solve as if no one had ever faced it before. And the solutions become fairly zany, as in an example reported to Barbara L. Toffler, a professor of ethics at the Harvard Business School. When an employee came back to work at AT&T (T) after a dangerous illness, he was a man transformed: formerly by far the worst of his superior’s subordinates, he was now much the best. AT&T, then undergoing its breakup, had devised a new performance evaluation, requiring each manager to list subordinates in order of excellence. Should the manager rank her born-again subordinate first, as he deserved? Wouldn’t this be unfair to her three other subordinates, she agonized, since higher-ups were bound to think them awful if she ranked them beneath an employee known to be the bottom of the barrel?
Her long-meditated solution: gradually improve the best employee’s ranking, waiting several more quarters before anointing him No. 1. Toffler presents this case to her students approvingly; it takes a while for a visitor to get her to see that what the manager did was lie.
In the end, the business school ethicists may be as much a part of the problem as of the solution. Their main message starts off with the reasonable exhortation that the future managers in their classes must prevent the creation of cultures of corruption at the outfits they’ll help run. Corporate cultures powerfully affect employee behavior, students rightly are told, so you mustn’t have reward systems that encourage misreporting of revenue and expenses or that promote cheating on government contracts. But in practice all this talk about how employees are creatures of their culture ends up by tacitly accepting the notion that the individual employee really can’t be held personally responsible for his actions. The result is to genuflect piously to the idea of ethics without requiring any person to be ethical.
The corporate employees in most danger nowadays are chief executives, for they are most susceptible to the contagion bred of corporate restructuring. In them it produces symptoms like questionably ethical golden parachutes, dealmaking in which C.E.O.s don’t always keep their word to each other, leveraged buyouts in which the management team that arguably hasn’t maximized return so far acts as both seller and buyer of the shareholders’ assets, not to mention the host of company-bruising contortions chief executives have used to evade raiders and save their jobs.
CRITICS OF restructuring fear that the process may not prove quite the panacea its supporters foresee, which makes the unethical behavior of the participants seem not just sordid but sinister. These critics admit that mismanagement bloated many companies that then needed shaping up. But by now, certain investment bankers and business leaders believe, it is not just poorly run companies that are being put through the wringer.
Some critics worry that the restructuring is mere financial manipulation. ”The advent of junk bonds,” says Felix Rohatyn, ”took mergers and acquisitions away from where the industrial or business logic guided the merger to where the availability of finance became the guiding force.” Companies have been bought simply to be broken up, he argues, not for any larger, constructive purpose. ”We’re not going to look back on this period and think that Boone Pickens performed a great service to U.S. interests or to the energy industry.”
The vaunted restructuring may be making companies more profitable to shareholders, but that isn’t necessarily the same thing as making them stronger global competitors. Their cultures destroyed, they may be stripped down not for competitive action but to pay off their new, restructuring- imposed burden of debt, a burden that could prove unsustainable when business turns down.
Presiding over all this, increasingly as instigators rather than mere intermediaries, are the investment bankers, saying, ”Trust us, it’s all for the best — trust us.” But the steady barrage of their ethical lapses makes trusting them hard to do.
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