Restoring the house of Lehman

How tough-as-nails CEO Dick Fuld defied the conventional wisdom about Lehman Brothers -- and himself -- to recapture the investment bank’s lost glory.

On the evening of February 7, Lehman Brothers held a party to congratulate its newest crop of managing directors. Once dinner had been consumed, Richard Fuld, the investment bank’s 58-year-old chairman and chief executive, rose to address the gathering. He quickly turned its attention to one of his favorite subjects: how Lehman would boost its stock price, which had closed that day at $92.70 per share, to $150 by 2007. Fuld had often held the “Road to 150" out to employees as an organizing principle to focus the firm’s energies.

“We have a problem,” he told the group, many of whom had traveled from offices in Europe and Asia that Lehman had aggressively expanded as it doubled in size during the past five years. “The problem is that now I can see 150. We’re getting close, and we need to raise the bar. So I want you all to think about how we get to 200.”

Not long ago such lofty goals were unthinkable. By the time it was spun off by American Express Corp. in an IPO just 11 years ago, Lehman had fallen precipitously from its position as one of Wall Street’s preeminent investment banks. Years of vicious warfare between its investment bankers and its traders had torn the firm apart and driven it into the arms of AmEx in 1984. The card company then merged Lehman with its down-market Shearson retail brokerage. After that long and painful experiment failed, AmEx cast an undercapitalized, undiversified Lehman out into an investment banking world that had changed dramatically. Confined largely to the U.S. fixed-income business, Lehman was regarded as little more than takeover bait for a global, diversified powerhouse like Deutsche Bank or UBS and had all but lost its status among elite investment banks like Morgan Stanley and Goldman, Sachs & Co. When Lehman shares debuted on May 11, 1994, at $8 each (adjusted for a two-for-one split in 2000), the Road to 150 -- let alone 200 -- could scarcely be imagined.

But Fuld, who has never worked anywhere but Lehman since joining as a summer intern in 1966 -- and who was devastated by its fall -- has led the firm all the way back. Largely through the sheer force of his outsize will and intense personality, he has driven a resurgence as unlikely as it has been exhausting. At the same time, he has learned to control and channel his intensity in the interest of keeping the once-divided firm unified.

“Nobody gave this guy any hope of making it when American Express spun it off and he was made the CEO, and he has proved everybody wrong,” says Henry Kravis, chairman of giant leveraged-buyout firm Kohlberg Kravis Roberts & Co. and a friend of Fuld’s for some three decades. “He’s incredibly determined.”

Indeed, since Fuld took over as CEO on the eve of the IPO, Lehman has overcome a series of crises: an inadequate capital base and a credit rating downgrade in 1994; false rumors of near-insolvency amid severe bond market ructions caused by the collapse of hedge fund firm Long-Term Capital Management four years later; and the terrorist attacks of September 11, 2001, which rendered Lehman’s lower Manhattan headquarters uninhabitable, forcing employees into borrowed offices and hotel rooms and prompting the firm’s eventual relocation to the city’s midtown theater district. Each setback has seemingly made Lehman stronger, with Fuld and a cadre of battle-scarred veterans cultivating an intensely loyal, us-against-the-world culture that has fueled the reclamation of the firm’s lost glory.

Today, Lehman again stands as one of the most admired investment banks on Wall Street. It has doggedly rebuilt its capital base and diversified revenues beyond the U.S. fixed-income business. Last year it ranked sixth among global merger advisers, up from eighth the previous year and as low as 11th in 2001, according to New York research firm Dealogic. It was the third-ranked adviser on U.S. deals and stood fourth in U.S. equity underwriting, after falling out of the top ten in the early 1990s. After posting losses of $123 million and $102 million in 1992 and 1993, respectively, Lehman regained profitability in 1994, earning $113 million. It increased earnings by nearly 1,500 percent over the next six years and in 2004 turned a record $2.4 billion profit, a nearly 40 percent gain over 2003’s results. First-quarter 2005 profits of $875 million and revenues of $3.81 billion were both records for the firm. Lehman’s share price, at about $88 in early May, has jumped 135 percent in the past five years, vastly outperforming those of rivals such as Goldman (20 percent), Merrill Lynch & Co. (15 percent) and Morgan Stanley (38 percent). Just last month, UBS stock analyst Glenn Schorr, in praising Goldman on its solid first-quarter earnings, described its performance as “very Lehman-like.” No longer thought of as buyout fodder, the firm is now aggressively -- but carefully -- pursuing acquisitions. In 2003, for instance, it spent $2.6 billion to acquire money manager Neuberger Berman.

The story of how Fuld pulled Lehman through these travails is especially instructive as other investment banks still struggle with the aftermath of the 1990s bubble. The excesses of so many of Lehman’s competitors in those days -- from overhiring and overpaying to making wrongheaded acquisitions and winning business at any cost -- continue to present what amount at best to distractions and at worst to serious threats to their competitive positions. Witness the once-inconceivable turmoil at Morgan Stanley, where persistent cultural and business-integration issues stemming from the firm’s 1997 merger with Dean Witter Discover & Co. have prompted a blood feud between CEO Philip Purcell and a group of Morgan Stanley’s former leaders, not to mention an exodus of talented bankers and traders. Citigroup, the giant financial services supermarket largely built through a bubble-era acquisition spree, has been so dented by legal and regulatory woes that the Federal Reserve Board in March prohibited it from making further acquisitions until it improves its controls. Citi’s great rival, J.P. Morgan Chase & Co., which has suffered its own share of unflattering headlines and regulatory snares, continues to grapple with the difficulty of absorbing two huge acquisitions in four years. And Credit Suisse First Boston has seen its business slide since its 2000 purchase of the highly regarded but ill-fitting Donaldson, Lufkin & Jenrette turned out to be a disaster.

The tale of Lehman’s resurgence is also the very personal story of Fuld’s transformation from a rough-and-tumble commercial paper trader whom nobody -- least of all himself -- viewed as the future CEO of a blue-chip firm like Lehman into a mature, sober steward of a collegial culture. As a combative participant in Lehman’s bruising 1980s family feud, Fuld earned the nickname “Gorilla” for his pugnacious zeal on behalf of his trading brethren. Today he’s a more gregarious, self-effacing client man, who spends more time traveling the globe with Lehman’s investment bankers than he does in New York minding the trading floor.

“With factions you lose,” Fuld tells Institutional Investor. “I really learned a ton from that, and I learned it the hard way.”

“Dick has really matured in the 20 years that I’ve known him,” says Jeffrey Vanderbeek, principal owner of the New Jersey Devils hockey team, who worked closely with Fuld at Lehman from 1983 until he left the firm last year. “When you’re a trader you need to make snap decisions. But he has developed a patience and a willingness to listen that is rare in management, and that has helped the firm tremendously.”

BEN TISCH WAS IN TROUBLE. IT WAS LATE ONE summer morning in 1992, and Tisch, just ten at the time, was on vacation in southern Utah with his family and some friends from New York. The group had just hiked to the floor of scenic Bryce Canyon when Ben began to have an asthma attack. He immediately reached for his inhaler -- and realized he had left it back at the canyon’s rim, 1,000 feet above. His worried father, James Tisch, CEO of Loews Corp., knew he needed to get Ben to the top quickly. Just in case the boy needed to be carried, James Tisch asked his good friend and vacation companion, Dick Fuld, to accompany them.

Fuld sprang into action, telling the frightened, gasping Ben to lead the way and offering encouragement from just a step behind. After walking about two thirds of the way up, they encountered a fellow hiker sitting on a boulder by the side of the trail.

Hearing Ben’s struggles, the hiker exclaimed, “My, aren’t we wheezing today!”

Fuld, without breaking stride, looked up and glowered. “Eat shit and die,” he roared. “Eat shit and die!”

For Ben the outburst was like a shot of adrenaline.

“My son thought this was the best thing he ever heard, and he almost ran up the rest of the hill,” recalls James Tisch, retelling the story that has become legend in his family. “In that one instant my son saw that Dick would do anything for him. And as a result, my son would do anything for Dick. He’s a natural-born leader.”

Fuld is uncomfortable talking about the episode. Part of him regrets having given a total stranger such a tongue-lashing, and he’s eager to shed the Gorilla tag that he earned as a younger, more impetuous man. But part of him is unapologetic: “I was trying to get Ben to laugh and relax, because I could tell the comment got to him and I didn’t want him to get worse. All I wanted to do was get him back, and we got him back.”

Ben Tisch’s loyalty to Fuld continues today. He now works as an analyst for the investment banking group at Lehman that caters to private equity clients.

Richard Severin Fuld Jr. is unquestionably one of the most forceful leaders on Wall Street. But he never dreamed he would land at an investment bank, let alone lead one. Fuld grew up in the genteel New York City suburb of Harrison, in upper Westchester County, the younger of two children (his sister, a homemaker, now lives in Maine). His father was an executive at United Merchants and Manufacturers, a clothing maker founded and controlled by the Fuld family. His mother stayed home and cared for the family.

As a teenager, Fuld aspired to the thrill-charged life of a test pilot. After graduating from Wilbraham Academy, a preparatory school in southern Massachusetts, Fuld enrolled at Colorado College, joined the Air Force ROTC and began studying aeronautical engineering. An average student, he soon realized he had difficulty following design schematics and other engineering graphics.

“I’m one of those guys that, even if you show me architectural drawings today, I really don’t see ‘em,” Fuld explains. “And that hurt. They said, It’s going to be really tough for you to be good at engineering.”

Deeply frustrated, Fuld muddled through three years of arts and sciences electives and often was more interested in hiking and skiing in the Rocky Mountains than in hitting the books. But along the way his interest in finance grew, and every summer, beginning in 1966, he interned for Lewis Glucksman’s capital markets group at Lehman. Fuld first caught the attention of higher-ups at the firm by persuading about 500 of his Colorado College schoolmates to take a trip to Steamboat Springs, a then-struggling ski resort that Lehman had backed.

So it was that midway through his senior year, when Colorado College required him to pick a major, he settled on international business. At about the same time, Fuld broke his leg and couldn’t ski. Having nothing more exciting to do, he studied hard, earning his only 4.0 grade point average in his final semester.

Wall Street beckoned.

“I truly stumbled into investment banking,” he says. “I had zero interest in it. But once I got exposed to it, I discovered that I actually understood it, and all the pieces fit.”

Upon joining Lehman full-time in 1969, Fuld began trading the commercial paper, or short-term debt, of real estate investment trusts. Working with one other trader, he built the top REIT commercial paper desk on the Street and quickly became a key lieutenant to Glucksman, who in the early to mid-1970s promoted him several times, to jobs running the money market, corporate, mortgage and agency bond desks.

Fuld’s blunt, aggressive personality and iron will quickly became legend at the firm. By 1978, as part of his drive to gain more power for his capital markets executives, Glucksman, then the chairman of Lehman’s operating committee, recommended Fuld for a stake in the partnership. Late on the afternoon of Friday, September 23, Lehman chairman and CEO Peter Peterson had his secretary summon Fuld, then 32, to his office.

“I can’t really do it now,” Fuld told her. He was getting married the next day and was heading out the door for a tuxedo fitting and wedding rehearsal.

Half a minute later Peterson’s secretary called back. “It’s important,” she said.

“Why are you calling me again?” Fuld cried. “I’m late. I’m sorry, I don’t mean to be rude. I’ve got to go.”

Almost instantly, a red-faced Glucksman burst into Fuld’s office. “What the fuck are you doing, you idiot?” he shouted.

“What are you talking about, Lew? You’re coming to the wedding tomorrow. You know where I’m going!”

“God! I can’t believe it!” barked Glucksman. “You’re coming with me now! I’ll get you out of here in 15 minutes.”

The pair hurried into Peterson’s office. Fuld, worried about missing the rehearsal, heard hardly a word as the Lehman chairman, a former U.S. secretary of Commerce and ex-president of camera maker Bell & Howell Co., discussed Fuld’s joining the partnership.

“I’m just not even there,” recalls Fuld. “I figured it’s some deal we’re working on, and I’m worried that I’m in big trouble with Kathy” -- his bride-to-be and now his wife of 26 years.

Only after Glucksman delivered an elbow to Fuld’s midsection did he wake from his daze to hear the two men say, “Congratulations.”

Scenes of amity between bankers and traders would become rare at Lehman in the coming years. Glucksman’s capital markets group soon contributed most of Lehman’s profits, but the bankers, who were loyal to Peterson, continued to own the bulk of the partnership and resisted sharing the wealth.

As tensions built between the factions, Fuld was among the strongest supporters of his mentor. According to Ken Auletta’s definitive book on the Glucksman-Peterson war, Greed and Glory on Wall Street: The Fall of the House of Lehman, Fuld, then running all of capital markets and a director of the firm, in private conversations with fellow traders would rage at the “fucking bankers” who resisted making more traders partners. Not given to back-stabbing, Fuld prefers frontal assaults in such conflicts. “Even with my enemies, I try to be fair,” he explains. “I try to tell ‘em, ‘Hey, look, you piss me off, I’m coming right atcha.’ I don’t come in behind ‘em. I don’t try and sneak up on ‘em. It just makes it more fair.” It’s no wonder, then, that this was when he became known to friends and foes alike as Gorilla. Says one extrading partner: “He was our jungle fighter. That’s where the name came from.”

Ultimately, Glucksman outmaneuvered Peterson, forcing him out in September 1983 and donning the mantle of chairman and CEO himself. But the palace coup had poisoned Lehman’s culture. Disgruntled investment banking partners left. Their departures drew attention to the fact that Lehman, at a time when capital-intensive bridge loans and leveraged buyouts were fast becoming the norm in investment banking, had seen its capital base dwindle to an uncompetitive, even dangerous, level.

Compounding the remaining partners’ distress, the outlook for Wall Street had begun to dim because of lackluster corporate profits and flat trading volumes. Lehman’s vaunted trading department had suffered some sharp losses, and the firm’s profits were shrinking. A majority of partners and directors compelled a reluctant Glucksman to negotiate a sale to American Express. The $360 million deal was announced on April 10, 1984. Fuld, one of a handful of directors who voted against the sale (he preferred to shrink the firm and continue as a fixed-income trading house, without banking), was devastated.

“Could I have handled it a better way?” says Fuld, referring to his role in Lehman’s self-destructive internecine warfare. “No question about it. Could I have handled it in a more subtle way? Of course. Did I? No. And Glucksman had the same battle with Peterson. That’s what led to all the ridiculousness. We didn’t sell the firm. We lost the firm,” he says ruefully, eyes falling and voice trailing off. “We didn’t sell it, we lost it.”

Nevertheless, Fuld signed on with the new Shearson Lehman Brothers unit of American Express as a senior vice chairman and head of debt trading. Gradually, his management style began to evolve. Though still tough-minded and aggressive, he reached out more to colleagues, seeking to build consensus and encourage controlled debate over issues, as a way to prevent the factionalism and infighting that had driven his beloved Lehman into the arms of AmEx.

Despite Fuld’s diplomatic efforts, by 1990 it had become clear that the money-losing Shearson retail brokerage and Lehman corporate and institutional businesses weren’t meshing. AmEx separated them into distinct units, naming Fuld co-COO of the Lehman Brothers division with J. Tomilson Hill III, a veteran banker who had joined Lehman in 1982 and been loyal to Peterson’s camp. Fuld and a coterie of Lehman veterans who worked closely with him saw the move as a precursor to AmEx’s selling Lehman, and they began to manage the firm accordingly.

Fuld realized that the Lehman unit had to be both diverse in its business and amply supplied with capital to survive in an investment banking industry that was expanding globally and increasingly extending short-term funding to clients. That meant that the firm needed to excel not only at trading commercial paper and mortgage bonds, as it had always done, but also at trading stocks and derivatives, underwriting securities and advising on corporate mergers. Fuld spent much of the three years that he and Hill shared power learning from his new partner, joining him for client meetings and offering the support of his capital markets team. Fuld began to declare internally that Lehman was to be “one firm with one P&L.”

“Dick knew the only way Lehman Brothers could survive was if everyone worked together,” says Ronald Gallatin, who made partner with Fuld in 1978 and worked closely with both Fuld and Hill in the American Express years before leaving Lehman in 1995. “He had been a trader, or a manager of traders, his whole life, and he used that time to study Tom, to learn the culture of investment banking. He was determined to create a firm that would never again implode as it had in 1984.”

In 1993 thenAmEx CEO Harvey Golub pushed Hill out after clashing with him over compensation issues. He then sold Shearson to Smith Barney, Harris Upham & Co. and began exploring a spin-off of Lehman. Fuld was alone at the top -- he had played no role in Hill’s ouster -- and was ready to begin Lehman’s long march back to respectability.

BUT THE TRAIL BACK WAS STEEPER THAN ANY IN Bryce Canyon. By the time Fuld and his team had gained their independence from AmEx, 11 years ago this month, Lehman was a shell of its old self. With just $2 billion in equity capital, it was dwarfed by firms that had spent the previous decade bulking up. Merrill Lynch, for instance, boasted $5.5 billion in equity. Worse, AmEx had implied to the credit rating agencies that it would spin off Lehman with more capital. When the agencies found out how small the dowry actually was, they downgraded Lehman’s commercial paper rating -- a big blow to a firm that regularly taps that market for working capital.

Moreover, Lehman remained overwhelmingly focused on the fixed-income and domestic markets. Most of the firm’s senior executives -- Fuld, chief operating officer T. Christopher Pettit, fixed-income group head Joseph Gregory, fixed-income sales chief Stephen Lessing and foreign exchange head Bruce Lakefield -- had spent their careers trading and selling debt instruments. In investment banking, where clients crave stable, trustful relationships, Lehman had been hurt by a decade of turmoil. Meanwhile, giant retail brokers like Merrill and Smith Barney were using their massive sales forces to distribute deals and reinvesting the fat profits in overseas expansion. To prospective hires, Lehman was at once a snake pit and a laughingstock.

In 1995, after the IPO, it ranked ninth in global mergers advice and eighth in equity underwriting. The likelihood of Lehman’s succeeding in banking, equities and foreign markets -- and thus of enduring as an institution -- appeared slim.

Fuld was well aware of the challenges Lehman faced. As he prepared for the IPO, he drafted a detailed plan that set out ambitious goals: 50 percent of revenues from overseas, employee ownership of at least 40 percent of the firm, an equity business to balance fixed income and approximate it in size and a top-five market share in investment banking. To implement the plan, Fuld defied the conventional Wall Street wisdom that only experienced equity professionals and investment bankers could effectively manage those businesses: He turned to his cadre of grizzled fixed-income veterans. They set out to reach his goals with a quasimilitary zeal forged in the early-1980s Lehman civil war and the decade of struggles under American Express. Wall Street’s general mockery of Lehman provided an extra goad to their efforts.

“When I first got here, people felt special about the House of Lehman,” says the fast-talking Gregory, Fuld’s cerebral but personable No. 2, who started as a summer intern in 1968. “It was a big deal. So we hated when the company got sold. There were 2,700 or so of us who were suddenly landed in the middle of this 40-odd-thousand-person Shearson/American Express, going, ‘What happened?’”

Fuld sought to cement the partnershiplike culture he had been trying to create since Lehman’s separation from Shearson four years earlier. He insisted that the firm, even though it had become a public company, preserve the stock-rich compensation scheme devised by Gallatin after the break with Shearson. Inside Lehman it was called “the new partnership.” Today employees own about 35 percent of the firm’s shares, and Fuld is determined to boost the level to above 40 percent. He reasons that widespread ownership not only aligns the interests of employees with those of the firm, thus promoting teamwork, but also encourages them to call out co-workers for bad decisions or inappropriate behavior. (It’s also an antitakeover measure.)

“I want my employees to act like owners,” Fuld says.

The CEO next set out to rebuild equities and investment banking in the image of Lehman’s outstanding fixed-income division. He dispatched Gregory to take over the stock business, which had thrived under the leadership of Fred Fraenkel and Jack Rivkin in the late 1980s but nose-dived after the two executives clashed with senior management and left the firm before the IPO. Gregory named energetic high-yield research chief Joseph Amato to run equity research. To oversee the banking buildup, Fuld tapped Bradley Jack, who had joined the firm in 1984 and had spent a decade in the fixed-income division.

Though ridiculed by competitors as bond whizzes who were out of their depth in equities and banking, Fuld and his senior team were confident that they could duplicate their successful approach to fixed income -- hire team players, build a cooperative culture and emphasize risk management -- in those businesses. Lehman relentlessly recruited analysts, traders, salespeople and bankers from other firms, pitching them (not always successfully) on the opportunity to take part in the rebuilding of a storied enterprise.

Lehman’s senior managers, enjoying a camaraderie born of shared adversity that is rare on Wall Street, operated as an unusually cohesive team. Devils owner Vanderbeek recalls an interview with a job candidate that was interrupted by Gregory, who came into his office to confer on an important decision. In barely two minutes the two managers hashed things out and solved the problem, impressing the candidate, who remarked that the same decision might have taken days of meetings to reach at his firm.

“A lot of the time we were reading each other’s minds,” says Vanderbeek, who headed risk management under Fuld and served on the executive committee before leaving to buy the Devils last year. “We didn’t even have to have conversations. We had been through so much adversity together, for so long, that we had a faith and a trust in each other that -- I know it sounds corny, but it made us one of the most efficient firms on the Street.”

But just as Lehman was starting to gain momentum, the bond market debacle of 1998 threatened to undo all of its efforts. Fixed-income markets worldwide were roiled by Russia’s bond default and Southeast Asia’s serial currency devaluations. As false rumors flew that Lehman had taken a huge hit and would need a bailout to remain solvent, its shares plummeted, from the low 80s in July to about 25 by early October. Nervous credit rating agencies considered downgrades.

Furious, Fuld sought out scores of clients, shareholders, rating agencies and regulators, insisting over and over that the scuttlebutt was wrong and that the firm was in good health.

“He really put the company on his back,” says Gregory. “He must have gone through a thousand client meetings, talking about Lehman’s financial health and where we were.” Although Fuld kept the situation from spinning out of control, Lehman’s reputation -- and its share price -- took months to recover.

For the CEO the rumor-squelching exercise was another step in his metamorphosis from Lehman’s Mr. Inside to its Mr. Outside. “It was really a watershed in the development of his outside persona,” says Gregory.

Lehman emerged from 1998 in a fine position to exploit its rivals’ bubble-era overreaching. A welter of mergers -- Salomon BrothersTravelers Group, CSFB-DLJ, Chase Manhattan Corp.J.P. Morgan & Co. -- had dumped hundreds of talented professionals onto the Street. Lehman took its pick of the best. Just as Travelers was arranging a marriage between its Smith Barney subsidiary and Salomon, the five-year noncompete agreement between Lehman and former sibling Shearson, which had been sold to Smith Barney, expired. For the first time since its IPO, Lehman could hire at will from its old stablemate; this especially helped it in the equities business.

And when the tech-stock bubble burst in March 2000, these and other Lehman rivals began further rounds of massive layoffs. The firm benefited from its relative weakness in the once-hot areas of technology and telecommunications banking, and in equities, and seized the opportunity to build those businesses while its competitors were in full retreat. During the past five years, Lehman has doubled in size, to nearly 20,000 employees. It also has doubled its executive committee, which makes all major strategic decisions, to 12 people.

Among the additions were Jeremy Isaacs, a former Goldman executive who joined Lehman’s European equities team in 1996 and became European CEO in 1999, and Jasjit (Jesse) Bhattal, a veteran Asia investment banker who became the firm’s CEO for that region in 2000, reflecting the expansion of Lehman’s business overseas. Indeed, several thousand of Lehman’s new hires in the past several years have been in Europe. The firm moved into more-spacious offices in London’s burgeoning Canary Wharf district last year. Non-U.S. business now generates 35 percent of Lehman’s earnings -- not quite the 50 percent that Fuld dreamed of 11 years ago, which is why he’s still focused on overseas expansion. In Asia, for instance, Lehman has hired several senior bankers in the past year, including Zhizhong Yang, formerly of Morgan Stanley’s highly profitable China banking business, as head of China investment banking.

The firm’s turnaround has been stunning. It built strength in equities by starting with research. Amato, now the firm’s chief recruiting officer, and his successor as global research chief, Steve Hash, have recruited and trained a team of analysts that has made Lehman the top-ranked firm in this magazine’s annual All-America Research Team survey for two years running, after it had fallen from first in 1991 to 13th in 1995.

Research helped drive Lehman’s trading business, as did the addition in September 2003 of exMorgan Stanley trading exec Patrick Whalen, who has reorganized equity trading in the image of his highly successful former firm. When Institutional Investor asked more than 350 head buy-side traders last year to name the firms that were the best at executing stock trades, Lehman finished first at trading New York Stock Exchange shares and fourth at trading Nasdaq stocks.

And the firm’s treatment of equity and debt as fundamentally akin -- “they’re both about bringing together people who have money and people who need money,” says Gregory -- was prescient. Firms such as Goldman and Citigroup have since installed former fixed-income executives to run equities.

But what’s most surprising about Lehman’s success, from a historical perspective, is that its real driver of late has been, of all things, investment banking, specifically merger advisory work. Banking revenue climbed 27 percent, to $2.2 billion, last year. In the first quarter of 2005, it grew even faster, increasing 34 percent over the year-ago period. By comparison, revenue from principal transactions -- which includes trading for both the firm’s own account and on behalf of clients -- jumped 27 percent in the first quarter, and commissions from trading increased only 5 percent. In 2002, banking chief Jack promoted energy banker Hugh (Skip) McGee III, a big revenue generator hired from mergers boutique Wasserstein, Perella & Co. in 1993, to head investment banking. Last year Lehman brought in accomplished technology banker Mark Shafir, previously of San Francisco boutique Thomas Weisel Partners, as M&A chief. Their relationships have helped fuel the revenue growth.

Another surprise is that Fuld, the man once known primarily as a gruff former commercial paper trader, has been the smooth closer on many of Lehman’s biggest deals. The CEO was critical, for instance, in winning his firm the mandate to advise Sprint Corp. on its $40 billion takeover of Nextel Communications, announced in December. And Fuld’s relationship with hedge fund manager Edward Lampert helped Lehman win a role as adviser to Kmart Holding Corp., which Lampert has chaired since it emerged from bankruptcy in April 2004, on its $11 billion acquisition of Sears, Roebuck & Co., announced in November.

“He’s very, very involved in our banking efforts,” says McGee. “If you look at most of the significant transactions that we’ve been involved in over the past few years, Dick knows the CEO at the company.”

Even when Fuld is not on the road, he’s constantly in contact with clients. During a February interview in his Manhattan office, for example, a banker peeked in to remind Fuld that David Bonderman, chief of private equity behemoth Texas Pacific Group, would be dropping by for a visit shortly.

“He is as good as any CEO of a major firm as far as making sure that he knows what’s going on with clients,” says KKR’s Kravis, whose firm tapped Lehman last year to sell its stake in packaging company Owens-Illinois. “He is in constant contact with me, and his people are constantly talking with others at KKR.”

“Dick can establish an emotional connection with people,” says American Express CEO Kenneth Chenault, who became friendly with Fuld when they worked together under the AmEx corporate umbrella in the mid-1980s, despite Fuld’s prickly relations with thenAmEx chief Golub, a mentor of Chenault’s. “I knew instinctively, based on his persona, that this was someone I could trust,” explains Chenault, who regularly dines and plays golf with Fuld.

Fuld has had the freedom to spend more time as Mr. Outside since he designated Gregory as president one year ago to oversee day-to-day operations. And the CEO has discovered that he just might like being an investment banker more than he did being a trader.

“I never really thought I was a client guy,” he muses. “I thought I was always Mr. Inside. But you know what? I love it. I love it.”

FULD’S BIGGEST CHALLENGE NOW IS PRESERVING the culture that has resulted from decades of doggedly overcoming adversity, particularly with so many new hires coming aboard and with the crises of 1984, 1994, 1998 and September 11, 2001, receding into the past. In a sense the single most important question about today’s Lehman is whether a firm that has thrived for so long on its underdog status -- on proving the skeptics wrong -- can cope with success.

Fuld acknowledges that this is among the things he worries most about, and it affects everything the firm does, particularly its approach to growth. Consider asset management, which Lehman sees as a huge opportunity to smooth out what can be volatile earnings from trading and banking. The purchase of Neuberger last year was a watershed for the firm, in that it made a major acquisition after years of being regarded as takeover bait itself. More important, though, the Neuberger deal was a way to grow and diversify Lehman’s revenues, expanding its assets under management from $9 billion to more than $130 billion, without sacrificing its sacred culture. Neuberger’s top management -- CEO Jeffrey Lane, president Robert Matza and CIO Rivkin -- are all Lehman veterans from the Shearson/American Express days. Lane was president of Shearson Lehman Hutton, Rivkin is Lehman’s former equities chief, and Matza was Lehman’s CFO from 1990 to 1996.

“It was like old times,” says Matza of the talks and the integration process. “We understand these guys, and they understand us. We know what they’ve been through and where they want to go.”

Indeed, as Lehman seeks to expand further into investment management, it’s more likely to make strategic hires and small acquisitions than big purchases. Last month, for example, the firm paid some $80 million for 20 percent of $2 billion-in-assets hedge fund firm Ospraie Management, which has generated above-market returns lately with its commodities and basic-industries funds. Also last month, the firm hired Jolyne Caruso, formerly the COO of giant hedge fund Andor Capital Management, to build an internal hedge fund business at Lehman. And in March it agreed to acquire $300 million-in-assets high-net-worth manager Sloate, Weisman, Murray & Co., along with its three top portfolio managers. At the end of its fiscal first quarter on February 29, Lehman’s assets under management stood at $148 billion. Lehman also owns 20 percent of hedge fund GLG Partners, whose founders are Lehman alumni, and has had talks about acquiring the firm outright. It spurned an approach last year from Lazard chairman Michel David-Weill to acquire his prestigious merger advisory firm for $4 billion.

“We’ve looked at many, many trades that are strategically and financially attractive,” says David Goldfarb, a former brokerage industry consultant for Ernst & Young who joined Lehman at the time of the IPO and was promoted from CFO to chief administrative officer in November. “But we’re not going to do anything that compromises our culture, which we believe is our greatest strategic advantage.”

A lot of investment banking executives talk about culture and teamwork these days. Too often that talk is wishful, even empty. Wall Street’s type-A personalities and prima donnas inevitably wind up worrying more about their own bonuses and spheres of influence than the best interests of the organization. As Gregory puts it: “People by nature are gatherers. So they get parochial. They get turfy.” But when Fuld and his battle-tested management team at Lehman talk about culture and teamwork, they deserve the benefit of the doubt. They’ve learned these lessons the hard way and applied what they’ve learned -- none more so than Fuld.

“Dick deserves enormous credit for reinventing the culture of Lehman Brothers,” says ex-chairman Peterson, a foe in days gone by and now chairman of private equity giant Blackstone Group, which he co-founded in 1985. “He was wise enough to see how destructive the old Lehman culture was and effective enough to build a new culture to replace it. In today’s investment banking industry, with trading and capital markets and investment banking so integrated, that kind of teamwork is utterly essential, and I think it’s one big reason why they’ve been so successful.” That’s perhaps the best compliment that can be paid to Fuld.