In march 1996 Bruce Harting got himself into a messy wall street job change. The star Salomon Brothers securities analyst agreed to jump ship to rival Lehman Brothers. So excited was the financial services specialist about getting in on the ground floor of a turnaround that he forgot to pick up his briefcase as he left Lehman’s World Financial Center offices.
But doubt soon replaced euphoria. His boss at Salomon made an attractive counteroffer and, moreover, pointedly asked why the analyst would give up a successful career at a prestigious firm like Salomon to work at a brokerage whose equity research department was in shambles, torn apart by nasty politics and an outflow of talent. After considerable agonizing, Harting decided to stay put at Salomon.
Then fate interceded. The analyst was so embarrassed about backing out of the Lehman job that he couldn’t bring himself to call Lehman’s thenU.S. research director, Bernard Picchi, to tell him. A month went by, and Harting began to rethink his decision to stay at Salomon. Finally, he worked up the courage to phone Picchi.
“Is that job still available?” he asked.
“Yeah, it’s still available,” replied Picchi. “And I still have your briefcase.”
Opting to join Lehman’s equity research department isn’t such a heartrending decision these days. Defying its reputation as little more than a bond house that might make a good acquisition for a bigger Wall Street firm, Lehman has built an increasingly potent equities business anchored by a first-rate research department. After plummeting from No. 1 in 1991 to a lowly 13th place in 1995 in this magazine’s annual survey of the best brokerage firm analysts, Lehman has regained its dominance. This year it has more analysts (including Harting, the second-teamer in Mortgage Finance and in Specialty Finance) than any other firm on Institutional Investor’s All-America Research Team, ranking it No. 1 (see page 69).
Lehman is first by a mile. Its 50 team positions easily outdistance No. 2 Morgan Stanley’s 36, giving Lehman the widest margin for a first-place firm in 20 years.
Investors have taken note. Listen to Jack Rivkin, CIO at $65 billion-in-assets money manager Neuberger Berman (whose sale to Lehman is pending). “They just came out No. 1 in our quarterly internal poll -- for the first time in several years,” says Rivkin, who is credited with building Lehman’s equity research department in the late 1980s before leaving in 1992. “They’ve really come a long way.”
Lehman, the firm, has also made a dramatic comeback. At the dawn of the 1990s, when it was still part of Shearson Lehman Hutton, Lehman found itself in a capital crisis and needed an emergency injection of equity from Shearson parent American Express Co. By 1993 Amex had split off Lehman from the Shearson retail brokerage division, which it then sold. A year later Lehman Brothers regained its independence through an IPO, but by then it had lost critical ground to bulge-bracket competitors, such as Morgan Stanley and Goldman, Sachs & Co. Yet Lehman, capitalizing on its fixed-income prowess, outperformed most of its peers during the bear market while rebuilding its equity and M&A franchises. Now it’s regarded as one of Wall Street’s stronger firms.
Lehman’s research revival gained speed with a series of management changes just after Harting’s arrival in the spring of 1996. That’s when CEO Richard Fuld Jr. dispatched Joseph Gregory, who had turned Lehman’s fixed-income business into a powerhouse, to wring similar results from his equities group. Gregory, now Lehman’s chief operating officer, brought in high-yield-bond research chief Joe Amato to succeed Picchi as U.S. research director. (Picchi returned to being an analyst.)
Working closely with Steve Hash, a star real estate investment trust analyst whom Amato named to run U.S. research upon being promoted to global research head in 1999, Amato coupled intensive training of junior analysts with relentless recruitment of veterans. Earlier this year Hash was named global research director, succeeding Amato, who became head of global sales. It will be up to Hash and exentertainment analyst Stuart Linde, who has taken Hash’s spot as U.S. research director, to sustain the gains.
Are there lessons for other firms in Lehman’s comeback? Yes. One is the priority Lehman gives to research. Intense regulatory scrutiny, loss of investment banking support and disenchantment among chastened analysts have prompted some major brokerages to drastically scale back research or consider jettisoning it altogether. But Lehman, which was a party to the $1.4 billion settlement between ten Wall Street firms and securities regulators over conflicts of interest, has refrained from laying off large numbers of analysts or dropping scores of stocks from its coverage.
That is telling. To reflect market changes, II dropped six categories from this year’s survey, leaving 71. Combined with defections and layoffs of ranked analysts, this has resulted in most firms holding substantially fewer positions than last year -- No. 4 Smith Barney, for instance, is down 19 places. Lehman, however, is down only two slots.
Lehman’s commitment to research also encompasses bonds. It has been No. 1 in II’s fixed-income ranking for four years running. By investor acclaim, then, the firm has emerged as the unparalleled leader in research on Wall Street.
To be sure, Lehman’s rise hasn’t been without some tarnish. Holly Becker, whose negative calls on several Internet stocks burnished the firm’s reputation, is the subject of a federal investigation into whether the analyst tipped off her husband, a trader for giant hedge fund SAC Capital Advisors, about impending research recommendations. A Lehman spokeswoman says, “We don’t have a comment other than to say that the investigation doesn’t involve the firm.”
After Lehman went public in 1994, it set out to build up its now-sizable equities business around outstanding research as part of a larger strategy to revitalize a firm best known for its bond prowess. Lehman’s commitment to research makes it well positioned to profit as equity trading and underwriting spring back to life.
What’s more, Lehman has managed to develop talent from within despite tough business conditions. More than 60 percent of the firm’s All-America Research Team members this year are products of its own training program. “It’s impossible to keep going out in the market and hiring people,” says Hash. “You’ve got to bring your own best people out of the ranks.”
THE RISE AND FALL AND RISE OF LEHMAN RESEARCH is a compelling enough tale to have merited the interest of the Harvard Business School. In 1998 graduate student Boris Groysberg wrote his doctoral thesis on the ascent of Lehman research under Rivkin a decade earlier. Groysberg was intrigued by the human resources strategies that research managers Rivkin and Fred Fraenkel had employed at Lehman (then called Shearson Lehman Hutton) when they took the firm from 15th place in II’s 1986 All-America survey to first in the 1990 and 1991 rankings. He found that the pair’s emphasis on training and “systematizing analyst activities” were the keys to success.
Groysberg and professor Ashish Nanda turned the dissertation into a classic Harvard B-school case study. In 2000 they published an evaluation of Lehman’s post-Rivkin fall in the rankings, concluding that infrastructure and management are critical to producing and retaining quality analysts. A third study -- Lehman’s resurrection under Amato and Hash -- is under way. “The Lehman case shows how development and mentoring strategies made a no-name research department into the best on Wall Street,” says Groysberg, now a professor at the school.
It takes a lot longer to build -- or rebuild -- a research department than it does to destroy one. Lehman’s downfall started when Rivkin, who had been promoted to head of equities in 1990, clashed over control and style issues with then-co-CEO Fuld and his deputies and was forced out in August 1992. Top analysts began to flee. Fraenkel took his leave in February 1995.
When Harting arrived at Lehman in April of the following year, he couldn’t help but wonder whether his boss at Salomon would have the last laugh. “I went into the conference room the first day I was there, and they had these framed pictures of the II team from back in 1990 -- you know, a vestige of their past glory,” he recalls. “I looked at the current roster, and with the exception of [multi-industry analyst] Bob Cornell and two or three others, everyone was gone.” Amato, who became research director in November 1996, says: “It was a bit of a losing-locker-room mentality. Many of the good people were leaving, and a lot of others would have left if they could have found jobs.”
There were other problems. For a start, Gregory and Amato were both bond, not stock, specialists. Job candidates were skeptical of Lehman’s commitment to equities, and recruiting proved to be tough. “They convinced me in the interview process that it was going to be a real turnaround situation,” remembers Harting. “They said, ‘You don’t see it now, but put a little faith in us and you’ll be rewarded for your decision to move.’” Slowly, other well-regarded researchers, including Thomas Facciola, who covered specialty finance companies for Salomon Brothers, and John Bensche, who tracked wireless telecommunications stocks for Credit Suisse First Boston, began to come aboard. It wasn’t a dramatic gain, but in 1996 Lehman’s II ranking edged up from 13th to 12th. The following year the firm moved up three slots.
Lehman also got lucky. After Amex split Shearson Lehman Hutton into retail and institutional divisions, it sold the Shearson retail brokerage to Primerica. The big insurer merged the Shearson operations with its own brokerage, Smith Barney. That firm and Lehman, which became a stand-alone institutional house, agreed not to poach talent from each other for five years. Happily for Lehman, that noncompete pact expired in early 1998 -- just as Travelers Group, Smith Barney’s new parent, was completing its acquisition of Salomon Brothers and combining the two brokerage firms in a bloodletting. Lehman took its pick from among a host of displaced or disenchanted researchers.
As encouraging as its progress was, however, Lehman found itself mostly on the outside during the great bull market in technology stocks. The firm, still in the process of building an equities business, couldn’t compete with investment banks that were making gobs of money on technology stock offerings and were willing to outbid Lehman -- or anyone else -- for talent. “In 1998 and 1999 there were points where it was a real struggle,” admits Amato. “There were senior people who didn’t believe we could do it and left. We tried to replace them and couldn’t come up with the big hires.”
This tough period marked a major turning point for Lehman. In October 1999 Amato promoted Hash to head U.S. equity research. Hash, who himself had gone through Fraenkel’s training program, used it to create the current Lehman curriculum. It consists of two components: The first is an intensive educational regimen for junior analysts who apprentice to senior analysts; the second is a six-week course aimed at enhancing client service that senior and junior analysts must complete.
The junior analyst sessions are coordinated by associate director of research Alicia Ogawa, who teaches her charges how to build financial models, write research reports and make presentations for client calls and morning meetings. Hash himself conducts the weekly two-hour modules geared toward helping seasoned analysts refine their client-service skills. Topics include how to identify what institutional clients want and how to communicate better. Presentations get a thorough critique.
“The training program that Jack and Fred put into place is timeless,” says Hash. “They believed that it wasn’t stock picking as much as client service that makes the real impact with the buy side. That’s still true. Does Fidelity need a price target on General Electric? No way. But does a portfolio manager there need to talk to Bob Cornell about the lightbulb division, because he knows the guy who’s run it for 20 years? You bet.”
By the end of 2000, the combination of recruiting successes, an effective training program -- and some well-timed bearish calls -- had begun to boost the firm’s profile in the eyes of investors. To be sure, Lehman’s analysts were not immune to the temptations, or conflicts, of tech mania, but the firm did raise a red flag on a number of overvalued stocks before others did. And with less investment banking revenue at stake, and the support of a strong bond business, Lehman had the flexibility to challenge Wall Street’s bullish consensus.
Lehman registered a huge gain in ranked analysts in 2000, up from 19 to 31. Although it remained in eighth place in the All-America polling, the firm began closing the gap on competitors. Veteran analysts who had been skeptical about the training program “saw the results the following year and were lining up to participate,” says Hash.
In 2001 Lehman cracked the II top five, with 42 analysts, and last year the firm tied Merrill Lynch for second, just one team position behind leader Citigroup/Salomon Smith Barney. Remarkably, more than 30 of Lehman’s 50 All-Americans this year were not recruited from rivals but came up through the firm’s junior training program. As research directors find themselves under more and more pressure to maximize their bang for the buck (see story, page 47), having a strong farm team of junior analysts becomes critical. “You cannot spend your way to the top,” says Hash. Lehman is again becoming a role model for Wall Street. Merrill, traditionally known for paying top dollar to hire established stars, has begun a similar training program. “You’re starting to see the other firms on Wall Street that are still committed to research instituting some of the same things that made Lehman so successful,” says Harvard’s Groysberg.
“They just pay a lot of attention, account by account, to who they’re dealing with and how to service those folks,” says Neuberger’s Rivkin. “Those were elements that were ingrained in the business going back, and I’m happy to be the recipient.” Others are likely to follow.
