In all, the negotiations lasted seven days, from the initial session on April 3 to the board meeting on April 10. After a hundred and thirty-four years as a private partnership, Lehman Brothers was to become the eighteenth Wall Street firm to merge with Shearson/American Express.

The sale of Lehman was splashed across the front pages. It made the networks, the news weeklies, the business publications. It was big news, and Glucksman and Rubin felt humiliated, felt they were cast as the heavies, as if they were responsible for murdering a venerable firm. For Pete Peterson, on the other hand, the sale appeared to be a vindication. In the Candy Kitchen in Bridgehampton, where he went each Saturday and Sunday morning at about seven to read the papers, have tea and a dry bran muffin, and to mingle with the other business executives, editors, TV producers, journalists, writers, publicists and farmers who congregate there, he clucked knowingly about the sale. Absent his restraining hand, Peterson noted, Lew Glucksman and his gang had destroyed a firm he had spent ten years building. In the newspapers, Peterson resurfaced in a lofty, magisterial role. He was pleased to say, the press reported, that he had agreed to serve as an unpaid consultant to Shearson/American Express. “They asked me if I would help them with organizational structure and investment banking,” Peterson told the Times. “I felt a strong moral obligation to help during a temporary period.”

Peterson’s posture infuriated Shearson executives, who were still smarting from their strained negotiations with the former Lehman chairman. “Peterson was not a consultant, except in Peterson’s mind,” snapped chief operating officer Jeffrey Lane. One other senior Shearson executive exclaimed, “He’s really a number! That son-of-a-bitch! He was a self-appointed consultant. That caused a lot of grief here. People at Lehman were wondering what we were doing. It was awfully difficult to call the press and say, ‘No, he’s not an unpaid consultant!’” But the virulent reaction the name Peterson invoked among Shearson executives was out of proportion to the alleged “crime.” Partly, it was a backlash against Peterson’s insistence on being paid for his 1 percent of the profits, in contrast to Glucksman’s beneficent waiver of this contractual provision. Partly, it was Peterson’s insistence that Shearson honor another clause in his severance agreement calling for a $5 million investment in Peterson, Jacobs & Company. Partly, it was because Peterson was talking to his friend Jim Robinson, not to the Shearson people. When he met with Robinson and Cohen for breakfast on April 9, for example, Peterson would address his friend “Jim,” ignoring Peter Cohen. And partly, it was the condescending contempt Shearson executives felt Peterson displayed toward them, mere officers in a “wirehouse.” No doubt these frustrations aroused bitterness at the word “consultant.” In a formal sense, Shearson was right: Peterson was not a consultant. But in an informal sense, he was. “He agreed to help us,” says Sandy Weill of American Express. Peterson did meet with Lehman bankers to discuss strategy, did talk to and try to soothe Lehman clients, did consult with his colleague and neighbor, James Robinson.

There were other obstacles to be overcome before the merger would become final on May 11. On the day of the announcement, Peter Cohen came to address the Lehman partners at five in the afternoon. They crowded together in the boardroom. It was Cohen’s intention to answer questions, but after enumerating the advantages of the merger, Cohen waited in vain for questions. “They were shell-shocked,” he explains, by news of the sale. Something else shocked them. Partners recall* Cohen boasting “I want you to know we have a great organization. I made $1.2 million last year, and seventeen people at Shearson made more than me!”** This was not comforting to Lehman partners. “We all rolled our eyes,” recalls Henry Breck, “because after taxes we all made more than him.” And, adds a partner, “We were our own boss.”

At Lehman, relief at being rescued from Glucksman & Company was mixed with apprehension, which radiated throughout the organization. Many of the associates, those just below the partner level, were distressed that they would not have the opportunity to become partners. “There was deep resentment on the part of non partners at what was done,” says former vice president Steven Rattner.† “The feeling was that partners took their money and left us very little. They sold the firm when they felt a need to cash out.” At one meeting, an associate recalls, a nonpartner shouted at banking partner William A. Shutzer, “You guys have denied me a career at Lehman!” Another associate, who asked not to be quoted, complained that only the senior associates would tap the $35 million set aside in the purchase price for associates. “All those not here for three or four years are not eligible. In investment banking there are 290 associates at Lehman. They only provided money for one-third of them.”

Secretaries were also distressed. “We’re all depressed,” said one. “The salaries at Shearson are lower. They don’t pay bonuses to secretaries. They leave it to your boss to decide whether to give you a bonus out of this own pocket. Here my bonus was $3,000, $4,000 a year. The benefits are not as good. You have to contribute to your own life insurance and hospitalization. Lehman used to give you that.” Knowing Shearson’s reputation for cost-cutting, insecurity was rampant at Lehman.

There were obstacles to be overcome before some partners would sign the noncompete clause. On Saturday, April 14, Cohen and members of his team met all day with Shel Gordon, Bob Rubin and Dick Fuld to discuss the final list of partners who would be asked to sign, tying themselves to the new firm for three years. By the end of the day the list was ready, and the contracts were scheduled to be signed on April 17 and 18. But there were hurried last-minute negotiations with partners. Henry Breck and a few partners in the money management division, who enjoyed special profit-sharing arrangements at Lehman, wanted to be sure these arrangements carried over. (They did.) Negotiations with at least two banking partners threatened to break down. Alan Finkelson, who had reached an agreement with Lew Glucksman when he joined Lehman the previous summer to receive at least $750,000 in compensation and to go up to 2,000 shares of stock, would not sign without an agreement to honor these provisions. When this lawyer ultimately signed, he insisted on scrawling on the bottom of his contract that it was his understanding that he would continue to receive at least $750,000 annually. (Cohen later agreed.) Steve Schwarzman had another problem. He wanted out. He wanted to join his friend Pete Peterson at Peterson, Jacobs, and he discussed this with his neighbor Peter Cohen, who initially assured him they would “work something out.” Schwarzman took this as a pledge, and when word of this leaked, a tempest arose. If Schwarzman could depart, why not another partner? To permit one to escape negated the purpose of the noncompete contract, which was to tie up Lehman’s talent. Cohen had no room to maneuver. He told his neighbor there would be no sale if he did not sign. And Schwarzman, deeply disappointed, relented and was the last partner to sign. The announcement that “all the partners of Lehman Brothers requested to do so had signed employment contracts” was made on April 19.

There was also the matter of losses to contend with. There was a stipulation in the tentative agreement with Shearson that Lehman would meet a net worth test. That is to say, if Lehman’s book value dropped below $145.1 million, which was the value of Lehman’s equity as of March 31, 1984, Shearson could adjust the purchase price downward dollar for dollar. However, since Lehman losses were mounting, Bob Rubin says they agreed to lower Lehman’s net worth test to $133 million. But even this number started to look shaky. “During the three to four weeks of the merger,” admits Dick Fuld, “there was a tremendous amount I did not focus on in that period. There were losses.” In April, interest rates rose precipitously. “If Glucksman and Fuld were minding the store and saw that our losses were getting bigger and bigger,” observes one partner, “instead of sitting on them, they would have sold the securities. Their mind was not on the business.”

According to internal Lehman documents, the firm lost $37 million in April—and since banking and money management were together generating profits of about $10 million, this meant that losses credited to trading approached $47 million in April. There were further losses in the first two weeks of May.

According to Shearson documents, a Coopers & Lybrand audit of the Lehman Brothers Kuhn Loeb Holding Company revealed that by May 4—in just a month—the book value of Lehman had plunged from $145.1 million to $124.5 million. And it would drop still further by May II, the day the sale was finalized. According to a footnote in American Express’s 1984 annual report, their aggregate total cost for the acquisition, including fees, was $380 million. The footnote to their consolidated financial statements goes on to say: “The excess of the total acquisition cost over the fair value of net assets acquired was approximately $272 million and is being amortized using the straight-line method over 35 years.” Subtract one number from the other and the conclusion is this: Lehman’s book value on May 11, 1984, had plunged to $108 million.

Peter Cohen rejects this number, insisting that the true figure is “closer to $118 million,” though he will not provide an exact number. Chief operating officer Lane says the $108 million figure is accurate “from a bookkeeping basis,” explaining: “From January 1 to May 11, 1984, Lehman had operating and nonoperating losses of $59 million.” Lane says that these losses were not just in trading but included banking and branch office revenues that were off. They include, says Lane, reserves that Shearson set aside for severance payments, for legal settlements, and for bonuses. None would have been Lehman expenses, but they were legitimate expenses of a merger. In the course of a publicly announced merger, explains one Lehman banking partner, work often slows during negotiations; revenues unavoidably taper off; and those brokers bidding for shares traded by Lehman bid less, rightly figuring that Lehman is dealing from weakness.

Accepting Peter Cohen’s roughly $118 million figure for Lehman’s official net worth, this means that from March 31 to May 11 Lehman’s book value plummeted by $27 million, which represents a pre-tax loss of about $54 million—$74 million if one strictly follows the bookkeepers. To gauge the enormity of these losses using Cohen’s best-case calculations, consider: Lehman’s pre-tax profits fell from about $110 million between October 1982 and May 1983 to pre-tax losses of about $54 million in a comparable period a year later—a negative swing of about $164 million. Coupled with the exodus of partners, it means that in the ten months preceding the merger, Lehman’s book value plummeted by almost $57 million, or by about one-third.

Glucksman and Rubin say that some of the losses existed only on paper. They complain about the overly conservative way Salomon Brothers marked or valued their fixed-income and money management positions. And Rubin says he was never worried about meeting the net worth test. “Even if Salomon Brothers marked things differently, we said there was a whole list of other things. It was no problem,” he says. Those “other things” included an employee pension fund overfunded by $5.5 million, after-tax; tax reserves of about $5 million after-tax; an investment account, ranging from venture capital to European investments, that was undervalued by about $2 million after-tax; and real estate reserves worth about $2 million after-tax. In all, Lehman had about $15 million worth of after-tax assets not included in its publicly stated net worth. The reason, says Rubin, was the “conservative” way they did their accounting. Rather than lower the official $360 million merger price, which would have been publicly embarrassing to Shearson and perhaps fatal to Lehman if they resisted, Shearson amended the contract and abolished the net worth test. They knew they had a cushion. To be a stickler on the net worth test, Cohen reasoned, might lose them the “good will” they needed from Lehman partners to make the merger work.

Peter Cohen and Bob Rubin say that Shearson volunteered not to reduce the net worth test. Cohen also says that his audit of Lehman’s books produced “no surprises.” Not so, says one Lehman partner who was close to the negotiations. “We could have taken our tax reserves and offset a certain amount of our losses by saying these reserves were no longer necessary,” he says. “We went to Shearson and said that if they wouldn’t lower the net worth test, we’d make up the difference by using our tax reserves to boost our net worth. Also, we’d take in our revenues now. The problem is that if we accelerated revenues and the tax reserves were gone, Lehman would cover its losses and Shearson would lose. Their response was: Don’t do that. We’d rather show the losses and we’ll take all those goodies for ourselves. That was what the negotiations were about.”

When Lehman partners learned of this transaction, many groused. Were Glucksman and Rubin hiding these reserves to offset trading losses, and thus preserve their power? Did they even know of these reserves? Perhaps these assets would have hiked the sale price of Lehman Brothers, resulting in a larger payout to partners. Some partners saw incompetence, others deceit. “They were screwing their own partners,” observes a former partner. “By hiding these reserves, they could use them anytime they wanted to reverse losses. They were hoping the market would turn around. If not, they could use these reserves to offset losses.”

There were no surprises, insists Glucksman. Despite the evidence found in Lehman’s own internal gray books and Peter Cohen’s testimony, to this day Glucksman insists, “This company would have shown a profit for the period ending July 31, 1984.” Bob Rubin says, “We didn’t overlook anything. The overfunded pension can’t be taken into your income except over ten years.” Therefore the true one-year after-tax value of, say, the overfunded pension fund was only $500,000.

When the smoke settled, several previously undisclosed facts emerged. Lehman suffered losses that were never fully revealed to its partners. These hidden losses compelled Shearson to drop its net worth test. Lehman had assets whose full value may not have been included in calculating its stated $360 million sales price. Instead, these assets fattened Shearson’s net worth, not Lehman’s. And, as one banking partner wryly observes of Glucksman & Company, “They were remarkably conservative in valuing Lehman’s nonmarketable assets and remarkably lax in valuing Lehman’s securities.”

This controversy was related to one other that erupted around the time the merger was finalized in May 1984. It centered on the distribution of Lehman’s April gray books. A May 16 interoffice memorandum from the Lehman treasurer summarizes the firm’s April performance: “Gross income for the month of April was $10,161,000. After deducting expenses of $47,181,000, the loss before taxes and OIC [officers incentive compensation] was $37,020,000. No officers incentive compensation was provided this month. After a net credit for federal, state and local income taxes of $20,099,000, the net loss was $16,921,000.”

As soon as the gray books and this memo were distributed to all partners and principals, they were hurriedly retrieved. Messengers were sent to each partner’s office to get them. Michael Schmertzler scooped up Bill Welsh’s copy himself. “The books are wrong. Let me have it back,” Welsh recalls him saying. Some partners never saw them at all. When he returned from an uptown meeting, François de Saint Phalle discovered that his gray book had been snatched from his desk.

The order for the recall appears to have been suggested by Peter Cohen. Conceding that he was upset, Cohen says, “There was no reason to start publishing financial information subject to a great deal of misinformation. That gray book did not accurately reflect what went on.” Lew Glucksman says the numbers were inaccurate because the transfer of assets to Shearson made the losses appear worse than they were. “The firm never lost $37 million,” he says. “There was a write-down but not a write-up. It was to their advantage in terms of the sale to have a write-down.” In other words, Lehman’s treasurer wrote down all of the trading losses Salomon Brothers reported, without taking into account Glucksman’s disagreement over how Lehman’s securities were to be valued and without writing up the undervalued Lehman assets.

Whatever Glucksman’s explanation, many partners were irate, their ears closed to explanations. This one final act in the Lehman melodrama prompted partners to hyperbolically compare the actions of the messengers with those of Nazi storm troopers. Glucksman & Company, others said, were engaged in a Watergate-type coverup. It seemed to be part of a pattern. As partners weren’t told of Alan Finkelson’s deal, or ConAgra’s offer, or the secret bonus arrangement with three “senior bankers,” so they were not told of hidden losses that helped drive the value of their common stock down by $169.42 per share.*

It was a fitting close to a troubled partnership.

*Cohen says that Robinson, not he, made this point.

**In 1983, Cohen’s salary was $336,539 and his bonus $925,000. If the worth of the appreciation of his American Express stock was included, the worth of his 1983 earnings would dwarf those of one Lehman partner.

†Vice presidents were senior associates.

*According to the May 16, 1984, treasurer’s memorandum.