World Changers

It was May of 1969 when Dan Lufkin went to his very first meeting as a newly elected governor of the New York Stock Exchange. The investment banking firm he cofounded with two partners, Donaldson, Lufkin & Jenrette, had just filed a prospectus to take their company public.

At the time, it was an incredibly audacious move because Wall Street was dominated by private partnerships and there was no public ownership of the firms that effectively ran the markets. Yet the leadership of the Exchange was resistant to change even when it was becoming increasingly obvious that the status quo could not survive. As trading volume soared higher and the market demanded heavy investments in computers and professional management, many of these partnerships were starved for capital. Virtually all the cash they could raise came from either general or limited partners in their own firms and every investing partner had to be approved by the Exchange.

Just as constraining, a firm’s net capital had to match its trading volume every day. If not, a firm would be in violation of the Exchange’s rules and face a shutdown. By the late 1960s, Wall Street was in a severe crisis as a result. In 1969 and 1970, more than one hundred NYSE member firms, nearly one sixth of the country’s brokerage firms, would disappear. They either merged with other firms or simply went out of business. Thousands working in the securities business lost their jobs and careers.

Without broader access to more capital, Wall Street was facing collapse. Still, the old guard was reluctant to embrace change. They strongly believed that the rules brought personal accountability to the Exchange and were vital to the public’s trust in the markers. To take Donaldson, Lufkin & Jenrette (DLJ) public and gain access to public capital, Dan Lufkin and his partners would have to persuade the Exchange to alter its rules so that an investment bank could have public shareholders.

So when Lufkin walked into the august chambers of the Exchange for his first meeting, he carried with him a pair of brown Bloomingdale’s shopping bags overflowing with the company’s offering documents for the twenty or so governors who ruled the New York Stock Exchange. Lufkin went straight to Robert Haack, a governor who also held the position of president.

Recalls Lufkin: “His face went pale and he looked at me as if I had lost my mind. He took the bags I handed him and he literally ran to the podium where Bunny (Bernard) Lasker, the chairman of the Exchange, was conducting the meeting and said, ‘Mr. Chairman, I think you’ll want to see this.’”

For the next several minutes, after the documents were passed around the table, all one could hear was the shuffling of paper. Suddenly, breaking the silence in the room, Felix Rohatyn, then a partner at Lazard, stood up, holding the prospectus like a torch over his head.

Since the start of the Exchange, it had been a private club where tradition, ritual, and ego ruled. By attempting to go public, DLJ was breaking down the doors of that club to allow the public to get a piece of the action. To everyone in the room, that was heresy. “To use the word that Felix used, I was a traitor. They had a traitor in their midst,” Lufkin recalls, laughing.

It would take nearly a year of intense debate, but ultimately the Exchange altered its rules and DLJ became the first of the private partnerships on Wall Street to go public, paving the way for other firms to tap the public markets for capital. In the process, DLJ became a huge success, one of Wall Street’s top brand names, a firm involved in everything from securities underwriting and sales and trading to investment banking, venture capital, and asset management. When the company was sold in August 2000, Credit Suisse paid $11.5 billion for it.

At first, it would seem that Lufkin was an unlikely entrepreneur. When he went to Harvard Business School for his MBA degree in 1955, he had no idea of what he was going to do. Then, in his second year, Lufkin became fascinated by finance. Armed with his MBA, he went to work for a private investor, Jeremiah Milbank. It was there that the idea for DLJ was born. With William Donaldson and Richard Jenrette, Lufkin founded the firm just two years later in 1959.

Commissions on stock trades were fixed at that time, which was the late 1950s, so at Jeremiah Milbank we paid a lot of commissions supposedly for research that wasn’t very good. We did our own research and concluded we should invest in smaller companies where the returns were greater. We would go visit companies, spend time with competitors and suppliers, and conduct other kinds of research to do our own basic background work on industries and companies.

In good measure, the thrust of a small company is the long shadow of a single person. As the company grows, you get further and further away from that. We were interested in, and defined the market for, servicing institutions, and we did this by focusing on small, high-growth firms.

By and large, large member firms did not pay attention to smaller companies because there were no shares outstanding to speak of. The way large member firms made money was through the commission process, buying and selling large volumes of stock. If you were a small company, there wasn’t any stock or there was very little of it. It didn’t cover the overhead. It didn’t pay you to do any work on those companies. What we discovered was that the people we called on were so pleased to have someone take an interest in them that when they wanted to sell stock they would come to us.

Paul Williams, the president of O.M. Scott, the lawn care company, came to me and said, “You know I have some shares I want to sell.” It was a very thinly traded stock. And I called one potential investor and said, “I am going to offer you thirty thousand shares of O.M. Scott & Sons. I’m buying it from the president for $30 a share and I’m charging you $31.50.”

“Well,” I said, “we don’t sell this every day. We don’t have this every day. I think it’s really worth it. Look at it on the basis of the value you’re buying, not on the basis of five percent one way or another.”

That was something that was very beneficial to Paul, and as his company grew and they needed capital for a new plant or to enter a new market, they came to us. He said, “You know my company. You understand my company. You understand what we’re doing.” And then as the company grew and the principals began to build estates, they would come to us and ask, “What do we do with our money?” Well, we said, “We’re setting up an investment management capability and we would love to manage your money.” They knew us. We knew them. They trusted us. We did a lot of work for them. That was a logical extension of our services. That’s how that grew.

We also were learning another lesson, and this was the basis of DLJ and it was until it was sold. The integrity of the job and the character of the people are absolutely first and foremost. If you were going to provide these services, the sine qua non is that you are doing it with integrity, character, and in the customers’ interest. It’s obvious but not always in practice on Wall Street. A wise old professor at Harvard Business School once said, “Integrity is a function of the strain put upon it.” We made sure there was no strain put upon our integrity.

I would much rather be in the second-best business with the best people than in the very best business with the second-best people. If you’re defining the best people, it’s a given, assuming you’ve checked the person out, that he has management skills and knows the business that he’s involved with. Ultimately, however, the success of the business is going to depend on the character of the people running the company, and that’s what we looked for in our research.

The character of the people manifests itself in so many different ways. It is manifested in the loyalty of employees, the way the company treats its suppliers, and how the company articulates its responsibility to its employees and customers. These things ultimately spell success in a company. I don’t care what the company is selling or what kind of services it provides. Without that character, the company may get along for a while, but when the going gets tough, without that underpinning of strength and integrity, the company is not going to stay together.

Not a one said DLJ was a good idea. Sidney Weinberg came close to it when he said, “I won’t say it’s a stupid thing, but I don’t see how you can compete on the issues and in the areas you’re describing compared with the strength Goldman Sachs has, which shares your objectives but on a worldwide scale. And how will you compete with a Lehman Brothers, who has a hundred odd years of experience and a history of relationships? Relationships are enormously important.” He said, “I won’t say don’t do it, because you never know, but I wouldn’t say it’s an odds-on favorite.” That was the closest it came to “Maybe,” and everyone else said, “Are you crazy? Are you nuts?”

We didn’t rock or shake anything on Wall Street. One fellow at Lehman Brothers, who has since turned into a good friend, said, “We’re going to squash you like a fly on the wall.”

We had no business going into business. We had no source of income when we started. In fact, we didn’t have a business plan. We didn’t have any idea how long it was going to take. We raised around $240,000, mostly from our friends, because nobody else would give us a shot. Most of the people who put in money were our age, and included our classmates and friends.

I love the story about the reception you got when the governors at the New York Stock Exchange discovered you were going to go public. But what would have happened if the Exchange didn’t go along?

Well, in that prospectus there were risk factors associated with the offering. One of them was that if the New York Stock Exchange did not change its rules, we would have lost 70 percent of our revenues and would have been well into the red. Anyone buying these securities had to recognize they were at the whim and will of the New York Stock Exchange. And if it didn’t change the rules—and there was no indication they intended to—our volume would be cut by 70 percent and we would be making no money. Those are tough bananas. Had they not made that rule change, we would have tried to go public but I don’t think there would have been a guy in the world who would have bought the stock.

The Stock Exchange was about as undemocratic an organization as you could imagine. It was just a money machine until fixed commissions were eliminated in the middle of the seventies. And they were very interested in maintaining the status quo. There was no reason for any change nor was there any reason to do something differently. Everything was working just fine. If it was not broken, don’t fix it. Their fiefdom was intact.

The night after that meeting where I brought the prospectus I went to an Exchange dinner. It was the changing of the guard. The old governors were going out and the new governors were coming in. I go there and I’m by myself. I go to talk to someone and he turns away. I am standing by myself in the corner. I’m having a beer and no one will talk to me. So I just drank my beer and finally Gus Levy, the former chairman of the Exchange and a partner at Goldman Sachs, came over to me and said, “Well, I don’t agree with what you’ve done today, and I certainly don’t agree with the way you’ve done it. I don’t like it and I don’t like it one bit. But I will say one thing: I admire your courage to come to this dinner tonight.”

Confidence may be too strong a word. But we really felt this was the right thing to be doing. The underpinning of equity capital in Wall Street was very much in danger. Not only was it modest in numbers, it was dangerous. When partners retired they had the right to withdraw their capital, and there were some provisions that allowed a retiring partner to space those withdrawals out. So not only was the number small, but the permanent capital, which was even more devastating, was transient.

It not only made common sense but it was almost a necessity that there be permanent capital. And the only form of permanent capital was shareholdings, which is why you could sell the shares and not impact the capital of the corporation. It just changed who owned it. I had worked with the chairman of the Exchange to try to energize a commission the Exchange had formed five years earlier called the Rockefeller commission. It never did a damn thing. I don’t even know if they had meetings. There was nothing coming out of it. I tried to talk to Pat Rockefeller and he had no interest in the subject. That wasn’t going anyplace. We figured we had to look at another tack.

You could always raise more capital if you had people willing to put it in. But remember, there was always a time frame attached to it. The net capital rule was a complicated thing, but the bottom line was that you needed a certain amount of capital to do a certain volume of business. And you report your net capital every day, every single day. So by 3 P.M., the operations manager had a form he filled out and it reflected the volume of business you were doing on the Exchange and reflected the net capital. And that was a calculation made of your ability to do business at a certain volume. It was very strictly controlled and regulated and very strictly adhered to.

So yes, you could raise more capital but it was not easy. It was locked-in capital. It was private and there was no market. So it was not easy at all. The amount of capital you needed and what you had to give for that if you could get it was growing exponentially. When the capital was needed most was when the market was in stress. There were a number of violations of the net capital rule in the late sixties and early seventies due to merger mania. Many firms were driven into forced marriages to get capital to support the growing volume they were handling. Not only was there impermanence of capital through the partnership structure, but the nature of the beast was that there were failures, dislocations, and back-office screwups. To raise permanent capital in that environment was doable but certainly not easy.

No. It never had. The rule was that you could have anyone you wanted but they had to be approved individually by the board of governors of the New York Stock Exchange. If you’re selling shares to the public and the offering goes effective in the morning, and six thousand people buy shares, they are illegal until they are approved by the New York Stock Exchange. You can imagine how unworkable that was. You had to get rid of the fact that each shareholder had to be approved by the governors. That’s what we were challenging.

It happened almost immediately. All of the people who were yelling traitor and Judas suddenly looked around and said, “You know something. This solves our problem. This works for us.” I’ll never forget a man we knew and had done some business with. Tom Staley was his name. He was a very fine gentleman and banker.

I got a letter from Staley a year later saying, “I just want you to know I was against what you did. I didn’t think it was correct or appropriate for the Exchange. But I was wrong, totally wrong. And had you not done what you did our firm wouldn’t exist today. So I thank you from the bottom of my heart.”

That’s true. We were looking at the character involved, and especially when someone had to make difficult decisions when he or she was in the minority—to travel unwaveringly down a difficult road. I think back on the Exchange and the decision to go public. It did take a bit of courage. And we had to stay the course. There were times when we wondered what were we doing here. Those were tough times. That is true in any great business. You have to have the courage to stay the course. And there are times when you don’t even know if it will work, but you have to stay the course. That goes to the technical skills of the people involved, the product quality, the sales organization, the service organization, all those things play into it.

A lot has been said about the risks entrepreneurs often take. Certainly, you were taking a big risk in assuming that the Exchange would change its rules to allow you to go public. What’s the greatest risk an entrepreneur can take?

I think the greatest risk of an entrepreneurial career is not to embark on a venture. I think you can’t lose in an entrepreneurial career. You gain enormous experience.

Whether you fail or win, it is time very well spent. You learn a lot about yourself. You gain great self-confidence. And most other people don’t have it. Wasn’t it Teddy Roosevelt who said that the real crime is not to try? That’s what I’ve learned more than anything else.

People associate entrepreneurship with risk. Entrepreneurs don’t think about it that way. They think, “I can get this done.” The only risk an entrepreneur can take that is untenable or stupid is to go ahead without having enough capital or time to really see their venture work or not work, whatever the case may be. It’s one of the reasons our plan for DLJ only encompassed one thing.

We didn’t have a business plan, but we had an idea. We didn’t have any way of knowing how it was going to play out, but we said we wanted to give it a chance. So we figured out how to finance three years of business without ever earning a dollar. We could have built nothing in the first three years and still been in business. Most entrepreneurs underestimate the amount of money or time it’s going to cost to get the job done—and time is another form of money. As a result, entrepreneurs underfinance. When they do this, unless they have the good luck of being able to go back to investors again and again, entrepreneurs will not have the opportunity to see an idea through to the end, right or wrong. I think that is when a risk is unnecessary and foolish to take.

When you look back at having opened the door for the private partnership on Wall Street to go public, do you have any regrets? Because there are some who believe that public ownership allowed firms to gamble with other people’s money and to become reckless.

The truth is there would be no Wall Street, and we would not have the greatest capital market in the world. And we would not have had the growth that was engineered in the sixties, the seventies, the eighties, and the nineties without significant expansion in the capital base of Wall Street. It just would not have been. You wouldn’t have had anything. That’s someone trying to be smart.

If I had the smarts, I would be right in the Web. I would be doing apps for Apple. That’s what I would be doing. They used to say, if you don’t have any money, you do one of two things: You go into real estate where you borrow the moon, or you go into the creative world where your talent is your money. Today you can go and develop apps for Apple and Google.

I think that as you get older, as you move through life’s stages, you begin to look for different kinds of return. There’s a return on life, which is happiness, and we all forget the ultimate measure of success, which is good health.

One of the things I often refer to is The Little Prince. There is a quote in there that I have written down: “A rock pile ceases to be a rock pile the moment a single man contemplates it, bearing within him the image of a cathedral.” I think if you try to put one thing down about what makes an entrepreneur, he looks at the rock pile and sees a cathedral.

I thought about it and told her I would leave self-confidence. In all of the things we discussed, whether it’s integrity and character, the way you run your business, seeing a cathedral in the rock pile, going public when people are calling me a traitor, you need an underpinning of self-confidence to make it work.