Dan, Dick and I, we all made an equal contribution in trying to build something that was really unique.
—WILLIAM DONALDSON
Photo courtesy William H. Donaldson.
“Judas Iscariot!” Felix Rohatyn exclaimed when he heard the news. It’s unclear which founder of Donaldson, Lufkin & Jenrette he was referring to—perhaps all three. Like him, the three young men were rising young leaders on Wall Street during the 1960s, but while Rohatyn (just forty-one) was a lead partner with the tradition-rich, century-old Lazard Frères investment banking firm and was just finishing his term as a governor of the New York Stock Exchange, Bill Donaldson (thirty-eight), Dan Lufkin (thirty-seven), and Dick Jenrette (forty), were upstarts in the securities world. They had formed “DLJ” just ten years earlier, only a few years after graduating from the Harvard Business School, and had been members of the exchange since the firm’s inception. But now, on May 21, 1969, in utter defiance of the rules of the NYSE, they announced that DLJ was going to sell its common stock to the public. Everyone knew that could break up “the club.”
From the time of its founding in 1792—under a buttonwood tree on Wall Street, according to legend—the exchange enjoyed a cozy, club-like existence under rules requiring that all prospective new members be approved by the board of governors before they could trade on the NYSE. Ostensibly, that system ensured that all individuals operating on the exchange were financially sound and upstanding—not mobsters or other undesirables. It was a manageable system as long as the firms were partnerships or closely held corporations, where a small number of owners could be checked for suitability. If DLJ went public, however, there would be thousands of new owners of the firm and no way for the exchange to vet them all.
But Rohatyn’s rage—which was matched by the rage many other NYSE governors directed toward DLJ’s management—wasn’t just about the problem of screening new exchange members to ensure that only the “right people” were admitted. The larger issue was more self-serving. It was a matter of protecting the securities industry’s profitability. Since the 1792 Buttonwood Agreement, NYSE brokers had agreed to adhere to a fixed schedule of commissions, and they also agreed to limit the number of memberships, commonly called “seats,” on the exchange. Stripped to its essence, a seat was a license that allowed the holder to trade in NYSE-listed stocks, either as an agent for customers or for one’s own account. In 1969 the number of seats was limited to 1,366, and DLJ purchased two of them from former NYSE members to facilitate buying and selling stocks for its institutional investor customers.
If seats became available to the public, however, the exchange’s governors feared that big customers, especially the institutional investors (banks, insurance companies, and mutual funds) that chafed under artificially high commission rates, would become NYSE members. The reason institutions wanted a seat would not be to act as brokers, but rather to trade on their own behalf and avoid the commissions altogether. If that happened, the long-established exchange cartel could be irreversibly undermined.
It didn’t help matters that the principals of DLJ gave the exchange no prior notice of their plans. Rather, they approached the filing of their proposed initial public offering like a secret military mission with a surprise attack as the tactic. (All three had been junior military officers—Donaldson and Lufkin in the Marines and Jenrette in the Army.) They were aware that a NYSE committee had been studying public ownership for the last several years. But the committee’s work was going nowhere, and DLJ was a firm in a hurry. The firm’s business had become capital intense and it needed an infusion of new funds to support continued growth. Rather than asking permission to go public—which they knew would not be granted—Donaldson, Lufkin, and Jenrette charged ahead in secrecy. On May 21, they called a series of meetings with exchange officials, informing them that at precisely 2 p.m. the next day a registration statement would be filed with the Securities and Exchange Commission covering 800,000 new shares of DLJ stock to be sold for over $20 million.
By existing NYSE rules, the move was illegal. And if those rules were not changed in the months before the SEC approved the registration and the IPO got under way, the firm had real problems. A particularly ominous disclosure in the filing with the SEC stated that a large majority of DLJ’s revenues would vanish if it lost its membership on the NYSE. DLJ’s move was the ultimate bet-your-company decision.
What Do You Do on Wall Street?
DLJ was a corporation run in the spirit of a partnership, with “all for one and one for all” the proclaimed management style. But as the CEO, William Donaldson bore ultimate responsibility for the decision. DLJ’s planned IPO would ultimately revolutionize much of the way Wall Street did business, but Donaldson wasn’t exactly the revolutionary type. Calm, deliberate, and personally charming, he came across more as a reconciler than as a bomb thrower. (As it turned out, he wasn’t much of a bridge burner either—many years after his apostasy, the greatly transformed NYSE recruited him to serve as its chairman.)
Donaldson portrays himself as an entrepreneur, but one with “peripheral vision” to see the lurking problems and to think one or two steps ahead and plan for the inevitable setbacks. That coupling of entrepreneurship and caution may have developed as a result of a childhood spanning the Depression of the 1930s and the war years of the 1940s. During his youth in Buffalo, New York, he thrived on starting small enterprises—including United Enterprises, a service business he founded and managed during his teens that employed more than fifty high school and college students to paint houses, tend lawns, and do minor carpentry—but he was also a firsthand witness to the downside of entrepreneurship. During the Depression his father lost the small automotive castings business that he started in the 1920s and spent the better part of his life repaying its debts. “It had a major influence on me,” Donaldson later remarked.1
He followed in his father’s footsteps to Yale University, where he was a member of the secretive Skull and Bones and the student manager of the Yale Daily News. The Korean War started while he was at Yale, and upon graduation he joined the Marines. By the time he finished his training at the Marine base at Quantico, Virginia, the war was over, and he served his time in noncombat duties in Japan and Korea. The Marine experience was an important bond between him and Dan Lufkin. They both went to Yale and then the Harvard Business School, but according to Donaldson, their service in the Marines may have been the most meaningful shared experience. “There were many things we learned in the Marines that we applied at DLJ.”2
Donaldson’s last assignment in the Marines involved serving as aide to an air wing general, and that spurred his enthusiasm for the developing aviation industry of the early 1950s. “I was convinced that helicopters were the wave of the future and that everybody was going to have one in their garage.”3 The general set him up with a job with Sikorsky Aircraft, a major helicopter manufacturer, but Donaldson found life in the corporate world uninteresting and slow paced. He was offered another aviation-related job as a ticket taker for the recently organized New York Airways, but “that also didn’t seem right for a former Marine Lieutenant.”4
It was only by happenstance that he found a job in the investment banking business. Talking with one of his friend’s fathers who worked at the medium-sized G. H. Walker & Company, he asked, “What do you do here on Wall Street?” and was greeted with a surprising response—a job offer.
He served three short stints at G. H. Walker—one before, one during, and one after Harvard Business School. During his first experience he was involved in a number of transactions, acting mainly as a “bag carrier,” but the work piqued his interest in investment banking—and convinced him to apply to Harvard. During the summers between his first and second years at the business school he went back to G. H. Walker. This time he was in Salt Lake City rather than on Wall Street, working on operational problems with a wax refinery in which the firm had invested. That assignment became a turnaround opportunity, and he was asked to stay past summer in Salt Lake to assist in the company’s revival. He was sorely tempted but elected to return for the second year of business school. After graduating with his MBA in 1957—“imbued with a real appreciation for the positive side of collective thought and a great belief in the case method”5—he went back to a permanent job at G. H. Walker, this one in the firm’s mergers and acquisitions department.
Elevator Speech
During the two years he spent at G. H. Walker following his time at Harvard, Donaldson grew into a competent investment banker and earned his keep at the firm. At the same time, Lufkin—his college and business school classmate and fellow ex-Marine—was then working as an analyst for a private investor, Jeremiah Milbank. Their entrepreneurial instincts took hold, and before they were twenty-eight, Donaldson and Lufkin began engaging in “collective thought” and plotting the formation of their own investment firm.
From what he saw of it at G. H. Walker, Donaldson was convinced that the research coming out of Wall Street in the 1950s was “statistical, shallow, and superficial” and “totally focused on the retail mass-market.” He envisioned a much different form of research for the more sophisticated institutional investor that “would be a lot closer to what a McKinsey consulting firm might do than to just a Standard & Poor’s recommendation of the week.”6
It was Lufkin who realized that this research overlooked smaller companies in particular. In investing for the Milbank interests, he discovered a decided cleavage between the stocks of well-known, major companies and those of smaller, lesser-known companies. In 1959, individual investors and portfolio managers were not long-term investors in equities, and with memories of the Depression era still vivid, they tended to limit their exposure outside the bond markets to “the Generals”—General Motors, General Electric, General Mills, General Foods, etc.—and other well-tested and well-capitalized companies. But in their attempt to avoid risk by sticking with the bigger name stocks, Lufkin believed the institutional investor was actually taking on undue risk as the market bid up their prices to unsustainable levels. He became convinced that among the smaller companies that everyone was avoiding, there were many well-performing operations whose stocks were selling at bargain-basement prices.
Sizing up their own strengths and weaknesses, Donaldson and Lufkin concluded that they needed a third leg to the stool. They had their basic business mission—providing institutional investors with high-quality research on small- to medium-sized companies—but they reasoned that it would be good to have someone more seasoned in business to act as a foil for their aggressive and entrepreneurial tendencies. So they recruited another Harvard Business School classmate, Dick Jenrette, who became the “J” in DLJ. “My mission,” Jenrette later explained, “was to use my experience to tame Bill and Dan—to restrain their youthful exuberance, if you will.”7 He was all of thirty years old.
Jenrette had just been promoted from a research analyst to a portfolio manager at Brown Brothers Harriman, an old-line private bank that catered to high net worth individuals. When Donaldson and Lufkin approached him, Jenrette recalls, “I didn’t think the business plan made a lot of sense. But I knew we’d figure out some way to make money.” Jenrette’s explanation of his decision to leave Brown Brothers illustrates the casual manner in which DLJ began:
Brown Brothers was wonderful, but on the other hand, it was too slow. I’d be there forever and there wasn’t much mobility. Bill and Dan were two very exciting people that I’d known in business school, and I knew they’d be successful in one way or another. We were all bachelors at the time, so we said, “Let’s go for it.”8
One problem? The three partners of DLJ had no start-up capital. In order to raise funds, Donaldson says, “We got into the car and drove around to talk with friends and classmates and people we’d grown up with and people who had some confidence in us.”9 By this time, the three men had perfected the elevator pitch they made to their prospects, explaining the need they saw for high-quality investment research on smaller companies. They pointed out that institutional investors were becoming a much more important factor in the stock market because of the growth of pension funds and mutual funds. But because of the conservative bent of the managers of institutional portfolios, the lion’s share of their common stock investments was dedicated to a handful of very large and well-known “blue-chip” companies. Yet there were hundreds of well-managed but smaller companies—and the common stocks of those companies were available at very attractive prices. The problem, they told their prospective investors, was that institutions wouldn’t touch these smaller companies because there was no source of credible information and analysis to make them comfortable about the safety and prospects of such companies.
And that, they told their prospective investors, is where said DLJ would come in. It would be the first firm to perform in-depth research on the most promising smaller companies and package it into comprehensive and professionally prepared reports to justify the purchase of their stocks. DLJ, they maintained, would employ the best and brightest minds on Wall Street and would be uniquely positioned to benefit from the growing volume of commission dollars being generated by institutional investors.
Despite the logic and enthusiasm of the pitch, the reception from potential investors was mixed at best. Wall Street veterans were particularly unmoved by the idea that a start-up firm with a new approach to the investment business could succeed. Lufkin solicited ten industry leaders on Wall Street, and the most favorable comment he received about the DLJ plan was from Sidney Weinberg, then the head of Goldman Sachs: “I won’t say don’t do it, because you never know, but I wouldn’t say it’s an odds on favorite.” Most bankers were much less measured in their response, with Lufkin’s contact at Lehman Brothers being the most direct: “We’re going to squash you like a fly on the wall.”10
Despite the lack of enthusiasm from the investment establishment, the DLJ founders were able to round up $240,000 from old friends and classmates. It was short of their $300,000 target, but with the $100,000 they came up with themselves, it was enough to get started and pay each of them $7,000 per year in salary.
“We Hit a Gusher”
At the time of DLJ’s launch in 1959, the three principals wrote an influential, fifteen-page pamphlet called Common Stock and Common Sense that set forth the case for small company investing. (Donaldson still keeps a supply of the pamphlets in his office.) The pamphlet restated the argument for investing in smaller publicly traded companies, but now, buttressing the case with quantitative analysis, they produced a ten-year analysis of investment results showing that stocks of the larger companies—referred to as the “Favorite Fifty” or the “Nifty Fifty”—were selling at prices that greatly overvalued their present worth and future prospects. At the same time, the market was greatly undervaluing the much larger population of small- to medium-sized companies. With a disproportionate amount of money flowing to the safe-bet stocks, their prices soared. Between 1949 and 1959, the earnings of the Vicker’s Favorite Fifty companies doubled—but their stock prices increased sixfold. The reason for the disparity between the growth in the companies’ earnings and the growth in their stock price was “multiple expansion.” As explained in Common Stock and Common Sense:
The most significant change in the position of the 1959 investor vis a vis the 1949 investor is in the multiple of earnings reflected in common stock prices today. Today’s “Favorite Fifty” stocks are selling at price-earnings ratios which average 21 times estimated 1959 earnings. Ten years ago these same stocks could have been purchased at prices averaging 7.7 times 1949 earnings.11
At the same time, much of the rest of the stock market universe—the thousands of publicly traded companies that were not part of the Favorite Fifty—was stuck with 1949-level price-earnings multiples. That was DLJ’s opportunity—to point investors in the direction of these promising, overlooked companies.
The DLJ-produced reports would go deep into the operations of the business, including manufacturing and marketing, and into an evaluation of management and strategy. Donaldson placed a lot of importance on “scuttlebutt research,” a hands-on approach that entails getting out in the field and talking to competitors, customers, and the company’s middle management. That kind of research, he believed, would have appeal and value to a growing number of institutional investment managers who, like the DLJ founders, held MBA degrees.
Jenrette, whose nickname at the firm became “Bear” because of his caution and second-guessing, understood the niche in the market his partners intended to address. But he was initially skeptical about that niche being sufficiently large to support a full-fledged business. “We can produce twenty reports a year and prudently buy only 10 or 20 percent of the float of these companies,” he said to his partners. “Now, multiply that out by the number of shares times the commission. The net is we can’t make any money on this.”12 Jenrette’s statement, on its face, seemed to undermine DLJ’s very business model. But Donaldson had a ready reply to Jenrette’s concern—one that was tied to a membership on the New York Stock Exchange.
From their first day in business, Donaldson insisted that the firm become a member of the exchange. He thought NYSE membership would lend prestige to the young firm; he called it a “Good Housekeeping Seal of Approval.” Membership also carried a very tangible benefit: access to the substantial commissions institutional investors had to pay in those days when they bought or sold the common stock of exchange-listed companies. Before the NYSE began offering volume discounts in the early 1970s—and before the SEC mandated the end of fixed commission schedules a few years later—a bank or mutual fund buying or selling 100,000 shares of stock paid the same percentage rate as a retail investor who traded just 100 shares. As a result, the institutional investors, however reluctantly, sent a high volume of commission dollars to Wall Street.
Donaldson hatched a way to share in that commission bounty. The companies on which the firm’s analysts prepared research reports were usually traded over the counter and were too small for an NYSE listing, but Donaldson asked the portfolio managers at the institutions to reward the firm by directing NYSE commission business its way. “We didn’t want to be compensated for just our ideas. If our ideas were any good, we told them to pay us in anything they wanted. We told them to buy General Motors through us, or whatever they wanted, but just give us a flow of brokerage dollars.”13 So when DLJ created value to the institutions with its fresh, comprehensive, and insightful thirty- to forty-page reports on smaller companies, the firm asked to be compensated indirectly by handling the institutions’ trades in other common stocks. That approach worked. Later, commenting on the viability of the DLJ business model, Jenrette said, “Citibank, Chase, Putnam, and Fidelity had to pay out large fixed NYSE commissions and were getting lousy research. They were also glad to get someone to look at these small, innovative companies. So the commissions began to pour in, and we hit a gusher.”14
The Case for Going Public
For many years, few knew how big the DLJ gusher had become. In its first ten years, total revenues grew to over $30 million, with the majority coming from brokerage commissions from institutional investors. Most of those commissions, as Donaldson had hoped, were directed to DLJ as a reward for the firm’s good ideas. A 1964 BusinessWeek feature article on the firm recounted its many successful recommendations—along with some losses—and reported that the firm’s fifty-one basic recommendations, made over its first four years in business, performed 50 percent better than comparable investments in shares of the thirty companies making up the Dow Jones Industrial Average.15 That level of success caught the attention of Wall Street and the gusher of business grew larger as more institutional investors signed on as DLJ customers.
In addition to trading on its demonstrated stock-picking skills, DLJ enjoyed a powerful tailwind provided by the coming dominance of institutional investors in the stock market. Donaldson remembers that when he started in the business, “something like 95 percent of the stock in this country was owned by individual investors. Of course, that all reversed in the next twenty years.”16 In the five years following 1964, the business model that the three founders of DLJ were unable to sell to skeptical investors on Wall Street in 1959 was working far beyond anyone’s imagination.
The firm’s profitability was even more impressive than its growth. Most well-run businesses operate with pretax profit margins of between 10 and 30 percent. Throughout the 1960s, DLJ’s pretax margin averaged close to 50 percent. Part of the reason for its high margins was the low level of employee compensation compared with revenues. The firm hired talented people and paid them well, but unlike other Wall Street firms, DLJ employed virtually no full-time salespeople. It didn’t need the hundreds, or even thousands, of stockbrokers who generated commissions at a retail-oriented firm. Furthermore, the firm invented a new kind of employee, called the analyst salesman, who contacted institutional investors directly. With the firm’s focus on institutional research, almost everyone in senior management was an analyst and a salesman at the same time—including Bill Donaldson, Dan Lufkin, and Dick Jenrette. According to Jenrette, “If we did a report, I would go out and talk to Fidelity, Putnam, and Morgan Bank. We bypassed a whole expensive sales force.”17 By the end of the firm’s first decade in business it employed two PhDs in economics, fifty MBAs, five law school graduates, and five CPAs—and most of them were analyst salesmen.18
Since it was a corporation (rather than a partnership), the large profits that DLJ earned during its first ten years were retained in the business. The result was that the firm, by the end of 1969, had a stockholders’ equity position of approximately $25 million. That meant that, unlikely as it may seem, the Wall Street upstart was operating with more capital than most of the established investment bankers. Morgan Stanley, still the grand doyenne of investment banking, had a capital position of only $18 million. The puny levels of capital on Wall Street had partly to do with the nature of their operations and the legal structure of most firms. Although the situation would change quickly in the subsequent decades, the investment business was not yet capital intensive. Firms like Morgan Stanley needed some amount of capital to support their underwriting activities, but much of it could be readily obtained by borrowing from banks. Otherwise, their day-to-day activities revolved around advisory work that didn’t require a large balance sheet.
Another factor accounting for low capital levels was the partnership format. At the end of each year, the partners at most firms would “carve up the melon,” dividing the profits among themselves without much thought of leaving anything in the business. Further inhibiting capital expansion, the partnerships were begun afresh each year, and partners were usually allowed to withdraw their capital contributions on an annual basis. As a result, there was little stability, much less growth, in partnership capital.
Given that it was already so well capitalized, why did Donaldson, Lufkin & Jenrette feel the need to shake up the financial world by becoming the first investment firm to tap the markets with a public offering? At the anticipated offering price of around $30 per share, the 800,000 new shares sold in the IPO would result, after offering expenses, in something over $20 million in new equity capital. So while it seemed that such a move would make the firm awash in capital, there were a few good reasons to move in such a direction.
The simplest reason: because it could. In a 1969 poll conducted by the Institutional Investor magazine, professional investors were asked to pick the most valuable investment firm should any of the twenty-three leading Wall Street firms go public. DLJ wound up at the top of the list, ahead of runner-up Goldman Sachs. The average estimate of the price-earnings multiple for DLJ’s stock upon being publicly traded was 23.5.19 So with the apparent support and respect from Wall Street’s smart money, it was a near certainty that the firm’s IPO would be well received.
There was also a legitimate business reason for an offering. Institutional investors, sick of paying high commissions when trading in NYSE-listed stocks, began demanding a new service from brokerage firms called block positioning. Rather than buying or selling shares piecemeal (and tipping off other market participants of their intentions), the managers of pension funds and mutual funds wanted investment firms to better earn their handsome commissions by assembling and trading large blocks of stock—and using their own capital to do so. DLJ was one of the few firms active in the block trading business; by its own reckoning, it had made capital commitments of over $200 million in connection with block transactions in 1969. But that level of activity accounted for just 3.6 percent of all block trades on the NYSE in that year.20 Goldman Sachs and Salomon Brothers, with more capital to commit, were dominating the business. If it wanted to further enhance its credibility with its institutional customers and gain market share, DLJ needed additional capital.
The Big Board Relents
By 1969, the young founders of DLJ were convinced that an IPO was the right move. But the governors of the New York Stock Exchange did not feel the same sense of urgency. A few years earlier, they had formed a public-ownership committee to study the matter, mainly in reaction to mammoth paperwork jams earlier in the 1960s that disrupted the market and drove a number of NYSE member firms into bankruptcy. The committee recognized that the problems were caused at least in part by the failure of member firms to invest in the equipment and technology needed to keep up with the flow of paperwork. And that failure, more often than not, could be tied to the inadequacy and impermanence of their capital. Yet the NYSE still didn’t act on the problem. Donaldson noted, “There’d been countless meetings of the NYSE’s public-ownership committee and they all ended the same way, with everyone saying, ‘Gee, this is a problem!’”21
The main stumbling block to action was that the problem, while recognized by all, could not surmount other interests. According to Donaldson, “Older partners in the older firms wanted to keep the earnings and take the money out of the business.”22 In addition, there was the long-held notion that member firms would be more prudently managed if the owners had their own capital at risk; bringing in outside shareholders would presumably make management more prone to risk-taking behavior. And overarching it all was the fear that opening NYSE membership to outsiders would lead to the erosion of revenues if banks and institutions became exchange members to avoid paying commissions to brokers.
Finally, with the meetings yielding nothing of substance, Donaldson and his partners decided to force the issue and began a supersecret process to go public. They hired First Boston, then a major U.S. securities underwriting firm, to manage the offering. It was a provocative decision, since First Boston, which was a publicly owned firm and therefore denied NYSE membership, had hinted at initiating an antitrust suit against the exchange.23
At exactly four o’clock in the afternoon on May 21, the day before the registration statement for the IPO was to be filed with the SEC, Donaldson went to the office of Gustave Levy—a Goldman Sachs partner and until recently the chairman of the NYSE—to break the news. Then he went directly to the exchange to meet with its president, Robert Haack. Meanwhile, Dan Lufkin met with the exchange’s chairman, Bernard Lasker.24 The message was the same in all of the meetings, as described by Donaldson:
We told the Stock Exchange what we had done. We didn’t ask permission; we just did it. We talked about the paradox of Wall Street promoting public ownership and yet not allowing its own institutions to be publicly held. We had analyses about the capital needs that were coming into Wall Street and how inadequate the capital was for trading inventories, block placements, and financing the many new businesses that were coming along. As we showed, Wall Street was under-capitalized because so much of the money had been taken out of the street, year after year after year.25
The May 21 meetings were far from pleasant. To the establishment members of the “Big Board,” the planned IPO looked to be a nearsighted move of an impetuous management. Lazard’s Rohatyn referred to the “adolescent showmanship” of the DLJ principals and NYSE president Haack and Donaldson exchanged words that day “that are not likely to be forgotten by either man.”26 But by the time the DLJ offering was approved and sold on Wall Street, nearly a year later, the NYSE governors had relented. After putting in place a number of new rules making it more difficult for institutional investors to bypass the payment of commissions, they permitted public ownership among NYSE member firms.
Besides being comfortable that the new rules would make the scourge of institutional membership less likely, the exchange’s more conciliatory attitude toward public ownership may have had a touch of self-interest as they came to realize the windfall that public ownership could bring. When DLJ’s planned stock offering was announced, the expected price of the stock was more than eight times the firm’s book value. That meant that the owners of DLJ would enjoy a major jump in the value of their stock holdings as the firm transformed from a closely held business to a publicly traded company. Based on the information in the offering prospectus, Donaldson, DLJ’s largest shareholder, would see his holdings increase from a stated value on the books of about $3 million to a market value, at least on paper, of $25 million. Lufkin and Jenrette, with slightly lesser holdings, were also prospective multimillionaires.
The coming fortunes of the DLJ principals could not have escaped the attention of their counterparts at other firms. At the time, the NYSE had 645 member firms, owned by some 11,250 stockholders and partners. Even if their market price to book value was not as generous as DLJ’s eight-to-one multiplier, most of them could expect a major boost in their net worth if they were to do an IPO. In a 1969 Fortune article, writer Carol Loomis made a rough and “fanciful” calculation showing that those 11,250 owners might, if their firms went public, enjoy a gain in the value of their holdings of about $1 million each.27
Opening the Floodgates to the Capital Markets
The long-held fear that publicly traded institutions would become members to avoid commissions was never realized. Instead, institutional investors put pressure on the NYSE to get volume discounts to reduce commission charges. And the disclosures in DLJ’s prospectus also helped take down the NYSE’s practice of setting minimum commission levels. As Jenrette noted, “The institutions cited our high level of profitability to show that their commissions were too high. I think that by letting it all hang out, everyone—customers, competitors, imitators—saw how very profitable our business could be. The institutions—our customers—used this information as ammunition to beat on the SEC and, finally, to eliminate fixed commissions.”28 In 1973 the SEC announced, “The Commission will act promptly to terminate the fixing of commission rates by national stock exchanges after April 30, 1975, if the stock exchanges do not, on their own initiative, adopt rule changes achieving that result in advance of that date.”29 So in the end, DLJ did have a role in busting up the club, though not, perhaps, in the way initially envisioned by the exchange’s establishment members.
The indirect role DLJ played in bringing fully negotiated commissions to the NYSE was of major consequence. But the impact of the firm’s initial public offering was ultimately far broader. By opening the gates to the capital markets for Wall Street firms, DLJ led the transformation of the securities business in both its size and scope. DLJ’s offering was followed the next year by Merrill Lynch, and shortly thereafter by most of the other major retail firms of the day, including E. F. Hutton, Bache, Paine Webber, Jackson & Curtis, Reynolds Securities, A. G. Edwards, and Dean Witter. Lufkin recalls receiving a letter from the Reynolds’s chief executive, Tom Stahle, in which he said, “I just want to tell you something. I really wondered whether the rule change was the right move, but now we are in the process of putting together a public offering.” Without access to the public markets, Stahle opined that “there would be no Reynolds in another year.”30 For the retail firms, access to capital was key, and this new source came just in time to support the branch expansions and technology enhancements of the latter part of the twentieth century.
Wall Street’s major investment banks also joined the move toward public ownership. Goldman Sachs—the most prominent of the old-line partnerships—was one of the last to succumb, finally going public in 1999. In 2005 even Lazard Frères, the most private of all banking firms, went public. Unlike the retail firms, however, most of the new money raised by the investment banks did not go into equipment and infrastructure. Just as DLJ used much of its newly acquired capital for block positioning and other trading activities, the Wall Street firms tended to use their capital, for better or for worse, to increase the level of their principal transactions—securities trading, risk arbitrage, bridge lending, private equity investing, venture capital, and even hedge fund investing.
Profits earned at the investment banks as principal soon exceeded profits from the traditional agent-based businesses. When DLJ opened its doors, Morgan Stanley held sway over Wall Street, advising the bluest of blue-chip companies and working with the precious little capital its risk-averse partners thought was necessary; when DLJ essentially closed its doors—or at least lost its identity with the merger with Credit Suisse—the new version of Morgan Stanley was on its way to building a trillion-dollar balance sheet and traders were in the ascent.
Separate Ways
The threesome that founded DLJ did not stay intact long after the firm’s 1970 IPO. Dan Lufkin left the following year for a three-year stint as the first commissioner of environmental protection for the state of Connecticut. He later cited Georges Doriot in explaining his departure:
As General Doriot, the old professor at Harvard Business School, used to say in his French accent, “Gentlemen, you must remember that there are three types of people who run an organization. First is the entrepreneur, who begins the business. Second is the manager who develops the business and third is the manager who runs the business. Very rarely can they all fit under the same skin.”31
Evidently, Donaldson also did not see himself as a long-term manager. In 1973 Donaldson left to become under secretary of state to Henry Kissinger. Jenrette, who had been recruited back in 1959 to provide the managerial skills they knew they lacked, proved quite able to guide DLJ for the next couple of decades. The 1970s decade was the toughest. The economy and securities markets were lackluster, and the advent of negotiated brokerage commissions—which DLJ itself had been a catalyst for—made profits hard to come by. Yet Jenrette saw the firm through that decade and another fifteen years of corporate expansions and reorganizations. Shortly after he retired in 1996, DLJ was sold to Credit Suisse for $13 billion.
In his retirement, Jenrette pursued his lifelong interest in restoring old homes. Lufkin did some corporate freelance work in the 1970s and 1980s—including a brief stint with DLJ—but his personal focus has shifted to other ventures, including ranching and environmental causes. Donaldson’s interests after DLJ and his three years in the State Department, however, remained closely tied to Wall Street. His impressive resumé includes such positions as: special advisor to Vice President Nelson Rockefeller; founding dean of the Yale School of Management; chairman and president of Aetna; chairman of the Carnegie Endowment for International Peace; chairman of the Securities and Exchange Commission; and, in what might seem to be a paradox, chairman of the New York Stock Exchange. A few decades earlier, the leaders of the NYSE considered Donaldson to be a 1960s firebrand—albeit a firebrand in a Brooks Brothers suit. That he wound up serving as chairman of the exchange serves as confirmation of the transformation he and his partners brought to Wall Street.
Jenrette describes the company history as “a long saga, where DLJ tangos with the Arabs, tangos with American Express, tangos with Equitable, and then does the last tango with Credit Suisse.”32 But at the end of the dance, many billions of dollars of value were created for the DLJ’s shareholders—greatly aided by access to the markets and by its position as a publicly traded stock. But access to capital has not been an unalloyed blessing for Wall Street. The saga covered in the next chapter is not a tango as much as a danse macabre. Rather than creating value, another Wall Street operator uses publicly traded stock to raise billions in new capital and engineer a string of implausible acquisitions—resulting in the destruction of shareholder value and, ultimately, a record-breaking taxpayer bailout.
