Editor's Note

11/01/2007 12:00 am EST

Focus:

Howard Gold

Founder & President, GoldenEgg Investing

November 1, 2007

Shed no tears for Stan O'Neal.

The ousted chairman and chief executive officer of Merrill Lynch is leaving with a nice, fat $161.5-million retirement package after having presided over a nearly $8 billion write-off in the most recent quarter.

That produced a shocking revenue decline of 94% from last year's third quarter and $2.3 billion worth of red ink, probably the biggest quarterly loss in recent Wall Street history.

For all the talk about O'Neal's ruthlessness or aloofness amid the backslapping culture of "Mother Merrill," he was being hailed just months ago for making the tough decisions and turning around a long-time laggard. Merrill's stock had hit all-time highs and was in shouting distance of $100 a share earlier this year. (It traded at around $64 Thursday morning.)

O'Neal raked in around $49 million in total compensation in 2006, second on Wall Street only to Lloyd Blankfein of Goldman Sachs-even though as the chart below shows, Merrill's stock (the blue line) trailed most of its peers from the time he took over as CEO in December 2002 until his departure this week.

Even the plain-vanilla Standard & Poor's 500 slightly outperformed Merrill's stock over that period.

That puts O'Neal in the elite "Overpaid CEOs, Underperforming Stock Club" with Hank McKinnell of Pfizer and Bob Nardelli of Home Depot. Both of those men walked away with packages worth roughly $200 million of shareholders' money after their companies' stocks underperformed competitors during their tenures.

Unlike McKinnell and Nardelli, however, O'Neal did not have an employment contract. He isn't getting any severance or unpaid bonus-just benefits accumulated during his 21 years with the firm, company statements indicate. 

To some degree, O'Neal got the boot because he had already fired anyone below him who could serve as a sacrificial lamb. Bear Stearns' chairman and CEO, James Cayne, quickly dispatched his number two, Warren J. Spector, after two Bear hedge funds imploded-even though Cayne was busy playing golf and bridge at key points during the meltdown, as The Wall Street Journal reported (subscription required; Cayne has responded that he is “intensely focused on our business.”) .

But more importantly O'Neal broke Wall Street's cardinal rule: take all the risks you want, but do not-ever-lose big money for the firm.

Merrill's board of directors approved O'Neal's push for riskier business as long as it was reaping big returns. Merrill quickly became a leader in the market for collateralized debt obligations (CDOs), which bundle together risky and somewhat less risky loans into marketable securities. It took in an estimated $800 million in fees from CDOs since 2006. 

The board even signed off on the acquisition of a subprime mortgage lender, First Franklin, last September when hot housing markets were already cooling and there were warning signs aplenty.

In his last conference call with investors, on October 24th, O'Neal acknowledged "we got it wrong by being overexposed to subprime." Did you ever! And a Merrill spokeswoman conceded to the Journal (subscription required) that First Franklin was "'bought at the top.'"

But these days even once-docile boards like Merrill's can make their chiefs walk the plank when big bets turn out bad. Swiss bank UBS booted its CEO Peter Wuffli in the wake of heavy losses at its Dillon Read hedge funds. 

Like Merrill, UBS has warned it may face more losses in the wake of the subprime mortgage crisis and credit crunch-on top of a $3.4-billion writedown it already has taken.

And like UBS, Merrill was in many ways a wannabe. O'Neal reportedly suffered from the Freudian syndrome called Goldman Envy, a common disorder on Wall Street. To become a major player in Goldman Sachs' rarefied league, more than one wannabe firm has racked up big expenses and taken on big risks-and ultimately paid the price.

Just ask Ken Lewis, Bank of America's chairman and chief executive officer who said a couple of weeks ago he had had  "all the fun I can stand in investment banking" after losses from trading and leveraged loans nearly wiped out that unit's profits.

The next week the ax fell on Eugene Taylor, a longtime Lewis colleague and 38-year bank veteran, as well as 3,000 other souls.

Because the fact is that despite all the Harvard MBAs and MIT PhDs that prowl Wall Street's canyons these days, and despite all the multimillion-dollar computer systems and software the big firms use to slice and dice every last micro-percentage of risk, few people play this game well. Goldman is one, and Lehman Brothers (which has taken only a $700-million writedown so far) may be another.

"The history of Wall Street is essentially the history of risk management, and.the ultimate test is who remains profitable and who stays in the game," wrote Jenny Anderson in a recent New York Times profile of Lehman's CEO Richard S. Fuld, Jr.

"Wall Street has a well-worn habit of careering from the pain of crises to the euphoria of new opportunities," the article continued, "and chief executives are paid top dollar to find a balance between the two-though greed, hubris, or bad judgment often get in the way."

Or perhaps all three, in Stan O'Neal's case. Although he was paid top dollar nonetheless.

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Howard R. Gold is editor-in-chief of MoneyShow.com. The opinions expressed here are his own and do not necessarily reflect the views of InterShow.

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