THE IVEY INTERVIEW: Winthrop H. Smith, Jr.

Winthrop H. Smith

The rise and fall of Merrill Lynch is symbolic of the serious management issues facing today’s global financial sector. When excessive risk taking pushed the storied company into the hands of Bank of America in 2009, nobody was more heartbroken than Win Smith, whose father—Winthrop H. Smith, Sr.—famously partnered with Charlie Merrill in the 1940s to create a caring and collaborative corporate culture, which introduced stock market investing to the masses and produced what was once the most respected and largest brokerage in the world. In 2001, after concluding pursuit of profits was trumping the traditional Mother Merrill leadership mentality, Smith resigned as the firm’s executive vice-president and chairman of international operations. He cut all financial ties to the company and left the industry, choosing instead to acquire and run Vermont’s Sugarbush ski resort. But an emotional bond to Merrill Lynch remained. In this Ivey Interview, Smith talks about his new life as a professional ski bum, not to mention his new book Catching Lightning in a Bottle: How Merrill Lynch Revolutionized the Financial World, which was penned to honour the principled past of the firm his dad helped build on the 100th anniversary of its founding.

IVEY: Your book describes how your father and Charlie Merrill joined forces to introduce investing to the masses, seizing an opportunity generated by demand for war bonds. This was really revolutionary, right?

WIN SMITH: Indeed. Targeting Main Street using the retail chain strategy developed by my father and Merrill was a new concept. And it really altered the way average people managed wealth. In that day and age, most Americans didn’t know how to invest in stocks. And they didn’t trust Wall Street, so there wasn’t really an opportunity to participate.

IVEY: The book isn’t just a history of Merrill Lynch. You defend ethical financial professionals by pointing out the brokerage world was once dominated by a respected firm, noting former SEC chair Arthur Levitt once insisted Merrill Lynch was the only major financial institution with  “a soul.” Can you describe the Mother Merrill culture that you remember so fondly?

WS: Even before starting his own firm in 1914, Charlie Merrill had a code of ethics that required clients’ interest to always come first. He considered that to be a good way to add value as well as just good business. After partnering with my father to launch the modern Merrill Lynch, four additional basic principles were developed. As a people business, it was important to respect all concerned, including employees. To serve customers well, everything had to be a team effort. And because the company was targeting Main Street, in America at first, but eventually around the world, it had to be part of the community, participating in philanthropy and community associations, etc. And last, but certainly not least, the company had to operate with integrity. As one former chairman put it, if anyone was doing something that management couldn’t accept reading about in a newspaper, then it shouldn’t be done. Those five principles came together in a caring culture that created a family atmosphere. The company had high standards, but employees had a sense of belonging that made them proud working for Mother Merrill.

IVEY: The culture you describe was largely gone by the last shareholder meeting, which has been described as a funeral. With everything that has happened in the sector, do you think average folks will ever again believe integrity can be found inside the boardroom of financial institutions?

WS: It can happen, but it will take a lot of work. The skepticism that exists today is obviously somewhat justified and just as deep as the skepticism the public had in the 1940s. The leaders of Wall Street are going to have to work very hard to restore trust. And they can’t do it alone. It has to be done at the grass roots level, with every single financial sector employee working to regain client trust.

IVEY: Despite the culture, Merrill Lynch wasn’t immune to scandal. During its heyday, would you say the cultural difference was seen in how management responded to transgressions?

WS:  Absolutely. No matter how good your compliance controls, bad apples can be found in any company with thousands of employees. Some mistakes are unintentional and some are intentional. Either way, how management reacts is what is important. Money can’t be the really important thing in these matters. For example, when Merrill Lynch underwrote annuities for a company called Baldwin-United in the mid-1980s, it had good intentions. But due diligence wasn’t careful enough and a lot of clients ended up at risk. Roger Birk, chairman at the time, made a very courageous and correct decision to essentially make those clients whole. It cost a lot of money, but it was the right thing to do. I think that reflects how leadership of financial companies should react when mistakes happen.

IVEY:  You argue the culture was lost when the Merrill Lynch board allowed Stan O’Neal to operate in a way that would have made your father and Charlie Merrill sick. What did previous leaders do differently that set them each apart from O’Neal?

WS:  They appreciated the firm’s history. They didn’t have hubris. They understood they were in the top position of a successful company because of steps taken by others before them. They respected all five of the core principles and acted with total integrity.

IVEY:  The firm was obviously built via collaborative leadership, along with an appreciation for healthy capitalization levels. Why do you think the Board supported a more dictator-style of leadership and aggressive charge into risky products under O’Neal?

WS:  In my opinion, the Board concluded the firm was on the wrong course in 2001, that it was not healthy and needed change. The facts say different. For the year 2000, the company posted record earnings of US$3.8 billion and a return on equity of 24.2 per cent. It had US$1.5 trillion in assets under management and had led the global league tables in debt underwriting for 48 consecutive months, which was quite remarkable. It was healthy and strong. After the tech bubble burst and the events of 9/11, every firm needed to get rid of some fat.  But Stan O’Neal convinced the Board that much more needed to be done. He cut into muscle and even some bone, eliminating many businesses that had taken years of investment to build. So when markets turned around, many former growth engines were no longer there. There was then a struggle to find a path to profitability. And the easiest way was to leverage the balance sheet and jump into subprime mortgage products and other risky but highly profitable businesses at the time. And then, after getting intoxicated by the new-found profitability, they got in deeper. The leverage ratio reached 36:1 before that bubble burst.

IVEY:  Was greed at work?

WS:  Well, other firms like Morgan Stanley and Goldman Sachs were making better profits at the time, and profits are obviously directly related to compensation on Wall Street. It’s a very competitive environment, and I think people at Merrill Lynch were convinced we had to have much higher earnings in order to generate the incentive compensation pools that were considered necessary. I also think the form of compensation became less long-term. When I was at the firm, over half of my annual pay came in the form of restricted stock and stock options, so I looked at the long-term a little bit differently than if I’d been paid strictly in bonus cash.

IVEY:  A flood of senior talent left or were sent packing under O’Neal’s leadership. Why didn’t the Board see this as an issue?

WS: That is a perplexing question. Thousands of years of experience was forced out the door or chose not to stay. And in some cases, senior people were being walked out, which wasn’t the Mother Merrill way. Directors shouldn’t micromanage, so they are rightly hesitant about overriding the direction of the CEO. But when you see a disturbing exodus of talent like what happened under O’Neal, it’s curious that nobody reached out to people they knew and asked them what was really going on.

IVEY:  Was there a champion for the corporate culture on the Board at the time? 

WS:  I don’t believe there was. The Board had been turned over almost entirely.

IVEY:  So is one of the big takeaways here the need to have corporate culture championed at the Board level, not just within the rank and file?

WS:  Yes. I really believe that’s true. I think Boards have an obligation to understand what the culture is, let others know if they believe it is the right culture, and if it is the right culture, they have an obligation to make sure it is supported. The most important role that all Boards have is the selection of the CEO. They must make sure that the leader has the requisite skills and character, and the latter should include whether or not they actually buy into the organizational culture.

IVEY: Charlie Merrill and Edmund Lynch were very different individuals. Were fairness and honesty in business equally important to them? 

WS:  From my research, absolutely. Merrill Lynch had a number of great co-leaders over the years, starting with Charlie and Eddie. Merrill was the visionary. He was impulsive, creative, and charismatic. Lynch was more the governor on the ship. He could calm Charlie down and make him see reason when his ideas were foolish. My father played a similar role. My mother used to call him the glue that kept the firm together. Don Regan and Roger Birk were a great pair, partly because Birk really knew how to work with someone who had an ego like Regan. He didn’t challenge Regan publically, but in private, he could talk him out of bad decisions. Bill Schreyer and Dan Tully were also a great team.  So, there were a lot of examples of co-leaderships where two different types of skills come together to make a very effective team.

IVEY:  When Charlie famously tried to raise the alarm about client exposure to frothy markets prior to the 1929 crash, he had an uphill battle convincing Lynch and other executives to listen.  Do you think the Mother Merrill culture was truly in place at that time? 

WS:  Oh, I think it was still very formative. The company was only 15-years-old and it was still merging and defining itself. But I think you often see character and ideas defined in a moment of crisis. And Charlie Merrill’s steadfastness about selling in 1929, even though he had serious self-doubts which forced him to visit a psychiatrist, set the example for the future.

IVEY:  Do you think Charlie just had a better vision of what was coming?

WS:  Yes. I think he was a little bit more rooted in practicality, which maybe came from his early days running a drug store for his father.

IVEY: So the conflict with Lynch was really about differences of opinion over what was in the best interest of the client? 

WS: Yes. Bubbles always make some good people say the most dangerous words in investing, which are: “This time it is different.”

IVEY: Describe your reaction when O’Neal was allowed to retire with $162 million after the firm posted an $8-billion quarterly loss? 

WS:  I was sick to my stomach. I felt absolute disgust. If I had been near a tree, I probably would have punched it. It wasn’t just the money O’Neal got. I felt bad about selling all of my stocks when I left. I didn’t have any personal exposure, but I knew shareholders who trusted management were taking massive losses along with hard-working employees, ranging from highly-paid executives to secretaries and margin clerks, while this person walked away with $162 million. It was totally shameful and irresponsible for the Board to allow this to happen.

IVEY:  What would your dad have retired with? 

WS:  Oh, in that day and age, way, way less. To be fair, it was a much smaller firm when my dad was in charge. But his estate was only worth about $1 million when he passed away in 1961, which, of course, was still a meaningful amount of money.

IVEY:  What are some other big lessons or takeaways from the fall of Merrill Lynch?

WS:  Boards have to understand the business, even when it is complicated like at Merrill Lynch. And if you look at the profile of directors, there certainly were some people who should have understood leverage. But I’m not sure anyone really understood the business well enough to ask about derivatives.  So I think the importance of getting Board composition right is a very important lesson we should learn from Merrill Lynch.

IVEY: Your book offers a wide range of historical facts and interesting stories. What’s the most interesting tale that you uncovered?

WS:  Well, nothing was a total surprise because I knew much of the history. But I’m always intrigued by the story of J. Edgar Hoover coming to Charlie Merrill and my father and asking if they would hire an FBI agent and post him down in Buenos Aires to spy on the Germans before the war.  This agent employee became so enamored by the business that was his cover that he wanted to continue to work for Merrill Lynch in a real way after the war. I don’t think anybody really knew if he ever left the spy game even when he became an actual employee of the firm.  Howard Hughes is another interesting character in the firm’s history. The story of how that visionary in aviation accumulated a fortune and then squandered it is an intriguing tale.

IVEY:  Do you think mergers and growth weakened the culture at Merrill Lynch?

WS:  Uh huh.  Mergers are tricky for a firm with a unique culture. In my book, I noted the great success that followed the acquisition of Smith New Court, which came about because of the attitude of the acquired executives who wanted to become part of the Merrill Lynch culture. I contrast that a little bit with the Mercury Asset Management merger, in which the company retained its own name and really wanted to operate at arm’s length. That was not nearly as successful as it could have been.

IVEY:  What would you have done if you had taken the CEO post in 2001? 

WS:  Oh, it’s so easy in hindsight to say what you would have done differently. But I left was because I would not be party to what was happening, so what I would have done is not cut nearly as drastically in the international business, the relationship banking business and the US private client business.  I would have suffered lower short-term earnings, but they would have been earnings, not losses. And that would have positioned the firm for a sustainable recovery. I never would have allowed the firm to be levered the way it was and I never would have emphasized the sub-prime mortgages the way the firm did.  It takes a strong leader to resist pressure and the market pressures on public companies today are enormous. If you miss an estimate for a quarter, you get hammered by investors. That’s very difficult and it raises an issue about corporate governance. People don’t like dual class shares, but some of the companies that have dual shares have actually performed very well for the shareholder partly because they don’t face the same pressure from shareholders.

IVEY:  Was there really no feeling of privilege in earlier times?  

WS: My father carpooled. In my day, executive vice-presidents had a car and driver. But all of us felt very comfortable being with anybody at Merrill Lynch. There wasn’t a hierarchy that demanded a personal elevator for the CEO or required interns to avoid eye contact with executives.

IVEY:  A lot of things have changed since Main Street was introduced to Wall Street. Do you ever think that maybe Main Street should keep its distance?

WS:  No, I don’t. I think that long-term equities offer a very good opportunity for people and I think you really cannot be a short-term trader. That is very difficult and very risky. As Warren Buffett says, if you invest in the right people at the right companies and stick with it, you don’t have to watch the ticker tape. That’s why I don’t think that the trusted advisor is ever going to go away. The model works. And there are many good financial advisors, at big firms and in boutiques. In Canada, I am a director of Richardson GMP, which, in many ways, has the same principles and values that built Merrill Lynch.

IVEY:  In your book, you describe how tough many of the firm’s early executives had it when starting out, which helped develop their leadership character. Do you think Merrill’s modest means, his need to play baseball and sell newspapers for money, contributed to his respect for Main Street? And are you concerned about the relatively easy career path of many financial sector executives today?

WS:  I haven’t really thought about it.  But now that you’ve asked the question, I think there is a good point there. Humility is an awfully good trait. And I think the fact that the early people at Merrill Lynch had to share rides and apartments did keep them humble and in touch with average people. Partnership discipline also played a role. Partners at brokerages even in the 1970s typically took a very, very modest annual draw. It was only at the end of their career that they recognized real wealth. There wasn’t the same schism that we are seeing in society today, where the wealthy are seen as vultures as opposed to people that can help everybody else build jobs and grow the economy. Some of that is brought on by the excesses that people are seeing. But lack of humility is an issue.

IVEY:  You now describe yourself as a ski bum who runs a resort in Vermont, right?

WS:  Yes. It’s not a bad second career.

IVEY:  Are there similarities between Mother Merrill and how you run Sugarbush? 

WS:  There are. It’s obviously a very different business, but I’ve actually adopted the five principles I learned at Merrill Lynch. We really try to put guest interests first. We have a thousand employees, many are just seasonal, and they all have to feel respected to provide good service. They have to operate as a team. And I’m the big employer in a small valley, so I feel an obligation to be part of the community.  I tell everybody the same thing about integrity. If it’s raining, my employees know they have to tell people looking to ski with us that it is raining. That’s what integrity is all about.

IVEY:  Do you ever think about getting a group together and launching a new financial sector company based upon the principles? 

WS:  I loved every minute of the 28 years I was at Merrill Lynch, except for the last. It’s hard to go back and I don’t think I could ever emotionally compete against Merrill Lynch even though it’s a different firm under Bank of America ownership today, especially since I have two nephews and a son-in-law working there and doing very well. I have kept my toe in the water by being on the boards of four financial institutions, so I’m intellectually engaged. I’m involved, it’s fun and I think I am making a difference, but that’s the most I want to do right now. I really enjoy running Sugarbush.