Wednesday, December 10, 2014

Smith, Catching Lightning in a Bottle

Winthrop H. Smith, Jr., the son and namesake of one of the founders of Merrill Lynch (the Smith in Merrill Lynch, Pierce, Fenner and Smith) and himself a 28-year veteran of Mother Merrill until he resigned in 2001, has written a compelling history of the firm. Catching Lightning in a Bottle: How Merrill Lynch Revolutionized the Financial World (Wiley, 2014) starts with the rise of the ambitiously charming 5’4” Charles E. Merrill and the man he chose to be his partner after he went out on his own, the big-framed, skeptical, sometimes bullying Edmund Lynch.

The relationship between the partners was often fractious. Managers “remembered the two locked in sulfurous glares, faced off like the Monitor and the Merrimac, Lynch’s forehead knotted in fury, Merrill’s blue eyes turned into ice fields. The debates were bare-knuckled, and both were capable of extended, loud, and imaginative invective. At the root of these disagreements were fundamentally different approaches to life. Merrill was the visionary, Lynch the realist—but only Merrill recognized that a business needed both.” (p. 73)

Initially, the brokerage business was secondary to the investment banking business at Merrill, Lynch & Co. The firm’s bread and butter was underwriting stock issuances in expanding chain stores such as McCrory’s, Kresge’s, Penney’s, Kinney Shoes, and eventually Safeway.

After Lynch died in 1938, the company began to shift direction. At the urging of Win Smith, a partner of the ailing brokerage firm E. A. Pierce, Merrill merged the two firms. This “would be the realization of Merrill’s dream of a ‘department store of finance’ operated in the chain-store mold—a high volume of transactions with a small return on each to maintain profitability.” (p. 139)

Americans didn’t trust brokers; their main complaint was that brokers churned accounts in order to generate commissions. Merrill Lynch decided to offer a new model, where brokers were paid a straight salary, “with annual bonuses to reward special contributions to the firm.” … “This approach,” Smith notes, “lasted into the 1970s when competitive pressure forced the firm to change its method of compensation back to a commission-based one.” (p. 143)

The new Merrill model embraced ideas that were radical at the time: the customer’s interest would come first, the firm would advertise extensively, it would publish an annual report, its brokers wouldn’t give investment advice unless asked for it. But, despite efforts to cut costs and boost sales, in the early 1940s the brokerage firm was flailing financially. “The firm had an average income per transaction of $10.17 and an average cost of $14.29. According to Merrill, ‘When you figure that one of our clients, the Carnation Milk Company, can content the cow, milk it, pasteurize the milk, put the milk in the can, put a label on it, put it in a box, advertise it, and ship it all over the world, and sell the can of milk for five cents, then you realize how perfectly frantic these figures make me feel.’” (p. 158)

Smith recounts the subsequent successes of Merrill, and exposes its warts, with the fondness of an insider and the objectivity of a reporter. His anger about the course the firm took after Stan O’Neal became CEO (and after he resigned) is, however, barely contained.

Merrill is now 100 years old and no longer an independent legal entity. It, like so many Wall Street firms, was hijacked by a leader who did not understand the company’s principles and “unique culture” that had “allowed it to grow and prosper and survive in many challenging environments.” (p. 515)

Catching Lightning in a Bottle is not only an account of what was but a call for what should be. It’s a first-rate read.

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