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How BNY Mellon's Legal Team Weathered the Financial Meltdown
Corporate Counsel
January 21, 2009
It was mid-2007, and Carl Krasik's plate was overflowing -- and then some. Krasik's agenda as general counsel: to manage a megamerger between his bank, Mellon Financial Corp., and the Bank of New York Co. Inc.; to move the corporate headquarters from Pittsburgh to Manhattan; to battle Russia in a contentious lawsuit brought in Moscow; and to comply with different U.S. Attorneys who signed nonprosecution agreements to end scandals at both banks.
In his spare time, Krasik would have to meld 150 lawyers from two highly skilled, but very anxious, legal departments into one legal team. When the Bank of New York Mellon Corp. merger closed in July 2007, Krasik had structured a plan based on merit, lawyering skills and the company's needs. He named three deputy general counsel and divided the legal duties among them -- Matthew Biben (from BNY) would oversee all litigation and corporate governance; Raymond Dorado (from BNY) would be legally responsible for all nonasset-and-wealth management businesses; and James Gockley (from Mellon) would preside over asset and private wealth management.
All that was the easy part. Then came the market meltdown. Krasik and his three deputies had only weeks to gel into a coherent legal team before the debt monster started to devour Wall Street. Krasik's team had to not only protect its bank, but also help the government defend the world's financial systems from a brutal and unprecedented assault. Looking over the past year, the earnest Biben says with a sigh, "It felt like a financial apocalypse."
At the end of the third quarter of 2008, federal regulators counted up the carnage. The Federal Deposit Insurance Corp. said that about one in four institutions that it insured had a net loss for the quarter. Some 22 banks had outright failed, and another 171 banks were characterized as "problems."
Through it all, several major banks stood tall, and perhaps none taller than BNY Mellon. The bank ended the third quarter of 2008 with a profit of more than $300 million, despite a write-off of more than twice that sum -- while other financial institutions posted huge losses. In its modest way, the legal department takes some of the credit. How did the in-house team help keep the bank afloat when others were flailing and failing? The three deputy GCs credit strong leadership at the top, a powerful minute-by-minute communications effort and a keen focus on lowering risk. It may sound odd, but the lawyers also believe the heightened scrutiny of risk and importance of compliance under the nonprosecution ageements helped BNY Mellon navigate the financial storms by racheting up the visibility of the in-house legal team.
Through the autumn crisis, the BNY Mellon in-house team of lawyers had little to guide them through the crisis. "We were operating without precedent and without a playbook," Biben recalls.
"I'm very proud of how the legal department reacted," Krasik, their boss, says. "The results were not a matter of accident or good luck."
Both the BNY and Mellon legacy banks have a rich history. Mellon was founded in 1869 by the family of Andrew Mellon, Pittsburgh's wealthy industrialist and former U.S. Treasury secretary. BNY, the oldest bank in the country, was started in 1784 by founding father Alexander Hamilton, the nation's very first Treasury secretary. Hamilton lies buried in the Trinity Churchyard cemetery across the street from the bank, which sits appropriately at 1 Wall Street.
While not the largest bank on Wall Street, BNY Mellon holds a unique position as the bank to the banks. It has no retail branches, and provides no ordinary checking accounts nor single-family home mortgages. But it is the center of much of the financial activity on Wall Street. The bank provides financial services for a fee to institutions, corporations, pension funds, endowments, and wealthy individuals. It is the largest U.S. corporate trustee, and offers other services, such as handling payrolls, stock transfers, closings and foreign exchange. For example, BNY Mellon was servicing $15 billion worth of debt for Lehman Brothers Holdings Inc.
That's why last October the U.S. Department of the Treasury chose BNY Mellon as the sole provider of a broad range of custodial and trustee services for the government's bailout plan, called the Troubled Asset Relief Program (TARP). And it's why the government included BNY Mellon in the first group of nine banks that received infusions of billions of dollars. "BNY Mellon was in the room with the federal Treasury because it plays a vital role in our financial system," says Cornelius "Con" Hurley, a professor and director of the Morin Center for Banking and Financial Law at Boston University.
Hurley notes that BNY and Mellon made conscious -- and prescient -- business decisions a few years ago to leave traditional banking for the fee-for-service route, in contrast to the universal bank model used by Citigroup Inc., for example. "A universal bank that tries to do everything is not a good model anymore; they are too big and too unmanageable," Hurley says.
That the government tapped BNY Mellon for help in administrating the bailout also shows just how much both merger partners in the bank have mended their rifts with the feds and won back Uncle Sam's trust. Two years ago, prosecutors accused Mellon employees of misconduct in processing taxpayers' checks for the Internal Revenue Service in 2001. Its nonprosecution agreement expires in August.
BNY's deal came in 2005 because of weak compliance procedures that didn't stop its employees from engaging in fraud and money laundering. Krasik says the nonprosecution agreements were in some ways a blessing in disguise. The deals strengthened compliance and risk management, and "empowered" the legal department. As Gockley sees it, the agreements "created an environment where ... the board and executive management want the lawyers at the table."
BNY had hired Biben, a former Assistant U.S. Attorney in Manhattan, in 2004 to bring the bank into compliance and to negotiate the nonprosecution deal, which expired last November. Those same money laundering problems prompted Russia to file a $22.5 billion suit against BNY in May 2007. At press time the suit was ongoing, and Biben was regularly commuting to Moscow to oversee the case.
In the heat of the financial crisis, Biben had to travel to Russia with outside counsel Jonathan Schiller for two evidentiary hearings. Schiller, cofounder and managing partner of New York law firm Boies, Schiller & Flexner, describes one scene that made a lasting impression on him: During a hearing, "Matt passed me notes on additional cross-examination points as he listened to a court translator through a headset, and simultaneously was on his BlackBerry providing direction to his legal team working on the Lehman Brothers crisis."
Schiller says when court ended, the "prodigious" Biben kept going on the market crisis, working 14-to-18-hour days in Moscow. The work of Krasik and Biben "made a big difference for their CEO and board," Schiller says. "They contributed to the success of BNY Mellon emerging through the crisis to date as one of the five strongest banks in the world."
The 2008 crisis actually began in mid-2007. While BNY and Mellon were busy merging, two of the largest subprime lenders -- New Century Financial Corp. and American Home Mortgage Investment Corp. -- filed for bankruptcy. Financial firms had been bundling up subprime mortgages and using the bundles as collateral in the mortgage securities market. By August that market sputtered, leaving many financial companies trapped with unsellable assets.
Through the fall and into early 2008, the bank's legal team watched as the stock market fluctuated wildly. Dorado remembers the lawyers discussing various legal risks and how to mitigate them. One item that worried the bank's officers and legal team were auction-rate securities. This type of debt lets issuers borrow for the long term, but at lower interest rates that are reset at periodic auctions. In the summer of 2007, Biben says, the bank held $600 million worth of these securities. By the time the market froze in early 2008, a cautious BNY Mellon held only $20 million worth.
BNY Mellon navigated through one financial crisis, and then another hit. In an extraordinary government intervention on Sept. 7, the feds seized control of the nation's two largest mortgage finance companies, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp., commonly known as Fannie Mae and Freddie Mac. At BNY Mellon, the alarm bells went off. As Biben puts it: The seizure was another notch in what would become "a continuum of unthinkable events."
Then came the biggest wave in the financial tsunami: the Lehman Weekend.
That crucial weekend actually started early, on Thursday, Sept. 11, when rumors were flying about Lehman, the big investment bank. Dorado and a risk management team examined the company's exposure to the venerable investment house. They were poring over contracts and recommending hurried financial moves. Their work continued into Friday, when New York Federal Reserve Bank president Timothy Geithner summoned BNY Mellon CEO Robert Kelly to join U.S. Treasury secretary Henry Paulson and other Wall Street leaders at 6 p.m. The feds wanted Wall Street's banks, already ducking for cover, to bear the cost of a Lehman rescue.
The meeting ended after only an hour, but resumed on Saturday morning with more players. BNY Mellon's Dorado remembers that he was at home when his boss, Krasik, called and asked him "to get down to the New York Fed" with the CEO, chief risk officer Brian Rogan, and others. "When I walked in, they ushered me into a conference room filled with [senior executives] of all the major banks" talking about how to remedy the Lehman situation. Lehman's subprime mortgage debt proved insurmountable. By the time that session ended, "there was pretty much a consensus" against saving the investment bank, Dorado says.
The meeting then broke into smaller groups, with the lawyers from various financial institutions forming their own session. They focused on bankruptcy contingency plans and how to "orderly unwind" Lehman transactions. Then their discussions turned to saving Merrill Lynch & Co. Inc., as well as the giant insurer American International Group Inc.
Biben recalls a series of e-mails as the Lehman Weekend unfolded. One senior in-house lawyer that Biben wanted working on the Lehman problem was vacationing in California with his wife and children. "My first e-mail to him on Friday was, 'When are you coming back?' He said, 'Monday.' On Saturday morning, I wrote, 'I may need you sooner.' Then, a few hours later [when Lehman's fate was clear], I e-mailed, 'Fly back immediately.' "
At some point on that Saturday, BNY Mellon formed a crisis team called the Lehman Working Group. It included senior officers, the chief risk officer, and top members of the legal team, including Krasik and his three deputies. The working group set up a command center at the bank in an eleventh-floor conference room and established an open phone line. Business units around the globe were given a code to call to report any impact, problems or questions. All decisions had to be run through the command center. Krasik quickly pulled in Dorado's and Gockley's international counterparts in London, Wim Hautekiet and Jeremy Bassil, because bankruptcy laws in other countries differ considerably.
To the extent that the earlier Bear Stearns failure was unthinkable, Biben says, "Lehman Brothers was just more degrees of unfathomable. We were struck by the enormity of the situation and, frankly, by the fear surrounding other financial services companies, particularly Merrill." Like Bear Stearns and Lehman before it, Merrill Lynch was losing the ability to finance its operations. On Sunday, Bank of America announced that it would acquire Merrill Lynch.
Throughout the weekend, Biben and Dorado ran a Wall Street race against other financial institutions in the country to hire top outside counsel to work on the explosion of legal issues related to bank bankruptcies and mergers. They were considering about a dozen top lawyers, but some were already conflicted out. For example, during the meeting at the Federal Reserve, Dorado e-mailed someone at Cleary Gottlieb Steen & Hamilton. The lawyer he wanted immediately walked up to him and said, "I can't. I'm already representing the Fed."
Biben was able to snag Martin Bienenstock, who joined Dewey & LeBoeuf in New York about a year ago to build a group specializing in business restructuring and corporate governance. Bienenstock had spent 30 years at Weil, Gotshal & Manges co-chairing its business finance and restructuring unit.
To avoid conflicts of interest, Krasik and Biben had to build an ethical wall between lawyers representing its fiduciary clients, such as those in corporate trusts, and those handling nonfiduciary issues, such as institutional services. They hired Russell Reid, Jr., and Carren Shulman, partners at Sheppard Mullin Richter & Hampton, to handle the corporate trust issues. On that side of the ethical wall, in-house and outside lawyers set up a "sub-command center" at BNY Mellon's corporate trust operations center at 101 Barclay Street, near the World Trade Center site.
Lehman Brothers International filed its bankruptcy in Europe hours before the U.S. filing on Sept. 15. In Europe there was no orderly unwinding as was planned in the United States, and that created immediate and intricate legal work that went on for weeks, according to Hautekiet.
And it heightened anxieties. "The lasting impression I have is the feeling of floating in an unknown space," Bassil says. "You just didn't know what was going to happen next."
With $640 billion in debt and no help from Wall Street or the federal government, Lehman filed for U.S. bankruptcy protection that Monday morning. Then, as Biben puts it, "it was bang, bang, bang." Consider:
Wachovia Corp., the nation's sixth-largest lender, was forced to sell, eventually going to Wells Fargo & Co.
As for BNY Mellon, the company chose to reimburse its clients invested in funds managed by affiliates and affected by the Lehman bankruptcy.That decision cost the bank $433 million. The senior officers and legal team also expect that their own compensation will be seriously reduced for some time to come, Biben says, because of new executive compensation rules demanded by Congress of all financial institutions.
Across the nation, the stock market plunged; banks stopped lending; airlines, automakers, media companies and others went in search of bankruptcy advice; hundreds of thousands of workers were laid off. The end of September marked the end of modern banking's Gilded Age.
Boston University's Hurley thinks that if Paulson and Bernanke could have a Lehman weekend do-over, they'd find a way to save Lehman. "They misjudged the repercussions," Hurley says. "I think they know they blew it."
One critic of the government is Ann Graham, who teaches banking law at Texas Tech University School of Law in Lubbock and is editor of the Banking Law Prof Blog. Saving Bear Stearns and not Lehman Brothers showed the lack of a consistent strategy for dealing with the crisis, Graham says. It was a "soap opera" approach, she adds, resulting in uncertainty throughout the economy.
The Lehman Weekend had changed the world of banking forever. More immediately, the credit markets were frozen; huge banks had no confidence in -- and wouldn't lend to -- other financial institutions. "Those of us on the inside felt real fear. But there was this disconnect with the rest of the world. America was going on like nothing had changed," says Biben.
Then the lesson sunk in, and not just with the lawyers or bankers. Biben recalls returning home from work one late night after Lehman fell. An old elevator in his building requires a human operator, and this night, one named Sergio was at the controls. When Biben stepped onto the elevator that night, Sergio asked, "Mr. Biben, what should I do with my 401(k)?" He wasn't asking how to invest his money; he was asking if it was safe, Biben says. Fortunately, the money was in a safe institution, and Biben was able to reassure him. "That's when it dawned on me that the crisis was finally striking the rest of America. They were getting it," Biben says.
By Oct. 3, Congress got it, too, and passed the $700 billion bailout plan. Paulson quickly infused $147 billion into the nation's nine largest banks in a stock purchase program, to ensure that they would keep functioning smoothly. BNY Mellon sought nothing -- it ended the third quarter with $303 million in net income despite writing off a $726 million charge related to support agreements to keep their customers whole against Lehman and other losses. Biben says the bank felt it was "the right thing to do," but it also made sense from a legal and public relations standpoint. While BNY Mellon did not ask for bailout money, Paulson allotted the bank $3 billion to ensure that it remains strong and to protect its crucial role on Wall Street.
With the Lehman crisis behind him, and awaiting difficult but acceptable fourth-quarter results, the usually upbeat Biben grows solemn as he looks back on his legal department's efforts. His mind repeatedly goes to the words of one of his heroes, and everyone's favorite wartime prime minister, Winston Churchill. In 1940, after France fell and as Churchill readied Britain to face Hitler's onslaught, the prime minister proclaimed: "Let us therefore brace ourselves to our duties, and so bear ourselves that if the British Empire and its Commonwealth last for a thousand years, men will still say, 'This was their finest hour.' "
The Lehman Weekend was not a war, Biben concedes: "But all the investment banks and financial services as we had known them for the last two centuries were in very real jeopardy." His bank's lawyers worked through the long hours and weeks, while most of the bank's employees, indeed most of the nation, remained totally unaware of the deepening peril. "This was," Biben insists, his eyes moistening and his voice filling with emotion, "our finest hour."
| SHORING UP THE BIGGEST BANKS In an effort to solidify the nation's nine largest and strongest financial institutions, last fall the U.S. government took the unprecedented step of buying up $147 billion worth of preferred bank stock. Here is where the money went: Name of Institution: Bank of America Corp. Headquarters: Charlotte 3rd Qtr 2008* (earnings per share): $0.15 3rd Qtr 2007: $0.82 Amount (in billions): $15 Name of Institution: Bank of New York Mellon Corp. Headquarters: New York 3rd Qtr 2008* (earnings per share): $0.72 3rd Qtr 2007: $0.67 Amount (in billions): $3 Name of Institution: Citigroup Inc. Name of Institution: The Goldman Sachs Group Inc.** Name of Institution: JPMorgan Chase & Co. Name of Institution: Merrill Lynch & Co. Inc. |
