In the early months of 1980, Ivan Boesky
& Company, a Wall Street risk arbitrage
firm, offered me a job. I was in my senior year at NYUâs College of Business and Public Administration with only a few months to go before graduation. My major was economics, and to secure a job after graduation, I began applying to various financial firms. Boesky
& Company responded to my overture and invited me to their offices at 77 Water Street in downtown Manhattan in early February. I was ecstatic. I had followed Boesky closely and became intrigued with the practice of risk arbitrage
, essentially the purchase or sale of securities that are considered mispriced, often because of some looming change in a companyâs ownership or structure, and which usually manifests itself in the form of a takeover. Boesky
was one of the Streetâs most successful arbitrageurs, who along with Robert Rubin
at Goldman Sachs
, Guy Weyser-Pratte at Pru-Bache, and Richard Rosenthal at Salomon Brothers became known as the âFour Horsemenâ of Wall Street. It was a lucrative business, but what attracted me most was the opaque nature of risk arbitrage
and what would appear to be a combination of intellect, timing and chance. Boesky
and his competitors were the masters of this arcane corner of finance, deftly placing and removing their bets just at the right time to reap enormous profits. The skill that lay behind this practice filled me with both awe and curiosity.
When I applied to Boeskyâs firm I had little hope that they would respond. It was a long shot in my view, but one worth taking, and as a 21-year old from Brooklyn I reckoned I had nothing to lose. When I arrived at their Water Street office on a blustery February morning, I was ushered into a tastefully decorated office, with forest green wallpaper, gold-framed paintings of pastoral landscapes, and antique-looking furniture that echoed a distant period in finance. The room was bathed in a soft glow from several lamps stationed in various parts of the room. In the center was a well-polished wooden desk, with curved legs and no draws or cabinets below. It could have easily been sitting in someoneâs study on upper Park Avenue. It was a desk for reading, thought and contemplation, or writing letters longhand to distant relatives abroad. It was far removed from any trading room on Wall Street. The whole setting gave me the sense of polish, seriousness, and probity.
After a few minutes a gentleman of around 40 years walked into the room and introduced himself. His title and name now escape me, but behind his horn-rimmed glasses, receding hairline and expensive shirt and tie, emerged what at the time I could only describe as a WASPish type of character, one that I had rarely come across as a youth growing up in New York City, but now realized that through the various canyons of Wall Street I would run into such polished and urbane individuals quite frequently. He spoke in a direct, yet soft manner, without any discernible regional accent. He had a serious demeanor about him as he reviewed my resume. When he looked up he asked a few questions about what I wanted to do in the future, and after replying something along the lines of wanting to apply my NYU degree to better understanding financial markets, he said: âIâd like to offer you a position.â Just what that position was I also donât now recall, but what I do remember is being startled beyond belief. The thought that I might go to work for Ivan Boesky
was beyond the realm of my reality. It was as though I had hit the jackpot. I was elated, and the thought of coming to work every day after graduation at this storied firm was more than I could have hoped for. There was just one catch. âWe need you to start now,â said the bespectacled financier in his calm and cool manner. âStart now?â I asked. âYes. We can really use someone like you right away.â I can now imagine the look on my face was probably one of confusion mixed with anxiety, and after gathering my composure I asked whether I might have some time to think about it. The answer was I had until tomorrow.
Riding home on the subway after the interview I found myself confused and depressed. Why now? What could be so urgent? Couldnât they wait a few months until I graduate? Why the rush! It was a devilâs bargain, I thought. Perhaps they were testing me, trying to see how much I wanted it; the cut and thrust of risk arbitrage
at one of the top firms on the Street. Anyone else would jump at the chance. School? Graduation? That could wait, others might say. A job offer from Boesky?
Where do I sign? When I arrived home I told my parents about what just had happened. A puzzled look also came over their faces. But your education? Do you want to throw it all away? Of course not. They had sacrificed a lot to send to me to NYU, which even at that time was not a cheap place to get an education. I had done well and enjoyed my studies. I had come across a wide range of professors, from Marxists to free-traders to the Austrian school of economics. I was ready for the real world, so I thought, but not for this. Not for a decision where I had to weigh the risks carefully on both sides.
I turned down Boeskyâs
offer, and within a few months of graduation I landed a job as a research assistant in the economics department of Chemical Bank
, which at the time stood on the other side of the Chase Manhattan
Plaza from the Federal Reserve Bank of New York
. During the job interview the clincher seemed to be when I said I admired the writings of Friedrich von Hayek
and his strong anti-socialist views; how society must be free to arrange itself lest it avoid the slippery slope of excessive government intervention. Little did I know that my interviewer was an economist who adored Hayek; a political conservative who was only too happy to offer this young man a job.
The following 12 years were some of my most enjoyable in the financial industry. I had great mentors who taught me how to understand monetary policy and the workings of the U.S. economy. I advanced quickly to a senior economist role, and by the age of 28 I was on the bankâs trading floor explaining the actions of the Federal Reserve in the open market to traders, salespeople and their clients. It was an exciting time, particularly given that one had to interpret the Fedâs actions in the U.S. government securities market in order to understand whether they were easing or tightening monetary policy. The most challenging and frightening point during that period was the stock market crash in October 1987. No one knew what to expect following the dramatic 508-point plunge of the Dow Industrials. All we could tell our traders and clients is that the Fed had to open the monetary floodgates. It did, and what many of us thought would be the onset of a major depression was averted. Yet, around the same time something else happened that opened my eyes to the workings of the real world.
Timothy Tabor
was a star trader on Wall Street, working at Kidder Peabody
, when Chemical Bank
decided to hire him in 1986. He was a risk arbitrageur, a business the bank decided it wanted to get into. When Tabor, a tall, lean, good-looking guy arrived on the trading floor he ingratiated himself to all the female staffers by having a bouquet of red roses delivered to each of them. Many of us didnât know what to make of this grand gesture, but the women loved it. He had a certain star power. He was different. He came from an unfamiliar part of Wall Street, one more mysterious and lucrative than the traditional markets in which the bank operated. But after a while someone senior on the bankâs board decided that risk arbitrage
was too risky a business. It wasnât clear to me at the time whether Tabor had lost money, but for whatever reason both he and Chemical Bank
parted ways. Some months thereafter the front page of the New York Times announced that U.S. Federal agents had arrested Tabor at his Manhattan apartment. He was charged with insider trading while working at Kidder Peabody
. But Tabor wasnât the only one implicated. On that snowy morning of February 12, 1987, Robert Freeman
, a partner at Goldman Sachs
, who worked under Robert Rubin
in the risk arbitrage
unit, was arrested on the firmâs trading floor by U.S. agents. He was also charged with insider trading. A third individual, Richard B. Wigton
, a colleague of Taborâs, was also arrested that morning. The arrests sent shockwaves through Wall Street, casting a pall over the industry, most notably at Goldman, which was widely revered and at the time still privately held. What followed was a series of events that led to one of the biggest scandals in the industryâs history. In December 1987, Ivan Boesky
, one of Wall Streetâs most powerful speculators, was sentenced to three years in prison for conspiring to file false stock trading records. The lucrative gains made by Boesky were fueled by inside information over when various companies would merge or buy out others. The charges exposed what had been a secret web of traders, with Boesky at the helm, dealing off of proprietary information and reaping enormous profits. At his sentencing, Federal District Judge Morris E. Lasker said: âIvan Boesky
âs offense cannot go unpunished. Its scope was too great, its influence too profound, its seriousness too substantial merely to forgive and forget.â
1
The Boesky
scandal affected me in two ways. First, it removed the blinders I had as a young industry professional about how business was done in certain areas. It demonstrated that what at first glance might appear to be superior knowledge and expertise was actually fraud, fueled by excessive greed and a willingness to break the law. This was the first time I and many other young professionals had witnessed such behavior, but as we all know, it wouldnât be the last. The Boesky affair seemed to be an anomalyâa secret cabal of a few insiders who worked in a business that few outsiders understood. But the second impression I had brought me back to 77 Water Street and the job offer from Boesky & Company in 1980. At the time, I was deeply torn and conflicted, but decided to decline the offer and finish my studies. What I didnât know at the time was that I made a decision informed by my aversion to risk, the type of thinking that many of us go through when confronted with choices that affect our material or financial well-being. Behavioral economics
calls this âloss aversion,â and work in this area has been led by Amos Tversky
and Daniel Kahneman
, with the latter winning a Nobel Prize in economics in 2002 for his research. Loss aversion theory acknowledges that for many individuals âlosses loom larger than gainsâ; that the pain of losing is psychologically about twice as powerful as the pleasure of gaining. The influence of behavioral economics
has grown steadily, with Richard Thaler
at the University of Chicago Booth School of Business, taking home the Nobel in 2017. Thalerâs most recent book, âMisbehaving: The Making of Behavioral Economics
,â
2
takes us through the origins of this new and innovative approach toward economics, one that has not always found favor with mainstream economists. What behavioral science
tries to do is understand what motivates individuals to make decisions, even if at times when those decisions donât seem to be in their best interest. Within the financial industry what we have seen since the 2008 financial crisis are numerous instances of people âmisbehaving.â The costs to the industry, both financial and reputational have been considerable, and the behaviors uncovered range from the individual, ârogueâ trader to groups of people both within and outside firms colluding with one another to manipulate markets in foreign exchange and Libor pricing, for example. The sheer extent of the misconduct has led U.S. and foreign regulators to intervene and warn firms to get their houses in order and put a stop to the misconduct. Banks have responded in numerous ways, including the development of what one might call a âsurveillance state
,â where employees are monitored in ways that Orwell would never have imagined. These âcriminally-basedâ compliance programs
, many led by former enforcement officials hired from regulatory agencies, may be able to have some deterrent effect on misbehavior, but in numerous interviews and discussions over the past few years with banking executives and regulators, itâs clear that the industry is not where it wants to be on these issues. Itâs because of this lack of progress that some are turning to behavioral science
to get at the root causes of such behavior, attempting to understand what drives good people to do bad things.
In this book we will examine several of the most prominent scandals over the past decade and speculate how they came about, what were the drivers behind them, and why such behavior flourished for considerable lengths of time. We will outline the regulatory response to the scandals, what has been proposed and what might be in the offing should misconduct persist. Lastly, we will examine whether behavioral science
can provide companies with tools that better enable them to identify circumstances when employees are tempted to cross the line. For example, are we able to identify common elements that give rise to such behavior? By doing so we should also be able to frame the hallmarks of a strong corporate culture, one that allows employees to flourish in an environment where they are trusted.
This book will not have all the answers. This is merely a first step toward understanding alternative methods and techniques that might assist the management of financial institutions in restoring trust and ethics in their organizations. It is critical that they do so ahead of the next crisis, when they might not have the luxury of acting on their own.