FORTUNE 500 2006  
FORTUNE 500    
Lehman Brothers: A super-hot machine
How CEO Dick Fuld transformed the notoriously fractious firm from Wall Street also-ran to global powerhouse.
Andy Serwer, FORTUNE editor at large

Lehman Brothers, a 156-year-old firm that has had numerous brushes with death is now enjoying its greatest run ever. Richard S. Fuld Jr., 59, took over the notoriously fractious Lehman Brothers 13 years ago, when it was a forgotten subsidiary within the rat's nest that was Shearson/American Express. Driven partly by those who dismissed him and his firm as second- or even third-rate, Fuld transformed Lehman from Wall Street weakling to global powerhouse.

Consider this: When Lehman went public in 1994, it had only $75 million in earnings, with a paltry return on equity of 2.2%. Fast-forward to 2005, and the turnaround is breathtaking: Lehman (Research) booked $32 billion in revenues, $3.2 billion in profits, and hit 19.4% in return on equity. Over the past decade Lehman's stock is up 29% per annum on average, highest of any major securities firm and 16th best among the FORTUNE 500.

Dick Fuld, CEO of Lehman Brothers
Dick Fuld, CEO of Lehman Brothers
FORTUNE 500 2006
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In many ways Fuld is precisely what you'd expect at a firm that was once defined by its internecine warfare: aggressive, confrontational, blunt. Yet despite this no-holds-barred demeanoróor perhaps because of itóFuld has incongruously turned Lehman into one of Wall Street's most harmonious firms. Fuld's modus operandi has been to bind his employees' fates togetheróto turn the culture from one of sibling rivalry to cooperation and teamwork. His tool: money.

Skip McGee, Lehman's head of investment banking, puts it simply: "Instead of trying to divide fees up and allocate them to different bankers and departments, for purposes of compensation calculations, we just double-count revenues."

This practice has incentivized Lehmanites to help one anotheróand fueled a booming investment-banking operation that is now competing dead-on with Goldman Sachs (Research), Morgan Stanley (Research), and Merrill Lynch (Research) for megadeals. When Lehman was tapped recently to counsel AT&T (Research) on its $89 billion acquisition of BellSouth, it brought in its capital-markets experts to advise on financing, share buybacks, and liability management. Such integrated efforts yield not only more fees but also more points of contact with the client.

Notes Merrill Lynch analyst Guy Moszkowski: "Other banks talk about this silo-free model where the whole institution works together, but among the companies I cover, Goldman and Lehman clearly do it the best."

As you might imagine, the rewards for working at Lehman have been otherworldly over the past decade. But here, too, Fuld (who owns more than $300 million in Lehman stock) has an angle. His employees receive a disproportionately high percentage of their pay in Lehman stock and options. They are also typically locked up longer than their brethren at other firms (up to five years). There have been few complaints. When the company went public, employees owned 4% of the firm, or $60 million. Today they own some 30%, which amounts to $11 billion of employee wealth.

If you are old enough, or a student of Wall Street history, you are probably aware there was a previous golden age of Lehman Brothers. Decades ago it was known as a grand partnership, home to the best and brightest on the Street. It began in 1850 in Montgomery, Ala., where German-Jewish immigrant brothers Emanuel, Mayer, and Henry Lehman traded cotton. The firm helped finance burgeoning American giants like retailers Sears, Woolworth, and R.H. Macy. The Lehman family became part of the city's aristocracy. Family scion Herbert Lehman served as New York State's governor and, later, U.S. Senator.

(This is an excerpt from a story in the April 17 issue of FORTUNE. To read the complete story, click here.)

Herbert's cousin Robert "Bobbie" Lehmanówho ran the firm from 1925 until his death in 1969ówas the heart and soul of the old Lehman. The very definition of a patrician, Bobbie played polo, owned thoroughbreds, and posthumously donated his collection of some 3,000 works to the Metropolitan Museum of Art, which that institution described as "one of the most extraordinary private collections ever assembled in the United States."

Also a superb manager, Bobbie liked to say he "bet on people." Even into the 1980s the firm attracted remarkable talent, including stars who still shine on Wall Street: Pete Peterson and Steve Schwarzman of mega-buyout firm Blackstone Group, Steve Rattner of buyout firm Quadrangle, Roger Altman of private-equity firm Evercore, Eric Gleacher of investment-banking boutique Gleacher Partners, to name a few.

In 1983 (as chronicled in Ken Auletta's classic Greed and Glory on Wall Street) tensions between the traders, led by gruff and tough Lew Glucksman, and the bankers, led by Peterson, broke into the open. Peterson was pushed aside, and the firm began to implode. The following year the partnership agreed to be bought by American Express (Research). The business devolved into a worn-out subsidiary. A hard-charging buck in the bond department named Fuld, who had argued against the sale, ended up as CEO. Eventually he helped orchestrate Lehman's emergence as a public company.

Fuld has worked tirelessly to extend himselfóto become a salesman and to understand corporate finance, investment banking, and equities. As a bond trader, Fuld had little use for schmoozing with haughty bankers or with clients, or thinking about firmwide strategy, but it was from the fixed-income side that Fuld learned to emphasize the importance of integrating products and services across the firm. And it was living through the gilded age of prima donnas at the old Lehman that made Fuld want to build his firm without stars. In a way the old Lehman was like an NBA team, with Larry Birds, Magic Johnsons, and Michael Jordans. But when the stars departed, the team declined. Fuld's new Lehman is like an NFL team: Fans root for the Pittsburgh Steelers no matter who's wearing the uniform.

Still, doubts about Lehman continue to surface. What worries critics is that without a falling interest-rate environment, which buoyed the firm's performance over the past decade, future advances will be much tougher. "I'm not particularly wild about a flat yield curve," Fuld allows. "But when I hear talk about us slowing down ... they have been saying that to me for years."

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