(FORTUNE Magazine) – It's known as "The Crisis" around Texaco's sprawling office headquarters in a leafy suburb north of New York City, which is certainly apropos. It was the embarrassing and expensive saga that forced the oil giant to cut a hefty $175 million check nearly three years ago to settle a racial discrimination lawsuit filed by some of the company's African-American employees, the largest such settlement ever. As the drama evolved both before and after the settlement in November 1996, details emerged that exposed blatant acts of racism by Texaco managers and employees. There was the dicey taped discussion among company executives that included racist language and talk of destroying key evidence, and the vile occasion when a white employee stopped outside a coveted two-window office inhabited by an African-American woman and said, "Jesus Christ, I never thought I'd live to see the day when a black woman had an office at Texaco." Moments like these--along with several examples of institutional racism, such as hundreds of minority employees being paid less than the minimum salary for their job category--caused Texaco to be branded the worst of corporate rogues.

So, here's a shocker: Texaco, still perceived by many as a chamber of horrors for minorities, is in the midst of a remarkable transformation, one that just may turn the company into a bastion of equal opportunity for people of color. In time, it may even become a model for any corporation that wants to learn how to become more hospitable to employees of all races.

Just how far has Texaco come? Here are a few numbers worth noting: Last year minorities accounted for nearly four in ten new hires at Texaco and more than 20% of promotions. During the first six months of 1999, minorities accounted for 44% of new hires and 22% of promotions. In 1996 company officials vowed to spend at least $1 billion with minority- and women-owned vendors--or about 15% of overall spending--before 2001. They passed the halfway mark two years into the program, spending $528 million with minority- and women-owned vendors during 1997 and 1998. (Black and Hispanic firms received $135 million of that total.) Also, all employees are now required to attend diversity training; managers and supervisors are shipped to change-management communications courses, as well. CEO Peter Bijur, an aggressive, fast-talking, 33-year company veteran, also made several high-profile hires at key executive positions, a clear signal that Texaco's leadership--the "top of the house," in industry parlance--was not immune to dramatic change. Yet Bijur isn't ready to declare victory (white men, after all, still account for nearly 80% of company executives), though he's clearly satisfied with what he sees as concrete signs of a cultural shift. "Now," he says, "we treat all people with the utmost respect--that is a real achievement."

Here's another telling note: Company officials were feeling good enough about themselves earlier this year to apply for inclusion in FORTUNE's 1999 list of America's 50 Best Companies for Asians, Blacks, and Hispanics (July 19). Texaco didn't make the cut, but the very fact the firm aspired to make the list (and actually believed it had a chance) says plenty about how some folks there are feeling about themselves these days on matters of race. And at least one diversity expert says their new attitude may indeed be warranted. "I have never seen a company be so creative and so dedicated to change," says Weldon Latham, a senior partner at the Washington, D.C., law firm Shaw Pittman and a prominent racial-harassment litigator. "They are absolutely a model for how to approach one of the biggest problems facing this country."

The tale of how Texaco evolved from pariah to paragon wannabe begins on a Sunday in early November 1996, when Texaco lawyers, in the throes of vigorously defending the company against the discrimination lawsuit brought by some African-American employees, got some stupefying news: A former top Texaco official had secretly taped meetings about the lawsuit, during which he and his colleagues freely used racial epithets and seemed to be discussing how and when to make magic with some incriminating documents--like make them disappear. Worse, the official supplied copies of the tapes to the plaintiffs' attorneys and the New York Times, which would be printing a front-page story about the mess the very next day, Nov. 4.

Texaco's stock plunged more than $3 per share in the days after the tapes became news, stripping nearly $1 billion from the company's market capitalization. Texaco was pilloried nationwide. Several major shareholders--including New York State controller Carl McCall, whose state is one of the company's biggest investors--even called Bijur personally and wondered out loud whether they should remain invested in Texaco. Right or wrong, guilty as charged or not, company officials knew they were staring at a potential disaster. So Bijur moved quickly and decisively; he reached for the white flag. The CEO told the company's attorneys to stop fighting the charges. On Nov. 15, a settlement was reached: $140 million in damages and back pay for minority employees, another $35 million to set up an independent task force that would monitor the company's diversity efforts for five years. Says Bijur: "I decided that I needed to set a new course for us."

Oh, if it were just that easy. The settlement didn't end the carnage. Another missile landed a few months later when Bari-Ellen Roberts, an African-American former senior financial analyst at Texaco who had been one of the lawsuit's plaintiffs, published a book detailing some of the humiliations she and other black employees suffered during her years at the company. She wrote about the time her performance review was downgraded because a white supervisor found her "uppity," and another time when a white official referred to her publicly as a "little colored girl." She also unveiled the pay disparities for minorities. In short, Roberts v. Texaco laid out the worst of Texaco's race faults.

By now, Bijur and his fellow top-of-the-house inhabitants were well aware that with Texaco under continuous scrutiny, middling efforts and paper promises on diversity just weren't going to cut it. So they chose a tack that remains all but revolutionary at a time when many corporations are still tiptoeing around the complexities of race in the workplace. They decided to conduct a total overhaul of Texaco's culture. No exceptions. Bijur announced he would show little patience with old-line managers who resisted the new paradigm. "I drew a line in the sand and said that we will not tolerate disrespect," he says. "Some people acted inappropriately; they are no longer here."

The details of the company's diversity plan were hammered out by Texaco officials and members of the independent task force. The plan was built around more than a dozen new and enhanced programs aimed at rooting out institutional discrimination in hiring, retention, and promotion. A significant first step was broadening the scope of recruiting efforts to ensure that more minority job candidates were among the pool of applicants for every position. To make that happen, Texaco began hiring search firms with solid records for recruiting minorities. New scholarship and internship programs were launched to attract minorities to crucial disciplines like engineering, the physical sciences, information systems, and international business.

Bijur also did something a lot of CEOs are loath to do, even those who lead and support solid diversity initiatives in their own shops: He set real goals with real timetables and issued several edicts designed to shake up a culture that had long stifled minority retention and advancement. Women and minority employees were added to all human resources committees, and formal mentoring and succession programs were added to ensure that minorities and women were being fed into the company's leadership pipeline. Also, to guarantee that employees with grievances weren't being ignored--a recurring theme in Roberts' book--the company provided workers with ways to air their complaints with impunity: telephone and e-mail hot lines; an alternative dispute-resolution process that includes independent arbitration and mediation; and a confidential outside counselor.

It's all noble stuff, but none of the programs and directives would be effective if failure to make satisfactory progress toward the goals went without consequence. So Bijur also told Texaco's top executives and managers that their career trajectories would be directly linked to their success in implementing the new initiatives. All bosses were to be subjected to lengthy 360-degree annual evaluations, which would include diversity issues, and compensation would be tied to their performance in, as Bijur puts it, "creating openness and inclusion in the workplace." Now, even Bari-Ellen Roberts concedes, though in measured terms, that the company she annihilated in print is actually starting to embrace real change. "They've made progress," she says. "They had to--things could not stay the same."

Credit Bijur's decisiveness and quick actions for preventing The Crisis from becoming The End for Texaco. He recalls, with a grimace, the phone call he received at home that fateful Sunday night nearly three years ago, informing him for the first time of the secret tapes. "I felt surprise, shock, and anger," he says. "Then I decided that I was going to use this as an opportunity to make us a better company." It's worth noting that the company's transformation took place during rough economic times for Texaco and the entire oil patch. During all of 1998 and through the first quarter of this year, the company was savaged by historically low crude oil and natural gas prices. Revenues tumbled 32% last year, to $31.7 billion, as earnings dropped 79%, to $578 million. Heads rolled. Texaco trimmed worldwide employment from 27,000 to 18,500.

In the face of such woe, most CEOs would have certainly put any diversity talk on the back burner to focus on the bottom line. Yet Bijur not only maintained diversity as a priority during this period but also made several hires that changed the complexion of the company's executive ranks. He recruited African-American heavyweights to Texaco and gave them key jobs. Ira D. Hall, director of global business development at IBM, came over to manage Texaco's joint ventures around the world--entities that are expected to generate about one-third of company earnings in 1999. Then came Angela E. Vallot, a hotshot Washington, D.C., attorney, to head up the company's diversity programs. Finally, Deval L. Patrick, a Boston attorney and former Justice Department official who had led the independent task force studying Texaco's diversity efforts, signed on as vice president and general counsel.

You might think Bijur would have had a rough time recruiting such talent in the wake of the settlement. But by that time, Texaco was in an unusual position in corporate America: It was under a court order to improve its diversity record. Says Patrick: "There's often a lot of noise created by employers about what they're going to do about diversity. This was a situation where they couldn't just get away with noise. I detected a very unusual desire to solve [the] problem."

Certainly Bijur needed to do some arm-twisting, but his obvious personal interest in enacting change at Texaco was often a key factor in negotiations. "It's obvious that top-of-the-house commitment is there, and it will remain there," says Vallot. For Hall in particular, a powerful selling point was the presence of a comprehensive, well-scripted plan for changing the company's culture. "It suggested that they had a systematic approach, which you need for success," he says. "There was a sufficient risk-reward profile for me to want to come work here."

It's hard to quarrel with Texaco's strategy and--at least in the short term--its results. But you still have to wonder if what's going on at Texaco represents essential, fundamental change or merely cosmetic alterations. Some company officials still seem to be in denial about the true state of racial affairs at Texaco prior to The Crisis. Nobody you talk to around headquarters will admit to having read Roberts' book in its entirety, and those who say they browsed contend that they didn't recognize the invidious culture portrayed in its pages. Not even Bijur, for all the good he's sparked, is willing to concede that widespread discrimination was taking place before the secret tapes appeared. "I never felt it or heard it," he says. "We were no better and no worse than anyone else."

Perhaps the best way to assess change at Texaco is to look at how the residue of past grievances is filtering through the system, and how managers and workers are dealing with each other daily. As Vallot puts it: "You're not going to change the way people think, but you can change the way people behave." By that standard, the company's transformation has indeed been significant--though not perfect. Consider this: Patrick, the new general counsel, had expected to be involved in frequent discrimination litigation, but new cases have dwindled to near zero. Instead, Patrick mostly works on meatier matters, such as Texaco's recent proposed merger with Chevron. Says Patrick: "It's a seismic change."

One potential speed bump looms in Texaco's efforts to increase its number of minority wholesalers, which declined slightly to 54 in 1998 from 57 the previous year. An African-American wholesaler from Chicago, Unicorn Oil, has filed a $23 million lawsuit alleging that Texaco reneged on several promises made to the firm under the company's new Minority and Women Business Development Program. Texaco counters that Unicorn failed to uphold its obligations and did not respond after Texaco provided financial assistance, equipment, business counseling, and other services.

For Bari-Ellen Roberts, the key to Texaco's turnaround is the independent task force her attorneys insisted upon as part of the settlement. It monitors the company's diversity efforts by meeting frequently and staying in close contact with numerous employee groups, then reports back to the court. "Had we not asked for the task force they would have paid up and moved on," she says. "As it is, Texaco will be a role model after five years." Bijur seems surprisingly content with the outside monitoring process. "It has turned out to be a useful sounding board," he says. There's even talk of institutionalizing the group in some fashion after its five-year term ends.

Ultimately, the clearest sign that Texaco is moving toward fundamental change may be the fact that nobody at the company seems to think the battle is won. Over and over, company officials caution that transforming their culture is an ongoing process, one that likely will require more than the five years the court has set to monitor Texaco's progress. "This is not paradise," says Patrick. "With diversity, there is no endgame."