In February, 2000, the Canadian Imperial Bank of Commerce blessed a select team of New York bank executives with a billion-dollar fortune in Global Crossing Ltd. shares.
The lucky recipients were Dean Kehler, Jay Bloom and a few of their senior partners at the bank's Manhattan-based junk bond division, known as the Argosy group. Under terms of a unique compensation plan signed in 1995, CIBC distributed 13 million of its own shares in Global Crossing to the junk bond partners on Feb. 15. With that transfer, the total number of shares given by the bank to about two dozen managers of the Argosy group amounted to 24.5 million
What did the partners pay for all these shares in the hottest telecommunications play on Wall Street? The equivalent of pennies a share, according to bank sources. What were they worth on the market at the time? About $56 (U.S.) a share, or a cool $1.37-billion.
"It was more money than anyone in their wildest dreams ever thought possible and the bank gave it to them almost for nothing," recalls a former CIBC executive.
Neither Mr. Kehler nor Mr. Bloom would comment for this story. A spokesman for the bank declined to comment on the executives' personal holdings or disclose when the shares were sold. But sources familiar with the group said much of the stock was sold or hedged through contracts signed in 2000.
Until now, few have known the full scope of the New York executives' stock windfall or that CIBC gave them the shares in the fibre-optics startup for next to nothing.
As outraged investors, employees and regulators examine troubling accounting allegations surrounding the collapse of Global Crossing, which filed for bankruptcy protection five weeks ago, CIBC's close and lucrative relationship with the fibre-optics company is coming under intense scrutiny.
In addition to the New York team's mother lode, CIBC expects to earn a total of more than $2.6-billion (Canadian) in pretax profits through direct or hedged sales of its Global Crossing shares. A spokesman for CIBC said no other executives were given cheap shares in Global Crossing, but he confirmed that record multimillion-dollar bonuses handed to some of its top managers in 2000 were linked to the bank's profits on the shares.
To some, the CIBC's lottery-sized win on Global Crossing is one of the starkest illustrations of the dysfunctional economics of the technology sector's boom and bust. Intermediaries such as CIBC reaped the lion's share of the rewards from risky new ventures, while, in the case of Global Crossing, most shareholders saw their investments wiped out.
"These are the kind of transactions that destroy our faith in the capital market system. Investors are left holding the bag, while Wall Street players like CIBC walk away with oodles of money," said Benjamin Mark Cole, a Los Angeles based business columnist and author of The Pied Pipers of Wall Street.
What has been good for CIBC's bottom line is now shaping into a public relations nightmare for the bank. Under the spotlight are the multiple roles its bankers played as early investors, directors, lenders and underwriters. Also attracting attention are the close ties of some of its New York executives with Global Crossing's controversial founder Gary Winnick.
The origins of the New York executives' fabulous wealth is a controversial compensation plan that was overseen by John Hunkin, now CIBC's chairman, and negotiated by David Kassie, now chief executive officer of CIBC World Markets Inc. "There were a lot of people at the bank who were very unhappy with the deal," said one former senior bank executive.
What made them furious, former officials said, was that a few employees were reaping a fortune equal to an entire year's worth of profit at the bank, while CIBC was putting shareholder capital at risk to lend money and underwrite securities for Global Crossing.
Some of those fears were realized in the first quarter ended Jan. 31, when CIBC announced last month that $200-million of its loans to Global Crossing are "impaired" as a result of the company's woes. A spokesman for the bank counters that the loss erodes only a fraction of the $2.6-billion gains it has reaped from the sale of its Global Crossing stock.
No one is accusing the bank of any wrongdoing. CIBC's top U.S. legal counsel says that after a close examination of its activities and those of its employees linked to Global Crossing, he is satisfied that the bank did nothing wrong.
"CIBC acted appropriately and responsibly at all times. There is absolutely no indication that any CIBC employee did anything improper," said Michael Capatides, an executive vice-president based in New York with the bank.
But as the U.S. Securities and Exchange Commission, the Federal Bureau of Investigation and shareholders launch investigations and lawsuits amid allegations that Global Crossing misstated its financial condition, many are asking why CIBC was smart enough to sell its shares early for a spectacular profit when so many others suffered huge losses.
"How much did the bank know about Global Crossing's problems and when did it know about them?" asked Joseph Weiss, a Los Angeles-based lawyer who launched a shareholder class-action suit last month against Global Crossing for alleged financial misstatements.
While CIBC says it has not been named in the recent spate of class-action lawsuits against Global Crossing, Mr. Weiss said his firm is examining the activities of each of the company's financial, legal and auditing advisers, including those of the bank.
How did Canada's second-largest bank become entangled in one of the messiest corporate breakdowns in U.S. history?
The story begins on the balmy shores of the Cayman Islands. It was in this tax haven on March 19, 1997, that a small holding company called Global Crossing (Cayman) Ltd. was formed by Gary Winnick. It was the first step in his daring vision of laying fibre-optic cable at the bottom of the Atlantic Ocean to carry the increasing volume of international Internet traffic.
A former convertible bond salesman at Drexel Burnham Lambert Inc. in the early 1980s who sat a few feet from junk bond king Michael Milken's famous X-shaped desk in Beverly Hills, Mr. Winnick launched his own investment firm in the mid-1990s. After drifting for a few years, he and his partners at Pacific Capital Group seized on the concept of an undersea fibre-optic cable in 1997 as a ticket to the Internet boom.
Mr. Winnick invested $15-million (U.S.) in the Cayman Islands company, but he needed hundreds of millions of dollars from bankers and investors to build the undersea network. One of the first people he called was former Drexel colleague Bruce Raben, who was then working for CIBC's investment banking arm in Los Angeles.
Mr. Raben was one of a team of junk bond specialists who joined CIBC in 1995 when the bank acquired Argosy Partners LP. Most of the Argosy partners knew Mr. Winnick from their days as junk bond specialists at Drexel. When Mr. Raben alerted CIBC about Mr. Winnick's global network strategy, the bank seized on it as a golden opportunity to make its mark in the United States as a one-stop financial service centre for corporate customers.
Changes in U.S. banking laws in 1997 had made it easier for commercial banks such as CIBC to expand into the investment and merchant banking fields. Former bank executives said CIBC was so keen to buy Argosy in 1995 because its junk bond expertise would allow the bank to break into the top tier of the lucrative high-yield-debt market.
Knowing how much CIBC needed the junk bond firm and its connections with prominent financial players such as New York's legendary investment house Kohlberg Kravis Roberts & Co., Argosy's partners asked for the moon.
According to former CIBC executives familiar with the Argosy takeover, the bank paid very little up front for the firm, and instead agreed to a so-called "earn-out" agreement that allowed the partners, during their first few years at the bank, to keep more than 50 per cent of the profit generated on their junk bond deals.
As part of the agreement, the Argosy partners were also entitled to a share of the equity CIBC acquired in ventures financed by the junk bond unit. These shares were given to the Argosy team at the same initial cost paid by the bank.
A number of CIBC's old-guard bankers, including then chairman Al Flood had reservations about the generous compensation plan, according to former executives. Mr. Flood could not be reached for comment.
Argosy's partners would bag huge profits if their deals were successful, senior bankers warned, while CIBC risked its capital by underwriting, investing in junk bonds and lending money to support the group's transactions.
CIBC's Mr. Capatides said the Argosy group's compensation was key to "retaining the type of employees capable of identifying opportunities such as Global Crossing."
If Argosy partners struck it rich, supporters such as Mr. Hunkin and Mr. Kassie argued, the bank would earn a share of the profits and, more importantly, a bigger presence in the U.S. merchant banking field.
The word rich would take on a whole new meaning with Global Crossing.
From the beginning CIBC was thrilled to be doing business with Global Crossing. The bank had been pitching itself in the United States, as one banker put it, as a "complete solution" for all corporate needs, and Global Crossing was one of its earliest successes at providing multiple financial services to a corporation.
After weeks of discussions with Mr. Winnick in early 1997, CIBC invested hundreds of millions dollars of its money to help launch Global Crossing's predecessor company in the Cayman Islands. As part of a package of financial support, the bank paid $41.2-million for a 45-per-cent equity interest in Global Crossing (Cayman). The price tag for the stake, bank sources said, was about 30 cents a share.
Bank officials said CIBC bought such a large stake in the fledgling company because, as one banker who helped structure the transaction said, "it was such an attractive deal." Former bank executives who are familiar with the transaction, however, said the bank agreed to acquire such a large stake because the company didn't have enough equity to attract the lenders and debt investors needed to finance undersea cable.
Within weeks of acquiring the Global Crossing stock, sources said CIBC sold some of its shares to other investors, lowering its stake to 34 per cent.
CIBC's financial package of services to Global Crossing's predecessor in March, 1997, included a $482-million loan and the purchase of $250-million in senior notes and preferred shares. Portions of the loan and securities were later syndicated or sold to other financial institutions and investors.
Over the next two years, according to securities documents, the bank earned $44-million in fees from Global Crossing as a lead underwriter of its junk bonds and as a senior project lender. The fees would be chicken feed, compared with what CIBC would earn on its equity stake.
Like most merchant banks, CIBC hoped to score on its Global Crossing investments through what industry players call a "liquidity event" - the moment at which a startup company has enough revenue and prospects to attract a broader group of investors willing to pay big bucks for securities initially sold for pennies.
At Global Crossing, the liquidity event took place Aug. 13, 1998. It was on this day that CIBC co-led an initial public offering to sell Global Crossing shares on the Nasdaq Stock Market at $9.50 a share, adjusted for a later stock split. By then, the small Cayman Islands holding company had been transformed into a Bermuda-based operating company that had started building the undersea networks.
It took a only a few hours for Global Crossing to establish itself as one of the high-flying legends that defined the technology boom. At the end of its first day of trading on Aug. 14, Global Crossing's stock price soared 34 per cent. The airborne stock price meant that CIBC's stake, reduced to 25 per cent following the IPO, was worth $1.2-billion.
It was just the beginning. Buoyed by investors' frenzy for Internet plays, Global Crossing's stock went into orbit. By May, 1999, only nine months after it went public, the company's stock peaked at $59.45 a share, giving CIBC's equity stake a market value of more than $4.5-billion.
At the bank's New York offices, the euphoria was unbounded.
"It was like we had climbed the Matterhorn without oxygen," recalled one New York CIBC official who has since left the bank. "Everyone was so thrilled. In one stroke Global Crossing had allowed us to break into the big time on Wall Street."
At the time, most of CIBC's New York bankers were convinced Global Crossing would climb to higher peaks. But back in Toronto, the bank's then chairman Mr. Flood was worrying about an avalanche.
In the spring of 1999, during one of Mr. Flood's weekly Friday meetings with his senior management team on the 5th floor of Commerce Court West, the seasoned credit-risk expert turned his eye to the bank's Global Crossing holdings.
"Al didn't believe that the stock was going to stay there," recalls one executive who attended the session. "He put his foot down and said: 'We have made enough money.' "
After that, some executives who attended the meeting said, Mr. Flood asked the bank's New York office to begin preparing a plan to sell or lock in its profits on the Global Crossing shares.
In hindsight, Mr. Flood's decision easily ranks as one of the best banking calls of all times. In early 1999, however, his directive put the bank in a sticky position.
Several months earlier, CIBC had served as a co-lead underwriter of Global Crossing's IPO and had been allocated 1.3 million shares to sell to its clients. If word got out that the bank was selling or planning to sell its 25-per-cent stake in the company, its stock price would have plunged, damaging the holdings of its clients and thousands of investors.
Another complication was the fact that five of the bank's New York-based executives, including Mr. Kehler and Mr. Bloom, served as directors on Global Crossing's 16-member board. If the bank sold such a large stake at the same time its executives were directors, CIBC and its officials could be vulnerable to accusations that it was acting against the interests of Global Crossing shareholders.
CIBC's Mr. Capatides said the bank carefully weighed CIBC's conflicts of interest as it prepared to exit Global Crossing in 1999. "At each step, potential conflicts were closely considered and mitigated through independent approval processes within the bank."
In June, 1999, CIBC sold the first of its Global Crossing shares, earning a pretax profit of $583-million (Canadian). It sold the stock to telecommunications company US West Inc. as part of a penalty US West had to pay for backing out of a takeover agreement with Global Crossing.
Three months later, two of CIBC's executives resigned from Global Crossing's board. The other three announced their resignations in the spring of 2000. Their departures cleared the way for the bank to begin selling its remaining shares. By the end of 2000, the bank pulled in close to $700-million in pretax gains by selling 16.8 million Global Crossing shares into the market.
But the most controversial move was yet to come. In one of the largest equity hedges ever negotiated in Canada, CIBC effectively locked in its profit on 47 million Global Crossing shares by signing hedging contracts to sell the stock at future dates ending in 2003 for fixed prices that ranged between $20 and $64 (U.S.) a share.
Having made its fortune on Global Crossing, CIBC continued to play a number of roles at the company. It still has loans outstanding to Global Crossing and last year it sold millions of its remaining unhedged shares in the company.
One of CIBC's New York analysts continued to recommend, as late as last fall, that clients buy shares in Global Crossing's publicly traded subsidiary, Asia Global Crossing. The Asian unit is now struggling to avoid bankruptcy proceedings.
The bank's U.S. merchant banking unit featured Global Crossing's executives at investor conferences as keynote speakers last summer. A press release announcing the event described Global Crossing as one of the "building blocks" of the communication industry's future.
Despite the complications posed by its many roles at Global Crossing, CIBC's Mr. Hunkin said after the annual meeting last week: "I think it's a great strategy and one that we will continue to employ."