The Predators’ Ball (23 page)

An only child, Icahn grew up in a small two-family house in the middle-class neighborhood of Bayswater, Queens; his grandfather lived upstairs. His mother was a schoolteacher. His father had a law degree but hated being a lawyer, taught chemistry but hated teaching. He had wanted to be an opera singer and had studied with Enrico Caruso. Unable to break into opera but desperate to have some opportunity to sing, he took a job as a cantor—nonreligious though he was—in a synagogue in nearby Cedarhurst, Long Island. That too proved unsatisfying. Having developed what the family calls “a heart condition” in his early forties, he stopped working and stayed home until his death in 1978. “He read Schopenhauer and listened to records, day and night,” one friend remembered.

Icahn's mother had two sisters, also schoolteachers, and a brother who was only about sixteen years older than Carl and was the family's success story. In the thirties, during the Depression, Melvin E. Schnall had attended Yale University, where he was painfully aware of being part of the Jewish quota. He married into a wealthy family, went into his father-in-law's business, became wealthy himself, lived in a lavish home in Scarsdale with a pool and four in help (where Carl was first “exposed,” as Schnall says, to the finer things). But the driving obsession of Schnall's life, which informed his decisions about year-round residences, summer homes, private clubs, and schools for his children, was his effort either to pass as a non-Jew or to be the accepted token. In the course of this decades-long struggle, he joined the Unitarian Church and changed his name from Melvin E. Schnall to M. Elliot Schnall.

Carl Icahn, after graduating from Far Rockaway High School, went to Princeton, where he became recognized as an expert chess player, studied philosophy, and wrote an award-winning senior thesis entitled “The Problem of Formulating an Adequate Explication of the Empiricist Criterion of Meaning.” At his mother's insistence, he attended medical school at New York University, but he hated it
and he has said, as reported in an article about him in the Princeton alumni magazine, that it aggravated a “slight hypochondria.” He dropped out after two years and did a stint in the Army (where, he says, he won several thousand dollars playing poker).

In 1961, Schnall got his nephew a job as a trainee stockbroker at Dreyfus and Company. Icahn invested his poker winnings, made $50,000 in a bull market, and then lost it all when the market fell in 1962. “I was so upset that I've really worked like crazy since then,” Icahn told
Business Week.

He decided that he needed a niche. Options—the trading of puts and calls, which are respectively the rights to sell and buy stock at a certain price at a given future time—were then, as Icahn says, “a wide-open field.” He became an options broker at Tessel Paturick and Company, where he worked with Joseph Freilich and Daniel Kaminer, and then the three of them moved in 1964 to Gruntal and built its options department. Trading information on options was not then publicly listed; Icahn started publishing a newsletter, called
The Mid-Week Option Report,
and built a strong client base of options sellers. By 1968, Icahn says, his options department was earning gross commissions of about $1.5 million, which made it one of the most profitable at Gruntal.

It was clear that the intense, abstracted Icahn had found his home on Wall Street. The niches he had carved and would continue to carve for himself satisfied his analytical bent. And the money was a perfect reward. At work he gambled, and for relaxation he gambled. One friend recalls Icahn playing not only the usual card games but Monopoly, for real money. “I walked into Carl's apartment, and there he was,” recalls this friend, “with this enormous pile of cash, buying Boardwalk for five hundred dollars.”

Icahn decided he wanted to open up his own discount brokerage firm, and he asked Schnall whether he could borrow $400,000 to buy a seat on the New York Stock Exchange. Over the last several years, he and Schnall had become close. Schnall was divorced, living on Sutton Place in Manhattan, running a looseleaf-binder company he had bought, and the two would meet at “21” at the close of most business days. Icahn had traded options for Schnall's account and made about a 30–40 percent return for him. In 1967, moreover, Schnall had sold for roughly $3 million a company he had bought two years earlier for about $400,000, so he had plenty of cash on hand.

Schnall received 20 percent of the stock in Icahn and Company.
With the rest of the $3 million he bought tax-free bonds, with an 8 percent coupon, which he subordinated to Icahn and Company to strengthen its capital base. In return, Icahn paid him $100,000 a year. Carl opened an office at 42 Broadway with Kaminer, Freilich and Jerry Goldsmith, another man who had been at Gruntal, as his partners.

Alfred Kingsley also came from Gruntal to the new Icahn and Company, as an associate. Kingsley, seven years younger than Icahn, had started as an undergraduate at Wharton at sixteen, had graduated from New York University Law School at twenty-three and then had gotten his master's in tax law. In 1965, still in law school, he had begun working full time for Icahn at Gruntal.

At Icahn and Company both Icahn and Kingsley began mixing arbitrage with options. What they were practicing then was not risk arbitrage—where one buys the securities of a target company after a deal is announced, betting on the transaction's going through—but classic arbitrage. Icahn would buy a convertible bond at 100, convertible to ten shares of stock at 10, and then he would simultaneously sell ten shares short at ten and one eighth—thus locking in the eighth-of-a-point profit on each share. Then he introduced options into the mix, in elaborate hedging formulas that left him protected on the downside with the potential for an enormous upside.

“There were great opportunities to make money,” Icahn said, recalling a particularly gratifying transaction in Polaroid where a combination of buying stock, puts and calls brought him $1.5 million for what he insists was “no risk.” “The arbs didn't know options, and the options brokers certainly didn't understand arbitrage. The arbs kept arbitrage very quiet in those days, there were only a few doing it, like Gus Levy at Goldman, Sachs. So when I put together arbitrage with options it was really great.

“Always, I looked for a spot that was not too popular. You want to be in something other people don't see—and which makes eminent sense.”

In 1973 the Chicago Board Options Exchange opened, and the field soon became too crowded for Icahn's taste. Kingsley, meanwhile, had been hedging capitalizations of various companies, which he described as “constantly molding a position. It was like a washing machine, going round and round. I'd look at the whole ITT mess [of varying securities], and I'd say, I could buy this preferred,
short that [security], and I'll he hedged. And then the next day I'd buy some other issue, sell against that. Round and round. It was driving me crazy, and I started getting really bored.”

Kingsley said it was boredom that drove him from Icahn and Company in 1973 and led him to a small firm named F. L. Salomon, to specialize in new issues. One longtime associate of Kingsley disputed that explanation, saying Kingsley left because Icahn was “paying him spit.” Icahn is notoriously tight-fisted. It seems to pain him to give another dollar. Even in later years, after he had made over $100 million, he groused when his team of investment bankers, working until 2
A.M
., ordered steaks from Smith and Wollensky's restaurant. Law firms that did work for him would often wait months to be paid.

Another of Kingsley's associates said he was disappointed at not having been made a partner in Icahn and Company, But by this time Icahn was shedding partners, not making them. He was already notorious for his sudden rages, and for the abuse he heaped upon employees, minority partners, outside lawyers. No one was exempt. Kaminer left, then Goldsmith left (although he said Icahn offered to increase his equity share if he remained). Freilich was later reduced to his one percent. Even Schnall was relieved of his stake.

Schnall had not been admitted to an exclusive beach club in Southampton, Long Island, and he decided to leave New York, changing his whole social circle (which summered in Southampton), and move to New Canaan, Connecticut. Icahn suggested that it might be a good time for him to take his money out, since Wall Street was in the doldrums and Schnall was nervous; but he asked Schnall to leave his bonds there. Schnall agreed, and continues to receive what Icahn calls his “allowance” of $100,000 a year. To this day Schnall chafes at having agreed to give back his 20 percent.

Kingsley, meanwhile, was finding the world outside Icahn and Company inhospitable. F. L. Salomon went out of business; Kingsley joined another firm, and it soon merged with yet another. “Every three weeks,” he says, “there was another name on the door.”

If acumen were the only determinant, Kingsley certainly should have thrived on Wall Street. Jeffrey Steiner, who assisted Nelson Peltz and would become one of Icahn's principal investors in the eighties, called Kingsley “the most clever business analyst I
have ever met in thirty years in business.” But Kingsley, a short, rotund Buddy Hackett look-alike, an Orthodox Jew who leaves work early on Friday so as to be home for the Sabbath before sundown, did not fit—nor did he aspire to—in the white-shoe investment-banking world. And life in the bottom-tier firms that were struggling for survival in Wall Street in 1974 had little to recommend it. In 1975, Kingsley returned to Icahn and Company after less than two years away.

Even while he was away, Kingsley had continued to talk to Icahn. In one of their conversations he had mentioned that he thought there were great investments to be made in “undervalued situations.” The one he recommended was a closed-end mutual fund named Highland. Kingsley bought some of its shares for his customers, Icahn bought some, and after Kingsley rejoined Icahn they accumulated a block of about 30 percent—which management (distinct from the company) then bought back in 1976. “It was a two-year play, it took us a lot of time to accumulate,” Kingsley recalled. “But we bought at two and we sold at six.”

That was the beginning. After that, they accumulated positions of 4.9 percent (at 5 percent a shareholder must file a 13D disclosure document with the SEC) in several more closed-end funds at discounts to their real value, the stock prices then went up, and they made a profit. Because these were mutual funds, all one had to do to determine whether they were undervalued was to compute the value of their portfolio and compare that to its stock price. “That was the chicken way of playing,” said Kingsley, comparing it to the task of targeting a company, whose value is harder to quantify. “And after we'd done those, Carl said, ‘This is an interesting way to invest—let's do some more.' ”

In 1978 Icahn waged a proxy fight to gain control of a real-estate investment trust named Baird and Warner. Like Milken, who had been investing in REIT paper through the midseventies, Icahn recognized that there was a lot of hidden value in the depressed REIT industry. And Baird and Warner was not a troubled REIT, just one whose stock price had suffered because of the REITs' general disrepute.

While Baird and Warner's assets were mainly illiquid at that time, they were worth about $30 million—a nice pool of capital for Icahn to control. Icahn renamed this REIT Bayswater, after his childhood neighborhood, and eventually caused it to revoke its status
as a REIT, in order to invest in new types of real-estate-related activities and also in the securities of public companies. Bayswater thus became a vehicle for raids.

The proxy fight—a campaign for the shareholder vote held at a public company's annual meeting—now became Icahn's weapon of choice. In the 1950s, proxy fights had been waged by outsiders, such as Robert Young at New York Central Railroad, to persuade stockholders to throw out incumbent managements and install them instead. At that time, however, the advantage lay with the incumbents; as long as management was paying a dividend and was not tinged with scandal, stockholders would rarely vote for a raider.

By 1979, the odds had changed.
Forbes
magazine reported that a check of twenty-five proxy actions taken that year showed management the victor in twelve and dissidents in thirteen. Icahn and others had started a new-wave proxy fight, in which the aim was not so much to replace management (although Icahn had done this at Baird and Warner) as to attract the attention of third parties to an undervalued company. And the issues in the proxy fight were framed in terms of shareholder profits. Icahn would point out that the stock was trading at some paltry fraction of book value, and that there was real potential for better earnings.

In 1979 Icahn won a proxy fight to gain board seats and then forced the sale of Tappan, the stove-maker—whose stock was trading at around 8 and had a book value of over $20 a share—to AB Electrolux, a Swedish-owned home-appliance manufacturer, at a price that gave Icahn a profit of close to $3 million. “Tappan worked like a charm for Carl,” said his lawyer for that deal, Morris Orens of Olshan Grundman and Frome. “It clearly demonstrated that if you are right about the company's assets being undervalued, and the company wishes to put itself up for sale, there will be buyers out there.”

Icahn was ebullient. Discussing proxy fights aimed at forcing a sellout, he told
Forbes,
“I think the risk-reward ratios there are a very exciting thing. Much better than arbitrage. It's the wave of the future.”

Icahn moved on to Saxon Industries, the copier company, where after threatening a proxy fight he sold back his 9.5 percent stake to the company at a premium over the market, making a $2 million profit. It was his first public greenmailing—selling back to a company at a higher price than was available to other shareholders.
But the word “greenmail” had not yet been coined. The activity—which had been carried out by others such as Victor Posner and Saul Steinberg—was known as a “buyback at a premium” or a “bon voyage bonus.”