Help wanted: Merrill Lynch CEO

Only one or two people in the financial world are qualified to run the banking giant - but it's such a risky bet, who would want it?

By Peter Eavis, Fortune senior writer

(Fortune) -- Taking on the top job at Merrill Lynch could turn an executive into a Wall Street legend, but it also has the potential to ruin anyone who takes the CEO post from the just-departed Stanley O'Neal. That stark choice may be one of the reasons Merrill hasn't lined up anyone just yet to lead the firm out of the crisis sparked by large losses from junk mortgages.

Tuesday, Merrill (Charts, Fortune 500) said that O'Neal has decided to retire immediately from the company and that board member Alberto Cribiore will chair a search committee for a new CEO, while co-presidents Ahmass Fakahany and Gregory Fleming will remain in their posts and oversee operations.

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Merrill Lynch boardmember Alberto Cribiore will serve as interim non-executive chairman until a successor for O'Neal is determined, the company said.

While it would have been a stretch to install a new CEO so quickly, speculation had been strong since the end of last week, when news that O'Neal was leaving came out, that the job could go to Larry Fink, the CEO of BlackRock (Charts), the asset management firm that Merrill partially owns.

Given the nature of Merrill's problems, someone taking on the CEO job would be making a swashbuckling bet on their career. It could yield massive returns for the executive involved - in terms of pay and reputation - but it would be so demanding and difficult that there may only be one or two people in the financial world who would be qualified - and who would actually want it.

First and foremost, the candidate would have to be capable of bringing Merrill through a period when it could show more losses and be subject to intense scrutiny from the press and regulators on how it reported those losses.

In the third quarter, Merrill said it took $7.9 billion of losses on complex securities called collateralized debt obligations and junk mortgages - a number that was $3.4 billion higher than estimated just three weeks earlier. On a conference call to discuss third quarter earnings, O'Neal and CFO Jeff Edwards, whose future at the firm is reportedly in doubt, failed to give sufficient information to determine whether even the higher $7.9 billion loss number was sufficient. Analysts now expect another $4 billion of losses in the fourth quarter from toxic bonds.

When companies move numbers around like that, it is never a surprise to see the Securities and Exchange Commission launch an inquiry into why that happened, because it suggests executives weren't handling the firm's bookkeeping correctly.

Quickly, the new chief would have to attach his or her name to new earnings projections, and explicitly say what future losses might amount to. If Merrill then reports losses higher than those predicted by the new head, he or she then would become the new focus of investors' ire.

In essence, then, Merrill needs someone who can do three things with the CDO mess: Take the right amount of losses, no matter how large that number is; set up strong risk controls across the company, and; be able to communicate quickly and convincingly what is happening when fresh upsets occur, as they almost always do when a company is working its way through a crisis.

This can be done. The most recent big-name executive in the banking world to carry it off was Jamie Dimon, who joined Bank One as CEO in 2000 and then had to work very hard to convince investors, amid losses and setbacks that surfaced under his reign, that he actually was capable of righting Bank One. He eventually did get Bank One back on track and went on to become CEO of JP Morgan Chase, (Charts, Fortune 500) which bought Bank One in 2004. Clearly, then, coming in to head up a distressed institution can be a great move for the right person. But if Bank One had not recovered, Dimon may have just become a footnote in American financial history.

Another important move that Dimon made was to buy nearly $60 million of Bank One stock with his own money before joining the bank. If the new Merrill CEO were to purchase a large slug of stock in the company before joining, it would be a clever motivating gesture, causing employees to warm to the newcomer. Of course, employee discontent could intensify if it becomes apparent that the new CEO has demanded an outsized pay-package, with little downside risk, to come on board.

In addition to dealing with CDO losses, the new head of Merrill would have to deal with another mind-bending challenge: Mapping out to employees and investors what the new, post-crisis Merrill will look like. Of course, there is going to be a sharp retreat from businesses like CDOs and other areas where risk is perceived to be high.

However, these riskier businesses -- which absorb huge amounts of capital -- helped Merrill grow strongly in recent years. For example, Merrill reported $7 billion of revenue from "principal transactions," or trading with the firm's own money, in 2006, double the number for 2005. Revenue growth from principal transactions dwarfed growth from other activities.

A new CEO would not want to stop all principal investing, but would he or she be able to quickly pinpoint what sort of trading Merrill can make money in over time, especially during the current credit crunch, when banks are fighting for a smaller amount of business?

If Merrill's trading and investment banking businesses stop having a big impact on earnings, Merrill's profits would become much more driven by its brokerage and asset management businesses. Nothing wrong with that, of course, as Merrill has $1.8 trillion in client assets, and it excels in these areas. But can focusing mainly on asset management and the brokerage business produce the sort of earnings growth that could support a recovery in Merrill's stock from its current low levels? Maybe, but a new CEO would have to show how.

And the new Merrill head won't be able to ignore the stock price for a second. If the stock continues to sag, Merrill will quickly become an acquisition target. That, in turn, could prompt a steady outflow of senior employees; working for a newly acquired financial company soon after a purchase is often a trying experience, to put it mildly.

Granted, an acquisition at a good price after a recovery wouldn't be such a bad outcome for a new CEO, as Dimon's ascent shows. But if it takes place at a low price from a position of weakness, it would be a black mark on the career of the CEO who ended up agreeing to it.

Taking the top spot at Merrill is a huge bet for whomever does it, but, as the firm forgot under O'Neal, all reward carries risk.  Top of page

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