Embattled Merrill Weighs Plans to Replace O'Neal

After a tumultous weekend of back and forth negotiations, the board of directors at Merrill Lynch is still weighing who will replace E. Stanley O'Neal as chairman and chief executive.

AP Stanley O'Neal

The 56-year-old O'Neal has been forced out in the wake of a multibillion-dollar write-off announced last week, according to people familiar with the situation.

But bigger issues loom: Namely, who will succeed O’Neal and whether Merrill’s board can avoid a civil war inside the company by selecting a candidate that can bring the various warring factions together and help Merrill survive as an independent firm.

Larry Fink, the CEO of BlackRock appears to be the leading candidate for the top job. Fink is close to current Merrill Lynch Co-President Greg Fleming, and if Fink is named he will probably give Fleming a top management role.

But many in Merrill’s huge brokerage sales force are pushing for Bob McCann, the head of the firm’s massive private client group, for a key role, setting up a showdown between McCann and Fleming.

CNBC learned that O’Neal’s fate was sealed during weekend conversations between board members. However, the writing was on the wall late Thursday and early Friday. As first reported on CNBC, O’Neal privately conceded to friends and associates that he would be forced out as CEO following the disclosure of a massive loss tied directly to his strategy of taking more risk in the bond markets. This massive loss resulted in a write down of $8.4 billion of bad bonds and other securities, and caused O'Neal to lose the confidence of the Merrill Lynch board, which he had largely composed since he became CEO in 2002.

Merrill Lynch Co-President Amass Fakahany, who oversaw Merrill's risk managment and was a close associate of O'Neal, also could be out of a job, according to people familiar with the situation.

Merrill Lynch had no comment.

Tumultuous Reign

O’Neal’s reign at Merrill had been a tumultuous one. Once in control, O’Neal slashed jobs, forced out long time executives and vowed to do away with Merrill’s paternalistic corporate culture, known as “Mother Merrill.”

At first, his cost-cutting showed results and profits soared. But O’Neal never developed a growth strategy for the firm -- which, with its 15,000-plus brokerage sales force, handles more accounts for small investors than any other brokerage in the country.

Instead, he ramped up the firm’s risk taking. Merrill began trading more in exotic credit market instruments, like collatoralized debt obligations, or CDO's, and he even bought a subprime mortgage lender at the height of the market.

When the markets for mortgage-backed securities plummeted, Merrill was among the hardest hit—and, maybe the hardest hit of all the Wall Street firms. It initially announced a write down of $5 billion due to losses from these bonds. CNBC reported that the write down was too low, but Merrill's public relations executives defended the disclosure. But last week, O’Neal personally told analysts that he was wrong. The write down totaled $8.4 billion, and despite O’Neal’s claim that he used a conservative analysis to come up with the write down, many analysts said the firm would likely have to announce additional losses in the fourth quarter.

By now the board had grown weary of O’Neal’s leadership, and they were becoming increasingly worried about their own reputations and exposure to the company’s financial problem. Since O’Neal became CEO, the board gave him carte blanche to run the firm as he saw fit. Most of all, O'Neal had the freedom to decide to increase Merrill’s exposure to credit market risk instead of growing the firm through major acquisitions or organically.

People close to the firm say the board also worried that O’Neal, who was known for his attention to detail, couldn’t grasp the severity of the situation the company was facing.

By the time O’Neal made an overture to Wachovia Bank for a possible merger without board approval, his fate was largely sealed. The Wachovia episode merely confirmed what most board members believed already: O’Neal had to go, say people close to the firm.

Who's Next?

The question now: Who’s next?

According to a person briefed on the matter, the board offered O'Neal an opportunity to remain in the CEO post on an interim basis. It is unclear if O'Neal accepted this opportunity, this person said.

This underscores the difficult situation faced by Merrill's board as it attempts to maintain some leadersip.

Larry Fink Larry Fink

At the moment, it appears the leading candidate is Larry Fink, the CEO of money-management powerhouse BlackRock , which is currently engaged in a joint venture with Merrill Lynch.

Fink, say several people close to the situation, is perfect for the job because he is a former bond trader and built his business from a backwater to one of the world’s premier money management firms. According to people close to the matter, Fink expects to be contacted shortly by the board, though he hasn’t made up his mind if he will take the job.

But the situation is thorny. Fink wants to give Merrill Lynch Co-President Greg Fleming a major role if he takes the CEO job, and many top producers in Merrill’s brokerage sales force consider Fleming too close of an associate to O’Neal, who they despised for his assault on Merrill's culture over the years.

Sources say that Fleming, on O’Neal’s orders, spoke with the chief executive of Wachovia, further angering the brokers. Wachovia has a large brokerage sales force as well. It is largely comprised of the old Prudential Securities brokerage network. By merging Merrill with Wachovia, O’Neal and Fleming would have had to kill broker jobs, and many Merrill brokers believed it would have been a further decimation of Merrill’s culture.

A group of top-producing brokers are planning to write a letter to Merrill’s board either later Sunday or early Monday making the point that Fleming's role in the Wachovia deal should be taken into consideration before giving him an important role in the new leadership of the firm.

© 2009 CNBC.com