In a business built on sound judgment, the investment banking boutique Keefe, Bruyette & Woods Inc. has been put to the ultimate test.

Its chief executive officer, James McDermott, was first accused in 1999 of tipping off his mistress to bank mergers the firm was working on. The insider trading case gained national attention, and the fact that Kathryn B. Gannon had starred in adult movies fueled a media frenzy that engulfed Mr. McDermott and Keefe Bruyette.

Two years later KBW has emerged from the frenzy and appears to be an even stronger player within its financial services niche, which has served up plenty of merger activity and ample trading opportunities - exactly what Keefe Bruyette needed to recover.

From its headquarters in the World Trade Center, Keefe Bruyette has expanded geographically, establishing an office in Richmond, Va., in 1999, a sales division in its San Francisco office last year, and a trading desk in its Boston office this year. In the last two years its work force has grown 27%, to 212 people, and its revenues have doubled. Revenues in the 12 months that ended June 30 were $115 million.

"Looking back, we lost little and achieved a lot," said Joseph J. Berry, the chairman and a co-chief executive officer. "We've created a lot of change at Keefe Bruyette, there is no question about it."

Though the privately held firm does not disclose its financial results, Mr. Berry said Keefe Bruyette's book value last year grew 15% from a year earlier and its biggest revenue source - commissions from equity sales - increased more than 20%, mostly because of the pickup in capital markets, which were sluggish in the first part of last year.

This year's first half was one of the strongest in the company's history, and revenues from equity sales commissions rose 58.8%, to $27 million, Mr. Berry said.

Keefe Bruyette was ranked eighth among lead financial advisers in the value of domestic bank and thrift mergers last year, when it closed 19 deals, worth $3.1 billion, according to Thomson Financial Sheshunoff Information Services. Its main rival, Sandler O'Neill & Partners, whose World Trade Center office is 13 floors above Keefe Bruyette's, closed 18 deals, worth $3.3 billion, and finished seventh.

However, in the first half of this year Keefe Bruyette moved up to fifth on the list, with 21 deals - more than anyone else by far - worth $5.4 billion. Sandler O'Neill moved up one notch, to sixth place, with eight deals, worth $1.6 billion.

(Merrill Lynch & Co. topped the first-half 2001 list with four deals, worth $21.4 billion.)

In addition to building its bread-and-butter business, Keefe Bruyette has expanded its services to include asset management for institutional and individual customers, many of whom are former CEOs of Keefe Bruyette's client companies.

The long-term goal for the company's KBW Asset Management Inc. is to accumulate $1 billion of assets under management, and it is roughly 20% of the way there, Mr. Berry said. Michael T. O'Brien, the president of KBW Asset Management, said the goal could be reached in three years, depending on how markets behave.

KBW Asset Management operates two financial services funds. The first, started in January 1999, requires a minimum investment of $1 million. The second, begun this January, requires $500,000.

Mr. O'Brien said the subsidiary is planning to introduce an offshore product next month to better serve foreign customers, but Mr. Berry said that financial stocks and financial services funds have been a hard sell in the last couple of years. "Marketing was not easy," but the products came back into fashion in the middle of last year, he said.

In the last few years Keefe Bruyette has pushed beyond its traditional coverage of banking and thrift companies into broker-dealers, asset managers, and insurers.

David P. Lazar, a co-head and a managing director of investment banking at Berwind Financial Group LP, the investment banking unit of the Philadelphia-based Berwind Group, said that supplying research is a key driver in the M&A business. "I am not going as far as saying that people go to an investment bank because it is writing research," he said, "but it is something that is building relationships."

Mr. Lazar, who advises mostly smaller banks that are being acquired, said he frequently finds himself across the negotiating table from Keefe Bruyette executives. Berwind is not a dealer, and it does not offer equity research, services Mr. Lazar said might be an advantage to Keefe Bruyette in finding new clients.

Keefe Bruyette was just initiating coverage of insurance stocks in mid-1999 when the insider trading scandal hit.

Executives first heard about Mr. McDermott's legal troubles during a board meeting in May of that year. The firm had finally decided to go public, but its IPO was canceled immediately after Mr. McDermott told the board that he was the subject of an investigation by the Securities and Exchange Commission.

Mr. McDermott resigned that June and was sentenced in October to eight months in prison but was released in February after the conviction was overturned on a technicality. One charge was dismissed, but prosecutors plan to retry Mr. McDermott on the insider trading count.

"We kept a low profile for some time," John G. Duffy, a co-CEO at Keefe Bruyette, said late last year.

The firm says it has no plan to resurrect the IPO plan, and Mr. Berry said it was never an essential part of the company's strategy.

Keefe Bruyette wanted to go public mainly to build capital for acquisitions to strengthen its position in the capital markets business, he said. However, after growing internally for the last two years, the firm does not need extra capital, and acquisitions are not on the agenda, Mr. Berry said.

"At some point we thought it would be easier to combine companies," but now "I don't see the need to acquire anybody," he said.

Keefe Bruyette executives, including Thomas B. Michaud, the director of equity sales, and Andrew M. Senchak, the director of corporate finance, say they are satisfied with the decision. "We don't regret not going public," Mr. Michaud said.

However, some observers argue that the main reason the firm keeps its shares in private hands is to avoid having to talk to unwelcome bidders.

There is speculation that the firm might eventually be taken over by a larger securities firm, or even a banking company, just as Tucker Anthony Sutro was by Royal Bank of Canada or Piper Jaffray by U.S. Bancorp.

Mr. Berry does not deny that some other regional brokerages are interested in buying Keefe Bruyette, but he said that no concrete offer has surfaced.

He also said he would not fight for independence if a sufficiently attractive offer came along. "We are all shareholders," he said. "If there is a bigger company around that would give us balance sheet muscles, that would be helpful."

Mr. Michaud said Keefe Bruyette considers its competitors to be the big players, like Morgan Stanley Dean Witter & Co., Merrill Lynch & Co., and Goldman, Sachs & Co., which are not necessarily going after only the biggest deals anymore.

"They are coming after the smaller deals now," he said. "We know how to compete with Sandler, but that is a different challenge."

Mr. Senchak said customers reacted with sympathy toward the firm when the scandal broke. "Some clients went out of their way to do business with us," he said.

But other sources on Wall Street say that notion is pure spin, and Mr. Senchak admitted that it is impossible to know how many deals the scandal may have cost Keefe Bruyette.

Few outside sources would talk on the record about the company. "We do work closely with Keefe Bruyette and therefore don't want to comment," was a standard reply to interview requests from clients, business partners, and former employees.

Nevertheless, its management seems to have leveraged clients' sympathy, and most sources agreed that it remains a sizable force on Wall Street. Without such a formidable reputation, the company would not have survived, sources familiar with the business said.

The financial services industry makes up about 17% of the Standard & Poor's 500 index, and Mr. Michaud said covering such a substantial part of the market should be sufficient for his company. "We like where we are," he said. "That's a good piece of coverage for a boutique."

He said Keefe Bruyette has no specific plan to expand beyond the financial services sector, but Mr. Berry said the possibility of adding coverage of health-care companies is being kicked around.

Though Keefe Bruyette holds a 6.4% stake in Superior Federal Bank of Fort Smith, Ark., Mr. Berry said it has no interest in operating a bank, as a competitor like Friedman Billings Ramsey & Co. does.

Starting or acquiring a commercial bank would only make sense if Keefe Bruyette wanted to expand into the trust business, said Mr. Berry, who himself holds a 6.3% position in Superior Federal. "We are going to stick to our niche."

The company's near-term goal is to form a closer tie between research and sales and giving clients more strategic advice, as do the larger brokerage firms that have market strategists to make qualitative investment calls comparing market sectors. Mr. Berry described the goal as "looking at the different sectors within the financials, coming up with thoughtful guidance on areas we like more than others."

During a conference in Boston this year, Thomas F. Theurkauf, an executive vice president, told clients: "We are not your daddy's KBW anymore."


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