ANALYSIS : B of A Battle: A Classic Case of Psychological Warfare

“All warfare,” the Chinese philosopher Sun Tzu wrote, “is based on deception.”

In his 4th-Century B.C. classic, “The Art of War,” Sun Tzu laid down the precepts of psychological and guerrilla warfare, the means by which a clever aggressor can defeat a larger and stronger target using propaganda, cunning and lightning attacks.

“When we are near, we must make the enemy believe that we are far away,” Sun Tzu taught. “When far away, we must make him believe we are near. Hold out baits to entice the enemy. Feign disorder, and crush him.”

Sun Tzu’s advice still is followed today, by guerrilla fighters, political terrorists and corporate takeover strategists.

In hostile corporate takeovers, as in guerrilla war, aggressor companies often try to weaken the will to fight of their targets by disrupting their daily business and undermining morale.

Repeated public and private attacks are designed to lead a company’s board of directors to question the continued viability of the firm as an independent entity. When that is accomplished, the battle is largely won.

The tactics employed by Los Angeles’ First Interstate Bancorp in its attempt to acquire the much larger BankAmerica offer a textbook case in the use of the techniques of psychological warfare on the corporate battlefield.

BankAmerica, which recently has begun an energetic counteroffensive, has been driven to adopt many of the same propaganda and guerrilla warfare tactics as First Interstate.

Under Chairman A. W. Clausen, it is fighting back with press leaks and pep rallies, personal attacks and private lobbying.

First Interstate’s methods and BankAmerica’s responses apparently are well within the bounds of currently accepted takeover ethics.

Numerous other companies and corporate raiders have employed similar maneuvers to mess with the minds of their targets, with mixed success, depending on the willingness and ability of target firms to fight back.

Investment banking and public relations firms specializing in takeovers study these psychological moves as military tacticians study ancient battles.

They are paid millions of dollars to devise means of attacking the target’s weaknesses or build defenses against a surprise assault.

In hostile takeovers, the financial offer for the shares of the target company is of secondary importance. The real war is fought for the hearts and minds of the enemy’s directors, employees and shareholders.

First Interstate first proposed the merger in mid-1985 as BankAmerica was descending into the worst financial crisis in its 80-year history.

The giant San Francisco bank was suffering under the weight of billions of dollars in bad loans, defections of top executives, a collapsing stock price and crumbling confidence among employees and customers.

First Interstate’s aggressive and self-assured chairman, Joseph J. Pinola, a 25-year veteran of BankAmerica management, was dismayed by the weakness of his former employer, the nation’s second-largest bank and the most important financial institution in the western United States.

Pinola also saw an opportunity to acquire BankAmerica’s awesome California banking franchise and worldwide network of offices at a fire-sale price. His vision was to restore BankAmerica to its former prominence and build the nation’s biggest retail bank, with Joe Pinola at the helm.

Gunfighter Image

His tactics were shaped in part by advisers from the small San Francisco investment banking house Montgomery Securities, which quickly is building a reputation as a band of cold-eyed corporate gunfighters.

Pinola’s initial approach to BankAmerica was on “friendly” terms, a proposal for a negotiated merger of near equals. Pinola said BankAmerica would retain its name, its board of directors and a majority of its top officers. But the knife--the threat of a hostile tender offer directly to the target company’s shareholders--was never fully sheathed.

Pinola followed the first tenet of psychological warfare: Disguise your true intentions, keep the target off balance.

Pinola’s overtures were rebuffed, although former BankAmerica President Samuel H. Armacost did sit down with Pinola to discuss the deal early last year. Pinola pulled back, but continued to publicly and privately pursue the deal.

He told his shareholders and the press that the merger would benefit the two banks and the nation at large.

Pinola’s press spokesmen and advisers at Montgomery Securities fed to reporters information designed to dramatize BankAmerica’s weaknesses and to bolster the case for the merger. Their aim, among other things, was to raise questions among BankAmerica directors, employees and customers about the bank’s future.

Privately, Pinola and his lieutenants approached BankAmerica directors and key executives, many of whom they know personally, to lobby for the deal. They contacted federal regulators to feel them out about the likelihood of government approval for the merger, which would be by far the largest bank acquisition in U.S. history.

Guidelines for Propaganda

Kautilya, a 5th-Century B.C. minister to Indian emperor Chandragupta Maurya, formulated guidelines for political propaganda in his “Principles of Politics.” Its precepts seem to apply as well to the modern corporation as they do to the ancient kingdom or empire, with the chief executive assuming the role of the king.

Kautilya counseled that a king’s propagandists overtly should proclaim that the ruler can work magic, that the gods and all wise men are on his side and that all who support his war aims will reap benefits.

Covertly, he advised, the king’s agents should infiltrate the enemy’s kingdom spreading defeatism and disinformation. They should cultivate influential advisers in the enemy camp and try to persuade them to sue for peace on the aggressor’s terms.

Last July, BankAmerica issued a stunning piece of news: The company had lost $640 million in the year’s second quarter, chiefly because of bad loans. The bank’s problems were much worse than anyone, including BankAmerica management, had previously imagined.

Within weeks, rumors spread around the world that the bank was on the verge of collapse. Armacost had to take the extraordinary step of going on statewide radio to deny that the bank was about to fold.

Pinola and his investment bankers remained silent but sharpened their war plans. They knew through their contacts among BankAmerica managers and board members that Armacost’s power at the bank was weakened, perhaps fatally. They suspected that the board of directors would be receptive to a dramatic solution to the bank’s crisis.

On the weekend of Oct. 4-5, Pinola struck. Just hours before a critical BankAmerica board meeting, he delivered a detailed merger proposal addressed to the board in care of Armacost. In the letter, he said he hoped the $2.8-billion buyout offer could be handled on friendly terms. He left the alternative unstated. And he demanded a quick answer to the proposal.

In one stroke, Pinola had utterly changed the terms of the game.

Strike With Surprise

“Terrorism is the war of the flea,” said Neil Livingston, director of Washington’s Institute on Terrorism and Sub-National Conflict and an expert on psychological warfare. “You isolate vulnerabilities and strike with surprise, terror and cunning.

“Terrorists win by intimidation. It demoralizes a company, or a society, when it cannot respond effectively to those attacks or threats of takeover. When the leadership does not respond, it demoralizes everyone. Exploiting vulnerabilities, that’s the mind game you’re playing in a takeover.”

The offer sent BankAmerica’s board and management into turmoil. While publicly saying only that it was studying the First Interstate offer, the board desperately sought ways to combat the proposal and a public perception of helplessness.

First Interstate stayed on the offensive. In a round of interviews with reporters, it released specifics of the buyout offer and explained the rationale for it in great detail. The offer was based on First Interstate’s belief that BankAmerica’s management was incapable of solving the bank’s problems and that the bank would continue to flounder unless it agreed to a merger with the smaller but smarter and stronger First Interstate, they said.

First Interstate officials deny that the proposal and comments supporting it were designed to undermine BankAmerica employee morale and raise doubts among its directors and customers about its viability. But First Interstate’s actions followed classic takeover and guerrilla warfare strategy and had just that effect.

“The biggest mind game is played against the directors,” said a New York investment banking source familiar with the BankAmerica fight. “You are dealing with directors who typically are CEOs or high-ranking executives elsewhere with other things to worry about, who owe a duty of friendship to the CEO (of the target company), a definite duty to shareholders and have the additional problem of dealing with a bank that is the financial linchpin for the entire West Coast.

“Normally, what it comes down to is: ‘Am I going to get sued?’ ”

Directors Can Be Sued

Corporate officers and directors can be sued for failing to act in the best interest of shareholders. In this case, the First Interstate deal was worth, on paper, $5 a share more than BankAmerica stock was selling for at the time.

The BankAmerica directors had the additional concern of having only limited liability coverage provided by an in-house insurance subsidiary. BankAmerica’s outside coverage for its directors and officers had been canceled in 1985 after it sued its insurance carriers to recover $95 million that it lost in an alleged real estate scam.

Pinola apparently hoped that the heat of potential shareholder lawsuits would provide an added incentive for the directors to submit to his offer.

“If he can get some directors thinking, ‘Maybe this is a better deal,’ then he’s largely won,” said Robert L. Walters, chief of the investment banking division at Sheshunoff & Co., a bank consulting firm in Austin, Tex.

Less than a week after receiving the initial First Interstate offer, BankAmerica’s board called a special weekend meeting. At the session, it accepted the resignation of Armacost, whose effectiveness and credibility had been destroyed by poor results and the unsolicited takeover offer.

As his replacement, the BankAmerica board turned to Clausen, the man who had led the bank during its glory years in the 1970s. In Clausen, a demi-hero at the San Francisco bank, the directors hoped they had found a man on horseback.

Although Clausen and the board did not respond definitively to the First Interstate offer for nearly three months, Clausen’s mandate from the board was clear: Repel Pinola and restore the bank’s reputation.

Invitation to Mischief

“Whether you’re on offense or defense, you do a psychological profile of your opponent,” said a merger specialist at a New York public relations firm. “A company headed by a known turkey is a very good target; it’s an invitation to mischief.

“But if you come back with a strong answer, it starts changing the dynamics overnight. You have a leader to rally around.”

But Pinola, who worked for Clausen at BankAmerica more than a decade ago and who has less than complete confidence in his abilities, wasn’t about to abandon the offensive. Nor had he exhausted his scabbard of psychological tricks.

Two weeks after Clausen was named chairman, BankAmerica management agreed to recommend to the board that it reject the First Interstate offer. A newspaper story detailing that decision ran Oct. 28.

That same afternoon, Pinola struck again. He raised the value of his offer for BankAmerica by $600 million, to $3.4 billion. In a press release, he repeated his justification for the deal. He once again demanded a prompt response.

The sweetened offer led to a new round of news stories that unavoidably had the effect of magnifying BankAmerica’s problems. The second proposal also convinced a number of skeptical analysts and bankers that First Interstate was deadly serious about pursuing the deal.

“The key is for the hostile party to make their points of corporate weakness on a consistent and continuing basis,” said one Los Angeles banking consultant who has followed the BankAmerica fight closely. “The ultimate voter, the shareholder, tends to form an opinion that is based on a reinforced message, whatever that is. Once an opinion is formed, the defender is very seldom able to turn it around.”

The renewed attack also had the effect of further distracting Clausen and other top BankAmerica officials from the very difficult jobs already facing them: restoring BankAmerica’s profits, morale and reputation.

Like El Salvador

Terrorism expert Livingston compared BankAmerica’s problem to that of the government of El Salvador: it must reform an unjust social and economic system while fighting a guerrilla insurgency.

Under tremendous pressure, Clausen formulated BankAmerica’s business plan and its war strategy. The bank would accelerate its efforts to sell assets, cut costs and reduce employment in its drive to regain profitability. And he devised a number of measures to boost flagging employee morale and try to get more favorable treatment in the press.

Clausen and the BankAmerica board publicly asked Pinola to back off and give the struggling bank time to solve its problems. First Interstate declined, leaving little doubt that it intended to pursue a hostile deal.

In early December, BankAmerica began circulating to securities analysts a detailed assessment of the First Interstate offer, criticizing it on grounds that it was financially inadequate and unlikely to win regulatory approval. The report was later leaked to reporters.

Bank officials made their own approaches to regulators to present the case against the merger. The bank stepped up morale-boosting communications to employees and began dropping off-the-record hints to reporters about weaknesses in the quality of First Interstate management and the merger proposal.

First Interstate, following its own timetable, in December asked the Federal Reserve Board to approve the deal. A week later, it registered with the Securities and Exchange Commission the securities it planned to use in the deal.

Integrity Questioned

In response, Clausen sent Pinola a blistering letter questioning his integrity, his motives and his ability to pull off the merger. He suggested that his former subordinate had violated laws and business ethics in pursuing the deal. He threatened to sue on grounds that Pinola had deliberately spread malicious lies about BankAmerica.

The letter was designed as much for internal consumption as for Pinola. It was a signal to BankAmerica employees that Clausen intended to fight First Interstate hard on every front.

Finally, during the first week in January, BankAmerica’s board of directors officially rejected the First Interstate plan and unleashed a full-scale propaganda counterattack.

Clausen, in a press conference, shredded the proposal as “inadequate and undesirable” and revealed that he had asked Congress to hold hearings to investigate the First Interstate offer.

BankAmerica’s chief financial officer dismissed the First Interstate proposal as “a joke.” The bank’s public relations staff worked overtime to heap abuse on the deal and the First Interstate officials pursuing it.

Clausen went on a round of interviews with reporters in San Francisco and Los Angeles to present the BankAmerica side. He vowed to keep the bank independent at any cost.

And he held employee pep rallies in the two cities, complete with bands and fight songs. Thousands of fired-up bank employees left the rallies wearing anti-First Interstate buttons.

At least for now, the momentum appears to have shifted to BankAmerica. A long war tends to favor BankAmerica, analysts said, as long as Clausen can deliver on his promise to improve performance.

According to Sun Tzu, an attacker does not have to crush the enemy army in order to prevail in battle. Rather, he must only destroy the enemy’s will to wage war.

The ultimate victor in the battle for BankAmerica may well be the side with the greater desire to fight.