TIME: Almanac 1990/1990 Time Magazine Compact Almanac, The (1991)(Time).iso/time/010289/01028900.012

Text File | 1990-09-22 | 10KB | 182 lines

BUSINESS, Page 84

Let's Make a Deal

For a guilty plea and $650 million, Drexel hopes to get a clean

slate


    Christmas was just around the corner, but the videotaped
tidings that Frederick Joseph handed out to the TV networks last
Wednesday evening were not exactly festive. Looking tired and
tense, the silver-haired chief executive officer of Drexel Burnham
Lambert discussed the settlement that Drexel had reached that day
with federal prosecutors to end the largest probe ever of a U.S.
securities firm. Declaring that the long-awaited agreement "makes
sense from a business and human point of view," Joseph, 51, tried
to be upbeat. The deal, he said, would leave the firm "in a very
strong financial position, and allows us to refocus our energies
on running the business successfully."

    In fact, the agreement was a stunning about-face by the most
influential, go-go investment-banking house of the 1980s. After
maintaining for two years that Drexel had done nothing wrong, a
shaken board of directors voted 16 to 6 to accept the stiff terms
proposed by Rudolph Giuliani, U.S. Attorney for the Southern
District of New York. The deal calls for Drexel to plead guilty to
six felony counts involving mail, wire and securities fraud and to
pay a record $650 million in penalties. Some $300 million of the
fine would go to the Government, which has spent an estimated $10
million prosecuting the case so far, and $350 million would be set
aside to compensate the victims of Drexel's wrongdoing.

    In return, Giuliani agreed to drop his stated plan to bring
racketeering charges that could have crippled Drexel, the fifth
largest U.S. securities firm. Before the deal can be completed,
however, Giuliani stipulated, a 184-page civil complaint that the
Securities and Exchange Commission brought against Drexel in
September must be settled by Jan. 10. The SEC could conceivably
ask for a larger pool of money to compensate alleged victims, who
range from ordinary stockholders to Drexel's clients. Even so,
Giuliani declared Drexel's fines and concessions "appropriate
punishment." He added, "You do not put corporations in prison."

    But Giuliani is expected to try to put at least one Drexel
employee behind bars. In perhaps its most humiliating cave-in,
Drexel agreed to cooperate with the Government investigation of
Michael Milken, the financial wizard who created the market for
high-yielding junk bonds (total now held: $180 billion) and who
remains the ultimate target of Giuliani's probe. Milken, who was
not represented in the settlement talks, is expected to be indicted
in Manhattan sometime in January.

    A senior officer at Drexel, Milken was the chief architect of
the firm's rise from a lackluster, second-tier brokerage into a
feared and envied powerhouse. By developing the use of junk bonds
to stake such corporate raiders as Saul Steinberg and T. Boone
Pickens, Milken presided over the radical reshaping of American
industry in the past ten years. Along the way, dozens of Drexel
executives became multimillionaires.

    But Drexel's very success led to its comeuppance. As in a Greek
tragedy, the company seemed to suffer from an overabundance of
hubris that concealed a fatal flaw. In Drexel's case, it was
Milken's growing appetite for power and control. The turning point
came in November 1986 when Ivan Boesky, a notorious Wall Street
speculator, pleaded guilty to a single count of securities fraud
and agreed to pay $100 million to settle SEC charges that he had
used insider information to buy and sell stock. Boesky, who is
serving a three-year term in a minimum-security prison in Lompoc,
Calif., agreed to identify others who had joined his schemes. The
trail led to Drexel and its wunderkind, who allegedly used a
complex network of contacts to manipulate securities prices.

    During the nearly two years that the Government spent preparing
its case, Drexel defiantly declared its innocence and launched a
major advertising campaign extolling the civic virtues of its junk
bonds. Joseph claims that the two-year federal probe cost Drexel
$1.5 billion in lost revenues and an additional $175 million in
legal and advertising fees. Since November, the firm has bargained
for an agreement that, as chairman Robert Linton put it, "would not
make us look like a bunch of thieves."

    Negotiations appeared to collapse last Monday, when Drexel's
board of directors voted against a settlement. Joseph boasted that
his staff had sifted through 1.5 million Drexel documents without
finding any incriminating evidence. A former lightweight boxing
champion at Harvard, Joseph insisted that the best defense against
a heavy punch is "to come back at your opponent smiling."

    But the blows kept furiously raining down, and Joseph's smile
began to fade. When the board voted that Monday, Giuliani had
already turned three close Milken associates into Government
witnesses by granting them immunity from prosecution. The knockout
power of an indictment under the 1970 Racketeer Influenced and
Corrupt Organizations Act was also greatly feared. Charges under
RICO, developed to prosecute the Mafia and other organized
criminals, would allow Giuliani to tie up much of Drexel's $2.3
billion of capital -- including the fortunes of the firm's 1,700
employee stockholders -- throughout a lengthy trial.

    Meanwhile, a fierce struggle raged inside the firm. On one side
stood Milken's supporters, many of them younger executives who
worked in the Beverly Hills office where Milken has been based
since 1978. The leading loyalists included Leon Black, Drexel's
mergers-and-acquisitions chief who works in New York, and Peter
Ackerman, Milken's top assistant. Arguing that the California group
was responsible for 90% of Drexel's profits over the past decade,
both threatened to leave the company if it reached a settlement
that might harm Milken's defense. They were opposed by older
executives, mostly in Manhattan, who feared losing the firm's
accumulated net worth if RICO charges were brought.

    The hawks on the board held sway over the doves until Giuliani
gave an ultimatum. Following the directors' rejection of a
settlement on Dec. 19, Giuliani phoned Joseph the next day and
promised that unless the board swiftly came to terms, the firm
would be indicted at 4 p.m. Wednesday, Dec. 21. That took some of
the remaining fight out of Joseph, who had taken to sporting a
lapel button emblazoned with the word STRESS. After holding
late-night talks between Giuliani and Drexel attorneys in which the
proposed criminal penalty was pared from $700 million to $650
million, Joseph called the board back into session at 2:30 p.m.
Wednesday. By 4:30 p.m., the board agreed to Giuliani's terms.

    The Government consented to limit the plea agreement to less
severe and fewer offenses than those detailed in the SEC case
against the investment house, which described a pervasive pattern
of illicit practices in Drexel's junk-bond department. As in the
SEC case, the criminal charges focused on dealings with Boesky from
1984 to 1986. Included in the SEC litany of complaints were insider
trading, "parking" stocks to conceal their true ownership, and
schemes to gouge Drexel's own customers.

    If the criminal agreement had been broader, Drexel might never
have agreed to it out of fear that the guilty pleas would have
given Drexel's alleged victims a better chance of winning lawsuits
against the firm. Even now, the $350 million that the Government
plans to set aside to meet damage claims may barely cover the
awards that could arise from the 13 class-action suits already
lodged against the company.

    For Giuliani, the Drexel settlement was the most heralded part
of a dramatic three-way sweep. Hours before the deal was announced,
a federal grand jury in Manhattan indicted Paul Bilzerian, 38, a
raider who won control of the Singer Co. in a $1 billion buyout
last February. If convicted of fraud, conspiracy and other charges
that arose from earlier takeover tries, Bilzerian would face a
maximum of 60 years in prison and at least $3 million in fines. On
the same day, testimony began in the Manhattan trial of GAF Corp.,
a chemical and building-products company, which is charged with
inflating the price of Union Carbide stock that it sold after
failing to acquire Carbide in 1986.

    But the Government's big prize was Drexel, which must now face
life as a confessed felon. Said Congressman Edward Markey, a
Massachusetts Democrat who heads a House subcommittee that covers
finance: "We now know that the single most financially successful
Wall Street firm of the 1980s in large measure built its fortune
on the foundation of criminality."

    Such broadsides will die down, but it may take Drexel a long
time to restore its prestige and competitive position. The firm's
share of new junk-bond issues has slipped from nearly 80% in the
mid-1980s to some 25% today. That puts Drexel barely ahead of
Goldman, Sachs and Morgan Stanley, its main rivals. Drexel may
suffer a brain drain as well, losing not only Milken but also his
loyalists. Moreover, Milken is so much the mastermind that clients
may balk at trusting his understudies who remain.

    Yet Drexel still displays its characteristic moxie. The firm
is handling a $3.5 billion junk-bond offering as part of the $25
billion leveraged buyout of RJR Nabisco. For its share in financing
history's largest takeover, Drexel expects to take in $229 million
before expenses. Many clients still profess their allegiance. Says
raider and oilman Pickens, who relied on Drexel's financing clout
to make bids for Gulf Corp. and Phillips Petroleum: "I have the
highest regard for Fred Joseph."

    To help burnish its image, Drexel has been courting Howard
Baker, the former Senator and White House chief of staff, as a
possible new chairman or CEO. Joseph may step aside after the
settlement is complete. Without a forceful new leader of
unquestioned integrity, the company is in danger of losing morale
and momentum -- and something else as well. Mike Milken engendered
an innovative spirit at Drexel. If the company is to thrive once
again, it must somehow preserve that spirit while at the same time
escaping the darker side of his legacy.