TIME: Almanac 1993/TIME Almanac 1993.iso/time/010289/01028900.012

Text File | 1992-09-23 | 11KB | 201 lines

                É¡                                                            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.