The Business of America/The SEC vs. Drexel Burnham Milken
Stelzer, Irwin M.
THE BUSINESS OF AMERICA THE SEC VS. DREXEL BURNHAM MILKEN T here is more to the story about I Drexel Burnham Lambert's problems with the Securities and Exchange Commission, U.S. Attorney Rudolph...
...And what will be the consequences of the government's action...
...On top of this civil complaint will come a criminal indictment (not filed at the time of this writing, but expected momentarily), soon to be handed up by a grand jury being guided to that conclusion by Giuliani, until now more famous for making spectacular arrests of Wall Street figures than for subsequently proving his charges against them...
...Why has the government devoted such massive resources to this prosecution...
...Nor will the liquidity Drexel adds to the market...
...Drexel has shown the same creativity in mounting its defense as it showed in developing the junk bond market...
...The social basis of the hatred of Milken and the corporate arrivistes he financed is perhaps best illustrated by Michel Bergerac's reaction to Ronald Perelman's successful effort to gain control of Revlon, of which Bergerac was chief executive officer...
...That would be a pity: recent studies by Glenn Yago at the State University of New York show that the 755 companies that issued high-yield debt (a.k.a...
...But those charges are far from airtight...
...After all, junk bonds satisfy a real economic need: just as mass production didn't end when Henry Ford died, the use of high-yield debt to finance corporate growth won't stop if Drexel collapses...
...Indeed, these companies are often the most rapidly growing and innovative, and have been responsible for most of the new jobs created in America in the past decade...
...Rather, they are generally IOUs of companies too small or too new to receive a technical "investment grade rating" by rating agencies...
...If the firm did indeed use information it gathered from its investment banking clients to enrich Drexel partners, and if it allowed Milken to pierce the Chinese Wall that is supposed to separate its banking and trading functions, it should pay whatever price the law demands...
...There was] something . . . visceral: the age-old hatred for the outsider . . ." This makes understandable the enormous pressure put on Congress and the SEC by establishment groups, such as the Business Roundtable, to clip Drexel's wings...
...Drexel itself an-nounced eight transactions worth $1.7 billion during the week following the filing of the SEC complaint...
...Irwin M Stelzer is director of the Energy and Environmental Policy Center of the John F Kennedy School, Harvard University, and an American correspondent for the London Sunday Times...
...Indeed, the intensity of establishment hostility to Milken cannot be explained in terms of economics alone...
...Fred Joseph, its chief executive officer, regularly announces the latest developments to the firm's 10,000 employees over Drexel's internal communications systems...
...They point out that Drexel has a unique knowledge base: Milken and his colleagues know "every small savings and loan association that holds junk bonds," according to one banker who asked not to be named...
...This is not surprising, since Drexel is facing the most concentrated legal assault the government has ever leveled against an investment bank...
...In short, Bruck concludes that "Revlon was indeed a class war, between the corporate America and Wall Street elite, and the Drexel arrivistes...
...And the SEC is not alone in claiming that Drexel did just that...
...corporations with assets of more than $25 million, if they were to apply for a bond rating, would be rated below investment grade...
...Bergerac's contempt for Perelman was matched only by his loathing of Milken, who Bergerac said financed "all these people whom the banks would never lend to in a million years," more like "a pawnbroker" (restraint undoubtedly prevented him from using the term "Shylock") than a banker...
...Perelman is none of these...
...Milken/Drexel-haters among America's corporocrats at least equalled in number those in the commercial banks...
...Is this an intelligent use of those resources...
...And he did that by trampling on two pillars of the establishment—the commercial banks and America's largest corporations...
...In fact, junk bonds are not typically securities of companies that have fallen on hard times, although there are some such...
...While it was indeed marvelous for Drexel to have one man who embodied all those attributes, whose talents ran from trading and sales to corporate finance and M&A [mergers and acquisitions], Milken was a walking contradiction of the Chinese Wall principle," she writes...
...junk bonds) between 1980 and 1986 grew faster than industry in general...
...A decision to spend so much money protecting the high-rollers that there is nothing left with which to protect the small investor certainly seems subject to question, no matter how much it pleased the corporate elites who wanted Drexel stopped...
...Asked by this writer to assess the future of the junk bond market in light of the government's charges, leading merger lawyer and Drexel counsellor Joe Flom said that the market is "too deep to be affected by any one player...
...We cannot have investment bankers secretly taking the juiciest parts of the best deals themselves," says Dingell...
...The charges leveled against Drexel are far from trivial...
...As Bruck—no Drexel apologist—concedes, Milken "did more to shape it [the M&A movement] than any other individual...
...If all this were not bad enough for Drexel Burnham, more charges may be in the offing...
...he is young, aggressive, and Jewish...
...by Irwin M. Stelzer To answer these questions we must understand the peculiar role Drexel has played in the takeover movement of the 1970s and 1980s...
...Contrast this with the turmoil created in the junk bond market just a few years ago when Drexel's troubles first became public...
...As Bruck points out, "Milken has long professed contempt for the corporate establishment, portraying many of its members as fat, poorly managed behemoths who squandered their excess capital . . ." By raising money for a group of eager but under-financed "predators," Milken made it possible for these outsiders to take over firms THE AMERICAN SPECTATOR NOVEMBER 1988 33 whose managers were not delivering maximum value to their shareholders...
...The criminal charge will take precedence in the courts over the SEC's case, and is potentially far more dangerous, since it might permit the government to freeze a large portion of Drexel's assets and eventually seize the assets of Michael Milken, the firm's superstar and creator of the junk bond market...
...Joseph immediately videotaped a 30-second response, which was beamed by satellite to all major TV news outlets...
...The SEC has charged Drexel and some of its principals with insider trading, stock manipulation, false filings, fraud, and just about anything else it could fit into an almost 200-page indictment...
...Drexel's junk bonds gave them a competitive alternative to the banks, prompting the latter to join their establishment brethren in the industrial sector in seeking restrictions on the use of such debt instruments...
...As proof he offered two facts...
...Clients are kept informed...
...Simon and Schuster, $19.95...
...and outperformed industry by at least one measure of productivity, sales per employee...
...From both a policy and a private view, the need for this type of financing will remain, whatever Drexel's ultimate fate...
...But don't count Drexel out just yet...
...increased employment at an average annual rate of 6.7 percent, compared with 1.4 percent for industry as a whole...
...social standings were threatened...
...All but two of the SEC's accusations rest heavily (although, the Commission argues, not solely) on the testimony of Ivan Boesky, a convicted felon now serving a jail sentence for insider trading...
...But Drexel can at least console itself with the fact that it will finally have its day in court...
...they floated earthward from their corporate perches on opulent golden parachutes...
...For one thing, it has the resources—more than $2 billion in capital—and it remains highly profitable...
...Until now, it has faced a series of headline-making leaks, hinting that it would soon be accused of something, but providing it with no opportunity for a systematic response...
...This "junk" rating would be due to small size or lack of credit history, not to a lack of future prospects...
...That knowledge of where bonds can be placed won't be easily duplicated if Drexel departs the scene...
...The SEC's Ruder has testified that the Drexel affair has sopped up so much of his agency's budget that "we will not be able to handle other activities...
...Drexel reportedly has already paid accountants Arthur Anderson & Company $46 million to copy and organize the 1.5 million pages of documents the government has requested...
...Yet Drexel's dealings were primarily with highly sophisticated investors, trading in huge blocks of securities—hardly the sort of people most in need of government protection...
...His sentence was reduced in return for the information he gave against Drexel, a fact that might lead a judge and jury to wonder whether he wouldn't say anything prosecutors ask him to say, in order to get out of jail sooner...
...Now that it has that opportunity, Drexel can be expected to use it...
...Some had been inventoried in anticipation of the SEC filing, so that their announcement could be used to show Drexel's continued vitality...
...That would be good news for the next generation of corporate predatorraider-arrivistes, and bad news for non-performing managements...
...Long ignored by underwriters, they were forced to borrow from commercial banks, often at high rates...
...One need not agree with Drexel's claim of complete innocence to wonder whether the SEC's decision to devote a huge portion of its resources to the Drexel investigation represents a sound resolution of the always-difficult question of just where to deploy limited staff and money...
...Attorney Rudolph Giuliani, and various congressional committees than can be gleaned from the daily and financial press...
...But many in the investment community doubt Flom's analysis...
...If Flom is right, it will be businessas-usual in the junk bond market, even if Drexel is found guilty as charged...
...Perelman's lawyer captured that attitude: dealing with Perelman "was just beneath" Bergerac...
...Another important policy issue, and one that will be solved in the markets rather than in the courts, is whether the Drexel litigation, if successful, willbring junk bond financing to an end...
...Second, Flom points out that deals are clicking along...
...There is no doubt the fight will prove costly...
...As Drexel Burnham has pointed out, "Over 95 percent of all U.S...
...Bruck describes Bergerac as "a courtly, somewhat imperious, urbane, witty Frenchman...
...John Dingell, the powerful chairman of the House Energy and Commerce Committee, has forwarded to the SEC the results of his committee's own investigation of Drexel's dealings, which suggest that key Drexel employees invested in a firm being underwritten by Drexel, before that stock was offered to the investing public, in violation of SEC Rule 10b-6...
...I chose to fight these characters because I found them to be undesirable," Bergerac acknowledged...
...increased their total invested capital at an average annual rate higher than industry in general...
...And its army of top lawyers and public relations consultants will end up costing it well over $100 million...
...In any event, it is now up to the courts to decide whether Drexel is guilty, as charged...
...First, the filing of the SEC complaint produced a "ho-hum" reaction in the market: interest rates on junk bonds didn't change...
...Many Wall Street observers are guessing that given its day in court, the firm will emerge, if not unscathed, essentially intact as a leading investment bank...
...SEC Chairman David Ruder has promised to file an additional complaint if Drexel's defense—that the stock offering in question was a private, rather than a public offering, and therefore not subject to Rule 10b-6—is unconvincing...
...The sums involved in the transaction are indicative of the stakes in this game of high finance: the Drexel groups paid $5.7 million in 1986 for the rights to stock now alleged to be worth more than $500 million...
...Lifetime sinecures evaporated...
...What the courts can't decide, and the press has largely ignored, is the even more important policy and economic issues raised by the entire affair...
...Milken created a market for bonds of less-than-investment grade, sneeringly referred to as "junk bonds" by old-line financial and industrial firms...
...Reporters in those media have concentrated on the legal battles just beginning...
...After all, managers forced out of companies taken over by raiders hardly left empty-handed...
...Connie Bruck, in her highly readable The Predators' Ball' (the title is taken from the name given to the Beverly Hills bash thrown annually by Milken for his clients), argues that Milken's very brilliance in all aspects of the securities business made a mockery of the Chinese Wall concept...
...Milken, she argues, was the firm's, if not the industry's, best trader, salesman, deal creator, credit analyst, and underwriter...
...And the public quickly receives Drexel's position on all developments: when the SEC filed its laundry list of charges, Mr...
Vol. 21 • November 1988 • No. 11
