The Predators’ Ball (39 page)

Milken struck a different note. He told this reporter in an interview in 1987, “I welcome competition. Other people might see things we don't see. We might see things they don't see. The negatives are—and I'm trying to state this in a positive way—that some deals may get done that shouldn't get done, and then that may hurt the perception of the high-yield market. People have a tendency to remember only the ones that didn't work out.

“Financing is an art form,” Milken added. “One of the challenges is how to correctly finance a company. In certain periods of time, more covenants need to be put into deals. You have to be sure the company has the right covenant—to allow it the freedom to grow, but also to insure the integrity of the credit. Sometimes a company should issue convertible bonds instead of straight bonds. Sometimes it should issue preferred stock. Each company and each financing is different, and the process can't be imitative.”

By 1986, Milken's rivals had also followed in his footsteps by venturing into “merchant banking”—a term borrowed from the British, whose investment banks in the nineteenth century had pooled capital to buy businesses and thus had built empires. In this country it meant that the firms were putting up their own capital in deals, mainly takeovers and buyouts. They were no longer acting solely as agent, but also as principal. This was something, of course, that Drexel, through Milken (as well as a few others, such as Allen and Company), had been doing for years.

But Drexel's rivals had also come up with a new variation on merchant banking: the bridge loan. There, the investment bank puts up its own capital as a loan in order to facilitate a client's deal.
That loan in effect “bridges” the time from the closing of the deal to the time when the junk bonds are sold; the proceeds of the sale then pay off the loan or (if the investment bank is leaving some of its capital in the deal) part of it. In their enthusiasm, Salomon and a group of institutional lenders who were participating in thus funding deals together dubbed themselves “the Bridge Club.”

It was inevitable, once these firms—tantalized by those 3–4 percent spreads—had followed Milken into the original issuance of junk bonds, that they would then attempt to follow him the next step: to the junk-bond-financed takeover and buyout. How could they not try, after watching Drexel garner a financing fee of $86 million in the Beatrice buyout? Milken had no patent on greed. (Although he did, arguably, give the word new meaning. Drexel's financing fee in Beatrice was dwarfed by the amount Drexel partners were said to have earned by 1987 from their equity stakes in the deal—close to $800 million, several hundred million of which was said to have gone to Milken personally.)

But none of these investment banks had Milken's ability to tap into his network and raise billions overnight. None of them could enlist his buyers to give them a bridge loan—which is in essence what these buyers did for Milken. His first-tier buyers—who committed to buy the bonds and earned the commitment fees, but were often replaced by second-tier buyers by the time the deal was funded, or shortly thereafter—provided him a bridge.

Milken's rivals had two problems. First, they didn't have Milken's distribution system, and so they were unable to place $4–5 billion in junk. Second, they needed more time to place what they could. The bridge loan cured the time problem and made deals with less than $2 billion in junk financing viable for them. From the client's standpoint, the bridge went the “highly confident” letter one better. While that letter had been largely accepted in the business world as transmutable into cold cash, it was not cold cash. But now First Boston, Morgan Stanley, Shearson Lehman, Merrill Lynch, Salomon Brothers and others were offering to put cash into their clients' hands—and take the risk of the refinancing themselves. That risk was considerable, for time here was a two-edged sword: crucial for them to be able to place the bonds, but dangerous in that the market could change.

That, of course, had been the beauty of Milken's system—that there was such bountiful reward for so little risk to him or the firm.
When Icahn suggested that Drexel in essence give him a bridge loan in Phillips, his proposal had been dismissed and the “highly confident” letter conceived instead. But in their desperation to reap Drexel-like rewards, other firms were seduced into greater risk than Drexel had ever taken.

These firms' deepest obeisance to Drexel, however, came not when they tried to imitate and compete, but when they simply gave up and encouraged their clients to bring this much-hated rival into their deals—so that the dreadnought would be on their side. According to two executives at Donaldson, Lufkin and Jenrette, which along with Drexel represented management in the buyout of Viacom, they had urged their clients to hire Drexel, for just that reason. And it was the same thinking, according to a well-placed source, that led Goodyear Tire and Rubber Company, in planning a defensive restructuring after a month of frenzied trading in its stock during October 1986, to hire Drexel along with its traditional investment-banking firm, Goldman, Sachs.

While the rest of Wall Street was trying occasionally to disarm but more often to compete with the renegade firm, Drexel was not only fighting to keep its lion's share, but also gearing for posterity. Fred Joseph had become the firm's chief executive officer in May 1985. And Joseph was intent on building a towering, enduring financial institution from the foundation that Milken's machine had laid.

Over the past several years, Drexel had been plowing some of its enormous profits into new areas. Dr. Richard Sandor, generally considered the principal architect of the interest-rate futures markets, joined Drexel in 1982 to develop a financial-futures division. Joseph's brother, Stephen Joseph, joined Drexel from Salomon Brothers in 1984 to start a mortgage-backed securities department. By 1986, his department had 280 employees and ranked in the top five of the industry. In municipal finance, where it also expanded enormously through lateral hiring, Drexel in '86 underwrote some $15 billion in offerings, up from $1 billion two years earlier; it went from being ranked as the fortieth-largest participant to number eleven or number twelve. And in '86 Drexel also moved from fifteenth to eighth place in U.S.-government-securities trading. And Drexel—albeit far more measuredly than some of its compatriots, such as Salomon—followed the Wall Street trend toward globalization, expanding its offices abroad, particularly London and Tokyo.

Symbolic of this drive to make itself into a well-rounded Wall Street titan was Drexel's decision, in July 1986, to move from its scattered quarters at 55 and 60 Broad Street into the brand-new two-million-square-foot, forty-seven-story tower, Seven World Trade Center. Drexel, which acquired a minority interest in the skyscraper, committed to lease the entire building for $100 million a year. In 1986 the firm had 4,300 employees in New York, but the new tower, it was planned, would eventually house 10,000 employees.

This institution-building was Joseph's vision more than Milken's. It always had been. What motivated Milken was a consuming passion for dollars, and for an empire—ever widening—to control. But Joseph was bent on fulfilling the ambition he had expressed to Mark Kaplan, Drexel's then president, six months after arriving at the firm in 1974—when he said that, given fifteen years, he could create something as important as Goldman, Sachs. The iconoclastic Milken would have derided such an aspiration. Joseph, however, did not wish to remain the outsider forever. He would join the club. And now, twelve years after his declaration to Kaplan, he was on track.

As Stephen Weinroth remarked, “Don't take me literally, but Fred [Joseph] would like to travel around the country and say, ‘Drexel is the largest underwriter of corporate securities, and of this, and of that'—he'd like to say, ‘the largest in all things.' And if he had to say that we were second-largest in trading of government securities of Somaliland, he'd say, ‘But we're gaining on the leader.' And if we were the largest in everything, and we made only $10 million, he'd still be happy. He's a market-share guy.”

A central tenet at Drexel, frequently articulated by both Milken and Joseph, was that it was not capital but people that were the scarce resource. Both of them, therefore, were willing to pay more than anybody on the Street in order to hire and keep those they considered the best. In Milken's group, where the pay had been astronomical since the seventies, there were few defections. It was a historic event when, in the fall of 1986, one of Milken's traders of more recent vintage, Eugene Wong, was hired away by Prudential Bache; the headhunter had made a host of calls, seeking “one of Milken's disciples.”

People did burn out, or worse, under Milken's ceaseless lash (one trader was rumored to have been found under his desk chewing
his phone cord one day), but then they were generally shifted to less stressful positions off the trading desk, or placed outside Drexel to operate as adjuncts. A few simply retired, at an early age. Charles Causey, who had been with Milken since the Drexel Firestone days, gave it all up in 1981 and moved to Islamorada in the Florida Keys, to devote himself to bone-fishing.

In 1985 and '86, Joseph had gone on a firmwide hiring binge, as part of his goal of diversifying the firm's strength and expertise. By early 1986, one big drawing card he was playing as a recruiter was that Goldman, Sachs was the only other highly profitable private firm on the Street. If Drexel ever went public, its shareholders (and the stock was widely held throughout the firm, with about eighteen hundred stockholders in all) would be likely to reap a bonanza.

Now, in the fall of 1986, Joseph pointed with pride to some of his star recruits: Martin Siegel, whom he had finally succeeded in wooing from Kidder; Sam Hunter and Michael (Jack) Kugler from Merrill Lynch; Jeffrey Beck from Oppenheimer and Company; and Robert Pangia from Kidder. He had had some rejections, among them Bruce Wasserstein, the M&A star at First Boston, who would later leave to start his own firm, and Michael Zimmerman, a fast-rising M&A banker at Salomon Brothers who would soon become co-head of M&A there. But Joseph was still ardently recruiting. “The day Drexel gets the last of the best people [for each position] is the day the battle's over,” he promised.

And the buckets of money that Drexel was offering were not only for the superstars. Offers to the lower-tiered people also made the pay at other firms seem, as Martin Siegel had once commented, like the margarine spread. The case of one analyst at Donaldson, Lufkin and Jenrette is typical. DLJ had hired him out of Harvard Business School at $80,000 a year. After he had been with them for one year he was doing good though not exceptional work in the health-care field, and his salary and bonuses had risen to about $110,000. Drexel, meanwhile, had hired a corporate-finance team specializing in health-care businesses from Kidder, but it lacked an analyst. So Drexel targeted the DLJ analyst. They offered him $350,000. According to a DLJ executive, the analyst had been happy at the firm, content with his salary, never even imagining that he could be making more than three times as much. But when that tripled offer came, it was too much to resist.

I
T WAS CLEAR
by the fall of 1986, however, that in Drexel's sweep of the Street, in its self-touting as the hottest firm, one with a derring-do, entrepreneurial culture where there was virtually no limit to the dollars that someone with talent and drive could make, it had attracted some so greedy that even Drexel was unable to sate their hunger.

Dennis Levine was a warm, jovial investment banker whose personality outshone his intellectual attributes. Nonetheless, he had made himself into enough of an M&A presence that when he was passed over for a managing directorship at Shearson Lehman in 1984 and decided to leave, he received job offers from three other top investment-banking firms. But it was Drexel—which guaranteed the thirty-three-year-old an income of $1 million a year—that won the auction.

On May 12, 1986, Levine was arrested, handcuffed and taken off to spend the night at the Metropolitan Correction Center. He was accused by the SEC of having made $12.6 million in illegal profits through insider trading in fifty-four stocks. And in June he pleaded guilty to four felony counts and agreed to cooperate with the government in its continuing investigation.

Drexel reeled from the scandal. “It's more than embarrassing,” Linton, the firm's chairman, told
Business Week.
“It's like someone breaking into your home. You almost feel dirty about it.” In private at the firm, it quickly became material for gallows humor. “Did you hear why Mike fired Dennis?” quipped one Drexel investment banker. “Because anybody who had to do fifty-four trades to make twelve million dollars couldn't be any good.”

Levine's case quickly mushroomed into the scandal of Wall Street as his cooperation with the government led to charges against members of his ring—investment bankers from Shearson Lehman, Lazard Frères and Goldman, Sachs and a lawyer from Wachtell, Lipton. Moreover, within the next several months there were two other indictments, unrelated to the Levine case, brought against Drexel employees. One was arbitrageur Robert Salsbury, who was alleged to be a member of yet another insider trading ring. The other was senior vice-president in the firm's expanding international-finance department, Antonio Gebauer, who was charged with having misappropriated funds from client accounts while he was a banker at Morgan Guaranty Trust Company. Milken had hired Gebauer to work on his Third World debt project, attempting to find some original approach to the crisis (which, if found, would probably
rival the original issuance of junk bonds in its payout). Both these individuals ultimately pleaded guilty.

Drexel officials pointed out that all three—Levine, Salsbury and Gebauer—had been at Drexel for less than a year, and that their criminal conduct had started (and, in Gebauer's case, occurred wholly) before they arrived at Drexel. Furthermore, Drexel was by no means alone in this spreading scandal. With Goldman, Sachs; Lazard Frères; Morgan Guaranty; and Wachtell, Lipton, Drexel was arguably in better company than it had ever been.