He spoke with boyish enthusiasm, fixing his visitor with an unhurried, brown-eyed gaze. His talk was of noble pursuits. He spoke of plans to finance employee takeovers like one last month in which his firm helped a labor union buy a Seattle tugboat-manufacturing company. Such efforts, he said, would foster a more democratic kind of capitalism.
The one subject Milken studiously avoided was the intensive 22-month federal probe of the junk-bond department he heads at the Drexel Burnham Lambert investment firm, but the matter soon forced itself on him. Suddenly his lawyer . was summoned from the room. Within minutes he returned and led Milken away. Down the hall the attorney informed Milken that a long-feared moment had arrived: the Securities and Exchange Commission was filing a weighty civil complaint against him, his employer and several colleagues.
The case could be a turning point in the fortunes of Wall Street's most go- getter firm, the financing machine that drove much of the corporate raiding of the roaring 1980s. The complaint charged Milken and Drexel with a whole catalog of offenses, including fraud against the firm's own clients, insider trading, the "parking" of stocks to conceal their true ownership, and the destruction of accounting records to cover up the transgressions.
"They've thrown the book at them, almost every violation of the 1934 Securities and Exchange Act," said Edward Brodsky, a Wall Street lawyer and former U.S. Attorney. Potentially the most devastating charge was the accusation that Drexel, the fifth largest U.S. investment firm (1987 revenues: $3.2 billion), had cheated some of its important customers. Said Brodsky: "That is raw stuff."
The complaint casts the Beverly Hills-based Milken as the mastermind of a secret, bicoastal arrangement with Ivan Boesky, the Manhattan financier now serving a three-year prison term for insider trading. From 1984 until late 1986, according to the Government, Boesky secretly bought and sold huge blocks of stock at Drexel's behest to push forward the firm's takeover deals and to reap millions of dollars in illicit profits. Five others were charged as participants in Drexel's schemes: Milken's younger brother Lowell, an attorney who works in the company's junk-bond department; Cary Maultasch and Pamela Monzert, traders for the firm; and the Miami-based industrialist Victor Posner and his son Steven.
The SEC asks that the defendants be forced to return profits they made from the alleged scams, along with any losses they avoided, plus a fine of triple that total. The complaint leaves the court to calculate that number, but estimates put it as high as several hundred million dollars. If Drexel and company lose the case, the SEC could also impose penalties ranging from censure to banishment from the securities business.
Yet the civil case is probably just a prelude to criminal indictments -- and potential jail terms -- that Milken and his colleagues could face as soon as U.S. Attorney Rudolph Giuliani finishes a nearly two-year investigation that < has paralleled the SEC's. The prosecutor is expected to finish presenting his case to a Manhattan grand jury by the end of September. Last week Giuliani sent so-called target letters to Milken and four colleagues, notifying them that they are likely to be indicted within one month.
Milken and Drexel issued sharp denials and promised to fight the charges. Said Milken: "For the past 22 months, I have been the subject of a shadow trial of systematic leaks and innuendo based upon false accusations. No one likes to be sued, but I welcome the opportunity to have at long last a full and open hearing of the allegations in an unbiased forum."
At the same time, Drexel moved quickly to reassure employees and customers. Frederick Joseph, the firm's chief executive, spent an hour explaining the charges over a telephone hookup with 10,000 workers in the U.S. and overseas. The company handed out red-and-blue T shirts emblazoned with the slogan WHEN THE GOING GETS TOUGH, DREXEL GETS GOING. The firm sent soothing letters to 5,000 clients in which Drexel estimated that its fines would amount to only about $100 million and compared that figure with the firm's total assets of about $30 billion.
Reaction to the SEC charges was muted, mostly because Wall Street knew they were in the works. The stock market remained calm, and the prices of junk bonds barely moved. Said a rival executive: "The impression on the Street is that Drexel has done a terrific job of damage control." Added a Drexel manager: "If people have a concern, it's the size of their bonus at the end of the year."
The Drexel charges grew out of the Boesky case: in November 1986 the speculator paid a $100 million fine to settle civil charges of insider trading and agreed to provide information and testimony about his colleagues. Boesky had a close relationship with Drexel, which helped him raise $660 million to reorganize his business, a huge arbitrage operation that speculated on takeover stocks. The SEC charges that Milken developed an arrangement in which Boesky acted as a front for secret excursions by Milken and his colleagues into the stock market. The arbitrager would be the shareholder of record, but Drexel would share the profits and guarantee him against any loss. A central piece of evidence in the Government's case is the record of a $5.3 million payment from Boesky to Drexel. It was ostensibly for "consulting services," but the SEC calls it a payment of illicit stock-trading profits.
The Government claims that Milken and Drexel used the arrangement "to profit at the expense of their clients, publicly owned companies and the investing public." In some cases, Drexel told Boesky about takeover bids that the firm's clients were preparing. Since the stock price of a target company almost always rises in a takeover battle, Boesky could buy shares in advance, make a quick profit and split the proceeds with Drexel.
The accusations, if true, tend to diminish Milken's aura as the consummate dealmaker whose success can be chalked up to brilliant insights and 18-hour workdays. Even so, Milken's reputation will be far more difficult to explode than Boesky's. The junk-bond whiz has irreversibly changed the face of corporate America by making large-scale financing available to thousands of corporations and takeover artists.
Extremely publicity shy, Milken has always been a positive thinker. He was head of the cheerleading squad at Birmingham High School near Los Angeles. A graduate of the University of California, Berkeley, and Pennsylvania's Wharton business school, Milken realized the potential of junk bonds while earning his M.B.A. The bonds, which pay a higher yield than investment-grade bonds, formerly represented the downgraded debt of ailing companies. But as a trader at Drexel in the mid-1970s, Milken began pushing new junk-bond issues as a financing tool for medium-size companies that were unable to float higher- grade debt.
Milken persuaded Drexel to allow him to move from the East Coast to Southern California in 1978, a relocation that gave him more independence. By 1982 he had begun using junk bonds to raise money for takeover artists, which created both controversy and a huge run-up in his profits. Milken began staging an annual junk-bond conference that became known as the Predators' Ball. He soon emerged as the biggest moneymaker for Drexel, earning bonuses of $100 million to $200 million a year and accumulating a 4% ownership in the firm. His current estimated net worth is $500 million. Yet Milken is an ascetic (no alcohol, no caffeine, not even carbonated drinks) who lives in a modest five- bedroom home in the San Fernando Valley town of Encino. There he spends a quiet life with his wife Lori, his high school sweetheart, and three children.
Since the Boesky affair broke, Milken has occasionally met with journalists to avoid appearing to be a recluse and to shake off his reputation as purely a money hound. During the past year, Drexel has carried out a multimillion- dollar print-and-TV campaign to bolster its reputation and point out the socially useful applications of junk bonds. One spot tells how a bond issue enabled a municipality to afford the liability-insurance premiums to keep a playground open.
The junk-bond market that Milken created is growing less dependent on him for stability. Such firms as First Boston, Morgan Stanley and Salomon Brothers have become sizable underwriters, making the market more liquid and adaptable than it was a few years ago. Drexel's share of new junk-bond issues stands at about 50% today, down from 68% in 1984.
The Drexel case may speed passage of tougher laws against insider trading. Edward Markey of Massachusetts, chairman of the House subcommittee on telecommunications and finance, called the case the "most massive and pervasive scheme of fraud on Wall Street since the 1920s." He has introduced a bill that would give informants a bounty of up to 10% of the penalties for insider trading and would increase the maximum jail sentence from five years to ten.
Drexel has reportedly set aside a $650 million war chest to fight the SEC's charges. A big part of the firm's strategy will be to attack the Government's case for being too dependent on Boesky. Says Martin Flumenbaum, who will defend Milken: "It will turn completely on Boesky's credibility, and Boesky has a clear motive to lie and fabricate." For its part, the SEC claims that it has substantiated its case with transaction records and testimony from Drexel employees, most notably Charles Thurnher, a senior vice president in the junk-bond department. Says Gary Lynch, the SEC enforcement chief: "We are determined to litigate this to a conclusion."
Despite Drexel's combative public posture, the company is probably wrestling with a difficult decision: whether to endure a trial or try to negotiate a settlement. Drawn-out civil and criminal trials would be a drain on Drexel's resources and customer goodwill. Moreover, Drexel may have more court battles to fight against its aggrieved clients and the investing public. Late last week a lawyer in Philadelphia filed the first suit on behalf of stockholders in the companies listed in the Government's case. As Drexel's legal troubles proliferate, they are already transforming the firm from an aggressor feared by competitors into an embattled defender of its prominent place on Wall Street.