Michael Milken, Part IV…the Fall

Michael Milken, Part IV…the Fall

“The plans of the great financier may act as a catalyst to a

speculative mania, but the financier himself does not remain

untouched by events. His ambition becomes limitless, a chasm

opens up between the public appearance of success and universal

adulation, on the one hand, and the private management of

affairs which become increasingly confused and even

fraudulent.”

–Edward Chancellor

As the hostile takeover deals heated up in the mid 1980s, several

anti-takeover measures were before Congress. The public was in

an uproar over the number of jobs being lost with each

restructuring once a takeover went through. Of course, looking

back, you can say some of this action was a leading reason for

the current boom that the American economy is in. Corporate

America became lean and mean. The Europeans are finally

learning this lesson the past few years and it is contributing to the

tremendous changes taking place there as well.

But back to Michael Milken and his junk empire. It all began to

crumble on May 12, 1986 when Drexel banker Dennis Levine

was arrested on charges of insider trading in 54 stocks. As

author Robert Sobel notes, “This was for Drexel the equivalent

of what the discovery of the Watergate break-in was for the

Nixon administration.”

Levine had been a rising star at Drexel but between 1980 and

”85, the government alleged he had made more than $11 million

on his illicit trades.

Enter SEC chief of enforcement, Gary Lynch and U.S. attorney

Rudy Giulliani. They offered Levine a plea bargain if he would

cooperate with them. Levine accepted and fingered arbitrageur

Ivan Boesky [see previous “Wall Street History” pieces].

Boesky, in return for his plea bargain, then fingered Martin

Siegel, who was also at Drexel. Siegel then admitted to insider

trading while at Kidder Peabody, and he, too, agreed to

cooperate.

Levine, Boesky and Siegel were imprisoned, receiving light

sentences for having cooperated. Siegel fingered other bankers,

including Robert Freeman of Goldman Sachs, who also went to

prison.

By 1987 and early ”88, the atmosphere at Drexel”s headquarters

in New York as well as Michael Milken”s Beverly Hills

operation was tense. Boesky had told Giulliani of his dealings

with Milken. Giulliani then used the Racketeer Influenced and

Corrupt Act, RICO, to go after Milken. RICO had been

previously used against organized crime. In September, 1988 the

SEC charged Drexel with 21 violations of securities laws, 2 of

which involved insider trading. In November similar charges

were “initiated” against Milken. Several bankers agreed to

testify with promises of immunity and plea bargains.

Sobel: “Giulliani felt he had the power to destroy Drexel without

a trial.” He told CEO Fred Joseph that he needed to agree to a

settlement on his terms. As one Drexel banker characterized the

meeting, “Giulliani put the gun on the table and said to us,

”Either you will pick it up and use it on yourself, or I will.””

Milken and Drexel were Rudy”s prime targets. And to Congress,

they realized Giulliani was doing what they had intended to do,

only swifter and more effectively.

In the end, Drexel”s 22-member board elected to cooperate with

the government. On December 21, 1988 they agreed not to

contest six charges of malfeasance and pay $650 million in fines

and damages. And Drexel also agreed to put Milken on leave of

absence with no one at the firm being permitted to remain in

contact with him. All of this took place without Milken being

formally charged with any crimes.

The Street cheered. Of course, they had been jealous of Milken

and Drexel”s control of the junk-bond market. But who would

fill the gap? Prices started to decline, more from fears of

liquidity than anything else.

In June, 1989 Drexel”s bankers were unable to roll over $40

million of commercial paper for a client, Integrated Resources.

In the past Milken had rescued clients like this. But not this

time. Integrated defaulted on $1 billion of debt, most of it owned

by Drexel customers. The default jarred Drexel”s clients and

customers alike.

Two months later Congress passed the Financial Institution

Reform, Recovery, and Enforcement Act which required thrift

institutions to mark their junk bonds to market, which is to say,

carry them at market prices rather than face value, meaning that

some would show large losses due to the sell-off. In addition

they would have to dispose of their junk portfolios by June 1994.

As Sobel writes, “This whole act caused a loss of confidence in

thrifts, which hemorrhaged deposits, even though most were

covered by federal insurance. In 1988 there had been 223

failures, in 1989 there were 328 but none as a result of their junk

bond portfolios.” In 1990, out of 217, it was estimated that 4

were junk related.

[I just have to add the thought that when you look back on how

bear stock markets begin, often “bad legislation” has played a

prominent role.]

The junk network began to crumble. Plus the UAL buyout that

fell through in October (with the Dow Jones falling 6% in one

day) played a key role. Junk failures, which had averaged about

2% in the 1977-88 period, hit 8.7% in 1990.

Drexel was now stuck with a junk portfolio of more than $1

billion that could not be marketed. In early February, 1990, the

crisis came to a head when their Belgian parent refused to extend

its credit line for commercial paper. Joseph hoped for a rescue of

the type afforded Chrysler and New York City (and, as it was to

turn out in later years, Long-Term Capital.though many would

say this isn”t apples to apples). Federal Reserve Chairman Alan

Greenspan offered no help, nor did the SEC.

Fred Joseph said at the time: “There are constituencies out there

that have reason to dislike what Drexel has been able to achieve.

We have found ways to finance medium-sized growing

companies. That had taken a business away from the banks

(and) there were clearly companies that had been attacked in the

takeover game that felt very bitter about us. We were tough on

the way up and we never made friends. We stole business from

other firms. We made the banks look silly. This was pay back

time. The Establishment finally got us.”

Late on February 12th, Joseph was told by the Fed to file for

bankruptcy or accept forced liquidation. The board voted for

bankruptcy. There was no panic but much joy as everyone was

more than happy to hire Drexel bankers. But after all of this, the

Wall Street Journal wrote: “Now someone from the Justice

Department needs to explain what it was that Milken allegedly

did to justify the punishment being inflicted on the capital

markets.”

Giulliani knew he better get a conviction or he”d have to answer

for the destruction of Drexel. But Rudy resigned on January 18,

1989 and Benito Romano finally brought a 98-count indictment

against Milken, including 54 charges for mail fraud and 33 for

securities fraud. If found guilty he could be stripped of all he

had and incarcerated for up to 520 years.

Originally Milken”s attorney was Edward Bennett Williams but

Williams was dying of cancer. He had wanted Milken to plead

not guilty. Then Arthur Liman took over and, on his advice,

Milken pleaded guilty to 6 felony counts, none including insider

trading. Since the charges were light, Liman thought Milken

might get off without serving time. That was not to be as Milken

was sentenced to 10 years, plus 1,800 hours of community

service a year for 3 years, and was fined $200 million (on top of

$400 million already paid into a restitution fund). Later there

would be an additional $500 million. 6 years of the 10 had been

for assisting the dirtball, Boesky.

Judge Kimba Wood said on sentencing, 11/21/90:

“When a man of your power repeatedly conspires to violate, and

violates, securities and tax laws in order to achieve more power

and wealth for himself and his wealthy clients, and commits

financial crimes that are particularly hard to detect, a significant

prison term is required to deter others.”

Attorney Liman said:

“I am convinced that society needs a certain number of

demons.The case took on the characteristics of a heresy

trial.[Milken had] become a symbol, the symbol of an era, and

it was beyond any kind of control.”

Commenting on the whole matter, author Charles Morris writes:

“Milken seems to have been a particularly unattractive

personality – fanatically driven, greedy, arrogant, obsessive,

unfeeling to his subordinates, brutal in negotiations. He is also a

criminal, because he pleaded guilty to specific felonies. But the

actual charges were rather minor and the government never

succeeded in showing that Milken engaged in the kind of insider-

trading abuses that were Boesky”s specialty.The ten-year

sentence handed down by Wood was shockingly severe – a case

of an inexperienced judge playing to the headline writers calling

for blood. Perhaps 12 to 18 months of the sentence could be

attributed to the crimes Milken had pleaded to. The remainder

was the price exacted for being a ”symbol of greed.””

Author Edward Chancellor comments:

“While it is true that Milken was indicted for relatively minor

offenses (through plea-bargaining) and that, contrary to popular

perception, the great bulk of his fortune was derived legitimately

from his uncommonly generous remuneration package, Milken

was not the innocent scapegoat portrayed by his legal team and

PR advisers. His total control of the junk bond market turned

him and his fellow Drexel traders into bullies and braggarts.

Corners were cut in the pursuit of profit. The lust for money and

power created a collective adrenaline rush that fed upon itself,

until Milken and Drexel became insatiable. Milken

overreached.and brought about his own downfall.”

From author John Steele Gordon:

“Milken”s biggest crime, certainly, was hubris. He was

convinced that he was capable of carrying off any deal that he

put his hand to, and he underestimated his enemies. Milken

came to ruin as a financier because he lacked J.P. Morgan”s

sense of limits and of the strength of the forces arrayed against

him. In this way, like hundreds of other Wall Streeters in the

1980s who were making money hand over fist and thought it

would go on forever, he conceived of himself as a Master of the

Universe.”

Author Charles Geisst:

“Milken”s contributions to Wall Street remain hotly debated. He

is viewed as a financier of predators, a raiser of capital for weak

companies, and the ultimate inside trader. But there is no

denying that many of the once weak companies that he helped

finance became highly successful in the long run. [Duracell,

Viacom, MCI.to name a few] At the time of his indictment,

the New York Times summed up by saying:

”Michael Milken is a convicted felon. But he is also a financial

genius who transformed high risk bonds – junk bonds – into a

lifeline of credit for hundreds of emerging companies.The

Milken case presents issues far more important than one person”s

slide from the financial pinnacle. There is no condoning Mr.

Milken”s criminality. But if overzealous Government regulators

overreact by indiscriminately dismantling his junk bond legacy,

they will wind up crushing the most dynamic part of the

economy.””

As for my opinion? One can not forget that between 1980 and

”86, firms employing junk bonds accounted for 80% of all job

creation at public companies (contrary to what may have been

believed). But clearly, having pled guilty to felony charges, he

got what he deserved. And in my value system, his personality

seems so awful that that alone should have warranted time.

Next week, a promised change of pace.

Source: “Wall Street: A History,” Charles Geisst

“When Giants Stumble,” Robert Sobel

“The Great Game,” John Steele Gordon

“Devil Take the Hindmost,” Edward Chancellor

“Money, Greed, and Risk,” Charles Morris

Brian Trumbore