The Predators’ Ball (47 page)

Much of the wealth that was being amassed in Beverly Hills, of course, came through Milken's investment partnerships, and while he had allowed some members of the corporate-finance department to participate in several of them, the overwhelming majority of
these partnerships were for him, his brother and his group (and at least a few of them included individuals wholly unrelated to Drexel). Corporate finance, for example, had not been allowed into probably one of the more lucrative of them, Belvedere Securities—which was by its very existence testament to Milken's sovereignty. For Milken to be the majority owner of another brokerage firm, which according to an SEC lawyer traded some securities that Drexel underwrote and took orders from members of Milken's group for clients of “the Department,” was a situation so rife with conflict of interest, and so ripe for abuse, that it is difficult to imagine how it could have been allowed, even at Drexel, even for Milken.

Nor was Belvedere an isolated instance. A related entity, controlled by two of the same general partners, operating out of the same space in Chicago (although its official address was c/o the American Stock Exchange in New York), with 75–100 percent of its capital at the outset contributed by Milken, was EGM Partners, a broker-dealer in options. Among EGM's limited partners were Milken; many of his favored from his group; and James Regan and Ed Thorp (general partners of both Belvedere and Dorchester Government Securities). EGM Partners was formed in late 1982 and stopped doing business less than two years later, within a month after signing a letter of consent with the Chicago Board of Options Exchange for violating Exchange rules concerning size of positions.

Even when the New York corporate-finance members did participate in the partnerships, they still felt underprivileged. Particularly once the buyout boom was under way, much of Drexel's and Milken's profits came in the form of warrants in the newly formed companies. The bulk of these were in the investment partnerships—including at least one in which corporate finance participated. But even here, where there was joint participation between New York and Beverly Hills, the warrants were distributed in unequal proportions between the two coasts, with Milken's group taking the lion's share.

Another portion of warrants, many of them received as part of fees in underwritings, did not go into the investment partnerships but was available for more general distribution. This distribution, however, differed on the two coasts, according to a former Drexel investment banker. In New York, they went into a pool, known as the warrant strip fund; each year a certain percentage of those warrant strips were sold, and the proceeds distributed on a pro-rata
basis to the partners in corporate finance, according to their allotted percentages (senior partners had the largest slices of the pie). But in L.A., this banker said, Milken distributed the warrants not on a pro-rata basis but directly to those in his group he deemed deserving. The largest portion, to the most deserving, he is said to have allotted to himself.

“There were two separate firms, and Milken's was more of a meritocracy,” declared this former Drexel investment banker. “He was giving direct incentives. Bringing in one deal could make you a millionaire. It worked on a microlevel—you had guys who were really incentivized, which is what Mike wanted. They were animals, threatening companies and making a million dollars on a single piece of business they brought in. But Fred Joseph's problem was that it wouldn't work on an institutional level—you couldn't run a firm with ten thousand animals. So he had to institute a different system, where you did well if the firm did well.”

The schism was reflected, too, in the battle fought between the two groups on behalf of their respective constituencies—a battle that L.A. almost always won. As one corporate client recounted, “The way it works is that the New York office sort of represents you, and L.A. represents the bond buyers. Part of Mike's success, I think, is attributable to the fact that he negotiates a very, very favorable deal for the bond buyers. It was a great source of friction between Drexel and us—we thought L.A. was exacting much too much. But L.A. had the power.”

A former Drexel investment banker from New York added, “It is more true at Drexel than anywhere else that their real clients are not corporate; they are the buyers of the bonds. They feel they have a patrimony to protect. So if you're a corporate client, and you're not part of the inner circle, you are ripe for a raping.

“Usually, when it comes to a pricing for a deal, you [as the investment banker] have to fight with the client to get him to pay a sufficient amount [in interest]. Here the fights were with the guys from Beverly Hills, to get them to a point that was reasonable enough that you could even go to the client with it. At Drexel, the most difficult, contentious, acrimonious discussions were with your own people—in Beverly Hills.”

While Milken's reign showered gold upon his associates, his was not a pleasant dominion. Some at Drexel perceived him as an insatiable, abusive tyrant, who by 1986 was operating—and demanding
that others operate—at a whirlwind speed that no one else could, or should, emulate.

Shortly after the April 1986 Predators' Ball, one Drexel investment banker commented that it had struck him as a “feeding frenzy, everyone doing deals, deals, deals, so thrilled at being part of the new power elite.” That spectacle had caused him to think about what had drawn him to this business, back in the seventies. “To me, the appeal was essentially academic. You learned about the companies. You tailored the transaction. Lastly, I noticed, it paid well. But that was like a bonus.

“The trading mentality is supposed to be quick—traders are supposed to know prices. We [in corporate finance] are supposed to understand things. But when you start making these deals look like trades, you begin to question whether it's worthwhile. And what I came away from California with was [the realization] that we are essentially a processing arm for Michael and his trades—and he doesn't pay attention to nuance, and he wants them as fast as possible.

“Michael is interested in power, dominance, one hundred percent market share. Nothing is good enough for Michael. He is the most unhappy person I know. He never has enough. He drives people by insult. He drives everything—more, more, more deals. Michael doesn't care if it's a bad deal—he sees bad deals as an opportunity. You can refinance, restructure, do an exchange offer. Everything is an opportunity.”

The firm's founder, Tubby Burnham, also struck one of the few dissonant notes amid the euphoria at Drexel in 1986. For Burnham, who had built the firm by carefully husbanding its capital, the abundance of easy money that spilled from Milken's machine was discomfiting. He disagreed with the overfunding that was fundamental to that machine's operation. “Companies have been piggish,” he complained. “It's wrong for an underwriter to say to a company that needs fifty million dollars, ‘We can get you a hundred million.' I am always telling my guys, it's wrong!

“It's like a kid saying, ‘I want five dollars,' and you say, ‘Take ten dollars, have fun!' It's not right, it's too loose.”

Burnham was also skeptical of the way fortunes were being made by the nouveaux entrepreneurs, by what sometimes seemed little more than sleight-of-hand. “It took me fifteen-twenty years to become a millionaire—not like today, when it happens over-night.
When this is over, some of these people are going to find out they're not millionaires anymore—they're going to be looking for their next meal.”

Whatever reservations brewed quietly in the more conservative corners of Drexel in New York, however, were irrelevant. People might carp now and then, but who could afford to challenge? Milken's hegemony was nearly complete. In 1978 he had announced to Edwin Kantor, head of all trading, that he wanted to move to California; Burnham had had a fight with Milken about it; but as Kantor later said, “What could we do?” All that had changed was that Milken had made the firm's executives wealthy beyond their dreams, and had made Drexel into the most fearsome investment-banking firm on the Street. Drexel chairman Robert Linton, when asked in early 1986 who was the person to whom Milken answered, looked bemused for a moment and then replied, “Kantor, Fred [Joseph]—but that's a question that never gets asked.”

There apparently were occasions on which Milken did yield to Joseph. They had, after all, been partners from the beginning, when they started the original issuance of junk bonds. It was Joseph who had brought in many of the early corporate clients, and who was the superb salesman, and the genuine leader of the corporate-finance team. It was Joseph who attempted to make amends with clients or competitors whom Milken's crew had roughed up. When Linton had ceded the position of chief executive officer to Joseph in the spring of 1985, the strongest opposition to Joseph's appointment came from Milken, who did not want to lose him as head of corporate finance. In 1985, as the firm moved into the eye of the political storm, it was Joseph who was the consummate front man, and Milken who was able to remain cloistered.

Some of their associates suggested that Milken gave Joseph latitude because the two supersalesmen were simpatico, Joseph with his drive to be number one, Milken with his drive to have it all; Milken with his penchant for thirty-second phone conversations, Joseph agile and fast on the comeback. But, for Milken, who had so distilled his life that his smallest action was calculated and purposeful, compatibility would have meant nothing unless it enhanced efficacy. He must have deemed Joseph extraordinarily useful.

One occasion on which Milken paid attention to Joseph was in Drexel's financing of Ted Turner's $1.25 billion acquisition of the
MGM/UA Entertainment Company. Drexel had issued its “highly confident” letter in August 1985. But after the letter was issued, there was deterioration at MGM. And the “highly confident” letter, which drew its almost mystical powers (it was after all merely a letter stating intent, and not legally binding) from its record of irrevocability, was altered twice to reflect a restructured deal. It changed first in October 1985 and again in January 1986. Arthur Bilger worked on that deal and said that “forcing its restructuring is the greatest value-added thing I've done at Drexel.

“Mike did not want to do it. He still could have sold the paper, and he had this relationship with Kirk Kerkorian [MGM/UA's majority shareholder], and everybody was watching, saying, ‘Mike can't do the deal.' And he
could.
But it would have been wrong. So we had to bring Fred [Joseph] in to persuade him. And he did.” Milken did not discount Joseph, as he did most people. But in the main, he did as he pleased. And by 1986 he was doing it with ever greater frequency.

In theory, the Underwriting Assistance Committee (UAC), formed in 1982, had to approve every underwriting the firm did. On the committee were about eight or ten (it varied slightly over the years) corporate-finance professionals. The investment banker for every proposed underwriting wrote a memo to the UAC, outlining its substance and the pluses and minuses of Drexel's doing the deal. Also, in 1984 or so, Leon Black introduced into his memos (which then became the form) a first-page paragraph stating what Drexel's compensation would be. “That marked a subtle shift here,” claimed one investment banker. “The fees don't belong there. The deal should be judged on its merits, not the fee. It was going public with our venality.”

UAC meetings were held weekly in New York (with a phone hookup for members in corporate finance in Beverly Hills), and they lasted from several hours to more than a day. Everyone was expected to have read the memos beforehand, and the meetings were by no means a rubber-stamp process in which every deal was approved. But after all the memo-writing, the homework and the hours-long debates, Milken simply went ahead and did some deals that the committee had rejected.

By the fall of 1986, some of the committee members thought that Milken's increasingly frequent flouting of this fundamental process was a serious problem. They compiled a list entitled “Difficult
Deals.” On it were about twenty to thirty deals that had been bones of contention between Milken and the UAC—about half of which Milken had then proceeded to underwrite. A couple—for Sea-Containers and Bright Star, for example—had gotten into trouble within their first six months.

Others were not in trouble—yet. Milken had done an $80 million underwriting for Compact Video, owned by Perelman's MacAndrews and Forbes—a deal whose sole claim to viability was that the successful Perelman would make it work.

Milken had done a $135 million blind pool for Banner Industries, controlled by Jeffrey Steiner. Here the committee had argued that they ought not to be doing a blind pool for an individual like Steiner—a former oil trader and arbitrageur who had zero record as either a raider or an operator of companies—but should instead wait until he had chosen his target and then finance its acquisition.

Milken had also done a $50 million deal for Great American Management and Investment (GAMI), a holding company controlled by Chicago entrepreneurs Sam Zell and Robert Lurie. Zell had made his fortune as a savvy bottom-fisher in real estate, picking up valuable properties at distress-sale prices. Now, however, he was trying to apply that strategy to companies and had purchased a diverse mix of troubled companies over the previous five years or so. But thus far these acquisitions were still dismal, and it looked like Zell's bottom-fishing knack was restricted to real estate. The UAC had vetoed the underwriting.

And then Milken had done a $640 million deal for Ivan Boesky's arbitrage partnership. This had been one of the most hotly disputed deals within the firm. The arguments against doing it were compelling. It was a very large private placement with no registration rights, because Boesky's business changed too rapidly to be able to comply with the disclosure demands of a public offering. Therefore, if Boesky got into financial trouble, there would be no public market for the debt and only the thinly traded (though not so thinly as it was supposed to be) private market to rely on. Holders who wanted to unload their securities would look to Drexel. It would be placing hundreds of millions more in the hands of an arbitrageur who many thought was already overcapitalized. Drowning in dollars, he might chase the bad deals as well as the good and therefore not obtain the return he had in the past.