The Predators’ Ball (48 page)

Over the years, there had been SEC investigations of Boesky.
Though none had borne fruit, rumors of insider trading persisted about Boesky, far more than about any other arbitrageur. He was simply too prescient. And if he were ever caught, Drexel might be tarred.

Even without such a tarring, executives worried, the firm could be criticized for its conflict of interest. Drexel would be raising capital—and, as usual, taking an equity stake—in an arbitrage partnership where Boesky would be betting on the outcome of deals, many of which would be Drexel's. If he bet correctly, Drexel, which would have inside information on those deals, would share in his profits.

According to one Drexel executive, it was not only the more conservative New York contingent but those closest to Milken on the West Coast who had argued against doing it. Peter Ackerman, Milken's right-hand man for buyouts, had reportedly subscribed to the overcapitalized argument. Lowell Milken, the one individual whom his brother was most likely to heed, had reportedly been against it because he neither liked nor trusted Boesky. “But Michael,” said this executive, “thought Ivan was a winner.”

What Milken was doing violated the social contract of the firm. While Drexel prided itself on being nonbureaucratic and free-spirited—an institutional mirror of its entrepreneurial clients—it still had rules which were essential to its functioning as a coherent whole, rules which were meant to safeguard it against financial disasters and/or lawbreaking.

The UAC, formed after the debacles of the American Communications and Flight Transportation underwritings, was designed to carry out corporate-finance and executive functions—analyzing a company and a deal, determining whether Drexel should be its underwriter. All proposed deals came before the UAC: plain vanilla underwritings for general corporate purposes as well as those more adventuresome ones for acquisitions and blind pools.

No one from the trading side sat on the UAC. For Drexel, like other investment-banking firms, had built into its structure a “Chinese Wall,” meant to restrict the flow of information between its deal-making and its trading or arbitrage bodies. Such walls had been erected in investment-banking firms after the Texas Gulf Sulphur Company case in 1964, which expanded the definition of insider trading from company insiders to include anyone possessing material inside information.

Because of Milken, however, such separation was antithetical
to Drexel's very nature. Fusion had been the order of the day, ever since the members of the floundering corporate-finance department collaborated with Milken on the restructuring of the troubled REITs, back in the midseventies. From that time on through the original issuance of junk, Milken and corporate finance had been frequently intertwined. And while Milken had at first functioned as researcher, trader, salesman and business-getter and left the investment-banking, or deal-structuring, side of the transactions to his corporate-finance colleagues, he limited himself no longer after he moved to California. As Kissick, the Beverly Hills corporate-finance head, told
Institutional Investor
in 1986, “Prior to 1977, Michael had never done any traditional corporate-finance work. By 1978 he knew as much as virtually anybody on Wall Street.”

In that same article, an unnamed investment banker commented, “Mike is the only person in the securities business today who can do it all. He is a master trader, salesman, deal structurer, credit analyst, merger tactician, securities venturer. And he does these things at the level of the best guy in each of these categories. You look at the difficulty
firms
have in putting all these together—and here you have
one man
embodying all these attributes.”

In effect, Milken had appropriated all these diverse functions for himself. Just as he had no use for organizational demarcations in his group, because he believed that they subverted productivity by boxing people in, so he certainly would not allow himself to be constrained. For him, there was only one test: who had the best skills to get the job done? It was hardly surprising that Milken, who must have considered himself the best investment banker and credit analyst at Drexel, would simply subsume the function of the UAC and do the underwritings they had rejected. In earlier years he did not override the firm's veto so flagrantly, but by 1986 he seems to have considered it his sovereign prerogative. Just as there were few clients who would challenge him as his power increased, there was only one partner, Joseph, and he did so rarely.

Milken's subversion of the firm's authority in the underwritings was one problem. But another, potentially more explosive, was engendered by his being a kind of Renaissance man of finance. 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, Milken was a walking contradiction of the Chinese Wall principle.

Most firms tried to erect Chinese Walls between their deal
making group and their arbitrage department, which traded securities for the firm's account. In the gold rush of the eighties on Wall Street, however, even this relatively simple separation was not always maintained. At Kidder, for example, Martin Siegel had both headed its M&A division and helped create its arbitrage department.

But at Drexel, which had been practicing merchant banking before much of Wall Street knew the words; where Milken had invested for himself and the firm and his group and his customers in the REITs, many of which were Drexel restructurings; where he had then gone on to invest in both the debt and the equity of Drexel deals for his investment partnerships; and where he was often not only the source of the business but, increasingly, the structurer of the transaction, there could be no Chinese Wall. The only check upon Milken, who, as he had shown the UAC, did just as he pleased, was that Kantor theoretically had to approve all his trades.

One Drexel employee, asked about Kantor's supervision of Milken's trades, answered that that was indeed the rule. “Mechanics,” he added, “can mask substance.” For Milken, he said, opportunities for profiting on his inside knowledge were plentiful and the possibility of penalty slim. “If Mike sees bonds busting, lets them go to forty, thirty, twenty, all the while knowing that a deal is coming that's going to make them worth sixty-five, and if he buys up a bundle when they're at twenty, well, that's insider trading if there ever was. But who's ever going to be able to prove it?”

That may have been the problem that the SEC confronted in a 1984–85 investigation of Milken. That investigation—like at least two others since 1980—ended without the government's taking any action, and the SEC does not comment on investigations that are thus closed. But much can be gleaned from Milken's deposition testimony, given in January 1985, a copy of which was obtained by this reporter through a Freedom of Information Act request.

A major focus of the investigation was Milken's trading in the securities of Caesars World, the gambling casino. Milken, Kissick and John Taylor (one of the original salesmen who had joined Milken's caravan to the West) had attended a meeting at Caesars World corporate headquarters in Century City, Los Angeles, with the company's new chairman, Henry Gluck, and several other employees, on June 29, 1983. At that meeting, one of the topics discussed was the possibility of Drexel's doing an exchange offer—the popular 3(a)9—for some of Caesars' outstanding debt.

Either on that day or the next, Milken had purchased slightly more than $3 million (face amount) of Caesars World bonds which went into the firm's account. According to a trading ticket, they were moved into Milken's personal profit-sharing account at Drexel on July 1. Those bonds, within about two weeks, became the subject of an announced exchange offer on which Drexel was the adviser. Milken bought them at 81.5 and sold them at 101.67—making a profit of approximately $635,500.

From the deposition, it was not clear just when Milken had bought the bonds. The trading ticket for the purchase was stamped 11:05
A.M
., June 30—the day after the meeting. But on the ticket was also written, in one corner, “as of June 29.” Milken, who professed ignorance of the hieroglyphia of trading tickets, declaring repeatedly that he had not written a ticket in fourteen years, nonetheless went on to insist that the “as of June 29” must have meant that that was when the trade was executed, and the stamping must have been done the following day because the order had gotten temporarily lost. He also was adamant that they had been intended for his account at the time of their purchase, and that it was not an after-the-fact decision made on July 1 (as the trading ticket that showed them moving from the firm's account into his might suggest).

Milken is famous for his memory. Members of the Milken cult love to tell stories about how, in random conversation about a company on which he has not recently been focused, he will remember not only how many bond issues that company has outstanding, but the maturities and coupons of each one, and, more, the call provisions on a given issue. Joseph recounts Milken's recalling the trading pattern of a bond as much as ten years earlier—the bid, the selling price, how much was left in the portfolios of the buyers and the sellers.

At his deposition, however, Milken was positively forgetful on certain points. He could not, for example, recall the names of any limited partnerships in which he was an investor. He did not remember why the meeting with Caesars had come about; who had arranged it; when he had known about it; or much of anything specific that transpired at it. Asked repeatedly whether Caesars World doing an exchange offer had been discussed, or whether, indeed, there had not been an agreement at the meeting's end that Drexel would look into Caesars' doing an exchange offer, Milken asserted that they had “talked about fifty things at the meeting.”
And when pressed as to the agreement reached at its conclusion, Milken testified—after extensive maneuvers by his lawyer that seemed aimed at keeping him from having to answer—that he did not recall.

According to Caesars chairman Gluck, however, in an interview with this reporter, the meeting had come about because a Drexel gaming analyst whom Gluck had recently met at a business conference had been “pitching our doing an exchange offer.” Given Caesars' 3:1 debt-to-equity ratio, Gluck said, the idea of giving bondholders equity in place of some of that debt was very attractive. The meeting, Gluck added, was held to discuss the exchange offer, which was then carried out. “I thought it was not all that likely that the exchange offer would be widely accepted,” Gluck recalled. “If we had gotten a fifty percent acceptance rate, I would have thought we'd done extraordinarily well. But we got over eighty percent!”

While Milken was vacant on most of the above matters, he was crystal clear on others. He was adamant, for example, that he had purchased the bonds before the meeting. He was also vivid in his recollection of having spoken to Edwin Kantor and gotten his approval to buy these securities for his profit-sharing account. He invoked Kantor's name many times. He testified that when he decided to sell the bonds about a month later, he had again sought Kantor's approval. Asked whether in that conversation he and Kantor had had any discussion about the fact that Drexel had recently worked on the exchange offer, Milken replied, “I think as a senior member of the firm and on the firm's Executive Committee, Mr. Kantor should have more knowledge than I did related to any of the firm's activities on Caesars.”

Asked a second time whether they had discussed it, Milken said he did not recall.

It is, of course, possible that Milken has an astonishing memory for the bonds he loves and little memory capacity left over for ordinary human events, or for the trivia of life, like the names—any name—of his limited partnerships. Even so, the picture that emerges from this deposition is of someone who was full of certitude about details that would help him but aphasic on those which would not, and who was shockingly eager to pass the buck to Kantor (who had been his loyal partisan through the years).

Milken bought these bonds from Mark Shenkman, at Shenkman
Capital. Shenkman supports Milken's recollection that Milken bought the bonds from him on the morning of June 29, before the meeting at Caesars World (though Milken would have known the meeting was scheduled for later that day, and would probably have known its purpose). Shenkman added, however, that when the SEC questioned him in connection with this investigation, he was shocked to learn from the government lawyer that Milken had bought these bonds from him, an institutional client, and put them into his personal account. Recalling his days at Lehman Brothers, Shenkman said, “At most Wall Street firms—certainly at Lehman—you could never have mixed professional and personal that way, buying securities for your account that you were trading for the firm. There's too much opportunity for self-dealing.” Somewhat rueful about having made that losing trade, Shenkman calculated Milken's profit (as $635,500) and remarked, “People work a lifetime and never make that kind of money, and Mike made it in a three-minute phone conversation.”

Finally, from the line of questioning at this deposition, it appears that Columbia Savings, First Executive, and the Princeton-Newport Limited Partnership (controlled by James Regan and Edward Thorp, Milken's partners in Belvedere Securities, the Chicago brokerage firm in which he had the majority interest) may have done well, along with Milken, on the Caesars World exchange. Milken was asked whether he had had any conversation about the Caesars World bonds with Tom Spiegel, Fred Carr, James Regan or Edward Thorp between the time of his Caesars meeting and the announcement of the exchange offer about two weeks later. Milken testified that he had not. He was also asked if he was familiar with a sale of Caesars World bonds from the Drexel account of Prudential's high-yield fund (decidedly not an inner-circle member) to the Columbia Savings account, about a week before the exchange offer was announced. Both accounts were covered by James Dahl, Milken's favored, superaggressive salesman. Milken said he knew nothing about it.