by Connie Bruck
5
The Cloister at Wilshire and Rodeo
IN 1983 THE WORLD of junk exploded in size. By the end of 1983, 40 percent of all original-issue debt outstanding had been issued within the year—$7,310.2 billion. Twenty-three offerings of $100 million or larger were issued, compared to only eight in 1982. Drexel did $4,690 billion of junk offerings—three times the amount it had done the previous year.
In one ten-day period in February 1983, Drexel underwrote seven new issues totaling $500 million. In April, Drexel did the largest junk-bond offering ever, raising $400 million for MGM/UA Entertainment Company. And then, in July, $1 billion for MCI Communications.
Drexel’s leap to these megadeals was not as smooth and effortless as it may have appeared to outsiders. One former Drexel employee recalls that Milken and his team were extremely nervous about the MGM/UA deal, since it was about four times bigger than anything they had ever done. “One of Mike’s guys called me, wanting me to take ten million,” said this former Drexel retail salesman. “Now, whenever they had a good deal they didn’t want to give it to me, because Mike hates retail, he has no use for it, he doesn’t want to have to take calls from somebody asking for a million dollars of bonds when he wants to be dealing with a hundred million. And here they were asking me to take it. They said, you know, be a team player. So I did.
“Then it got oversubscribed. I got a call: ‘We want it back.’ I’d already placed it with my clients. I said, ‘Forget it.’ Then Mike’s hit man [another of Mike’s salesmen] called me. ‘You rotten . . .’ —every obscenity in the book. Finally we compromised—I would cut back five million, they would cut back five million. Even after that [he] started to call again, shouting that they had to have the rest.
“Mike plays very tough,” he said. “He doesn’t get in there and do it himself—I’ve never heard him raise his voice. But he has people who do.”
The MCI deal started out at $500 million. Milken’s sales force, however, kept coming back to him with reports of bigger and bigger demand; Milken moved to $600 million, then $800 million, then finally $1 billion. After all, the MGM/UA deal had been oversubscribed. But then, as the deal grew, the Street cooled; some buyers began to say that $1 billion was too much debt for the company, and that there would be too much dilution of the equity (warrants were being issued with the bonds).
At most investment-banking firms, if they had filed to do a junk underwriting for $100 million but found they could sell only $50 million, they typically would cut the deal back to whatever they could sell. But Milken had for years now made it a point of honor that he would not cut back a deal. As he would testify with apparent pride in a deposition in mid-1986, “I would say also that in my entire career on Wall Street I have never backed out of a transaction once I’ve agreed to stand up to it, no matter how onerous it turned out to be.”
This policy presumably sprang not only from Milken’s sense of probity, but from his knowing it was good for business. It was meant to—and generally did—incur a sense of deep indebtedness in the client. Marshall Cogen of General Felt Industries, for example, recalls that in the hard times of 1980 Drexel filed to raise $60 million for General Felt but found they could sell less than half of that; the firm took the rest. As Cogen said in an interview in 1986, “I have never seen that done by another investment banking firm—never. Today everyone wants to bank us—Goldman, Lazard. But no one else would have raised that money back in 1980. And without it I never could have developed the base I have.”
In the $1 billion MCI offering, according to this former employee, Milken was able to place only about $750 million. The firm took the other $250 million. But not for long.
A couple of months after the MCI offering, HITS was born. HITS is Drexel’s own high-yield mutual fund, sold by Drexel’s retail staff to the public. And in its portfolio was a healthy slug of MCI paper.
HITS was not a dumping ground for bad paper, but an outlet for deals where Drexel had trouble selling the paper and so had to buy a lot of it. HITS became one more cog in the increasingly well-integrated, high-powered Milken machine.
As the number and the size of deals increased in 1983, so did Drexel grow and prosper. The firm employed about fifty-five hundred people that year, up from three thousand in 1979. Milken’s group had grown from the twenty or so with whom he had arrived in Century City to 130. In 1978 Drexel had placed eleventh among corporate-bond underwriters; now it was sixth. And the firm that had earned $6 million in profits in 1979 earned an estimated $150 million in 1983.
In 1983 Milken and his brother Lowell, in partnership with several other investors, bought a four-story building at what is probably the most exclusive commercial address in Beverly Hills, at the intersection of Wilshire Boulevard and Rodeo Drive. They then leased the building to Drexel, and it became the new Milken headquarters.
It was also a statement, a graphic précis of things to come. Milken had chosen to live in relatively unpretentious Encino, but that was for his tiny sliver of private, family life. For his business, which consumed virtually all his waking hours, he was now setting a very different stage. Milken’s new office was smack in the middle of one of the most ostentatious displays of wealth that exist in this country, in a town that spawns every excess that money can buy. Milken chose this as his made-for-the-movies mecca. Over the next several years the stretch limousines would begin lining up at 4:30 A.M. on the cobblestone driveway just behind Wilshire, their passengers—not only raiders but corporate chieftains as well—come for an audience with the King.
By 1983, too, Milken’s investment partnerships—the repositories of much of his and his people’s wealth—were multiplying. Other privately held firms on the Street had investment partnerships that were firmwide, as well as some in which certain partners participated and others did not. But only at Drexel was there a system so Byzantine, and so custom-made for patronage, manipulation and control by a single individual.
One of Milken’s earliest investment partnerships, formed for him and his group even before he moved out to California, was Otter Creek. Then, according to the registration statements in Los Angeles County (where some but by no means all were filed), Milken and his brother, Lowell, started one partnership, GLJ, in August 1978, immediately after he had moved to L.A. According to Milken’s testimony in an SEC deposition in 1982, both Otter Creek and GLJ had accounts not only with Drexel but with Bear, Stearns. A National Association of Securities Dealers (NASD) rule stipulates that any employee of a broker-dealer who has a brokerage account at another firm must disclose its existence, and make its records available, to officers of his firm. There was no indication that Milken had not done this. In later years, Drexel would institute a policy forbidding employees from maintaining such outside accounts.
According to the L.A. County records, in 1982 Michael and Lowell Milken started three more, WB Associates, WRC Associates and Lobon Associates, and Lowell started a fourth, Carlyle Associates. The Milkens were the first-named partners, followed by various combinations of people in Michael Milken’s group. By the end of 1983, there were two general partnerships, for Michael and his wife, Lori (RA Partnership), and Lowell and his wife, Sandra (EJ Associates), started on the same day; and then there were Chanticleer Investors Ltd., Dunmore Partners Ltd., Moredon Partners Ltd., and Canterbury Group, again with various combinations of the members of Milken’s group, and also two lawyers working for Lowell in Cambrent. One of them was Richard Sandler, Lowell’s boyhood friend, with whom he had gone through college and law school. Sandler was often the filing individual for these partnerships, some of which he participated in, and he was also trustee for Milken’s children in some trusts. Given Sandler’s relationship with Lowell, he was closer to being family than any other lawyer the Milkens might have found.
Probably one of the more lucrative of these investment partnerships was one formed to create a Chicago brokerage firm named Belvedere Securities, in early 1981. Belvedere was somewhat unusual among Milken’s investme
nt partnerships in that it had people participating in it who were not members of Drexel. At the outset, Belvedere Securities had among its general partners two money managers whom Milken had done business with since the early seventies, James Regan and Edward Thorp. Regan and Thorp controlled a number of entities, including an arbitrage fund, Princeton-Newport Partners, and Oakley-Sutton Management. Three other general partners of Belvedere had all been previously associated with a Regan-Thorp group. The sixth general partner, which contributed 75–100 percent of the firm’s capital, was Milow Corporation (seemingly standing for Michael-Lowell). Lowell Milken was president, director and shareholder of Milow, and Richard Sandler was vice-president, director and shareholder. Within the next couple of years, Milow was deleted from membership and the capital contribution of Michael Milken (who was a limited partner from the beginning) rose to the category of from 50 percent to less than 75 percent.
Among its other limited partners, some of whom were added on through the early eighties, were Lowell Milken, GLJ, two corporate profit-sharing trusts at Irell and Manella (Lowell’s old firm), Saul Steinberg’s Reliance Group Holdings, and a large number of the more senior members of the Milken group.
Belvedere’s main purpose was to engage in the stripping of Treasuries, trading the corpus, or body of the bond, and its coupons separately. These transactions enjoyed an extraordinary tax benefit, in large measure because the stripped Treasuries were newly created instruments for which the law was unclear. It therefore gave Milken a chance to operate in a gray area, his favorite terrain. Milken (through the Milow Corporation) and the Regan group had first started doing this in the late seventies at Belvedere’s predecessor organization, Dorchester Government Securities. The Dorchester entity was located at the same address in Chicago as Belvedere later would be—One First National Plaza, Suite 2785—and all the general partners of Belvedere were also general partners of Dorchester Government Securities.
By the early eighties, zero-coupon Treasury bonds (which were the corpus) and the coupons or strips (known popularly as Tigers, Cats, Cougars and other names) were a multibillion-dollar business on Wall Street. In 1982, with the Tax Equity and Fiscal Responsibility Act (TEFRA), the tax laws changed. Until then, one did not have to allocate one’s basis (assign costs) to the various pieces of paper, so it was possible to create an artificial tax loss. TEFRA closed that loophole. But until its passage, the tax benefits of these instruments, as used by Milken, made them perhaps the most powerful of all the financial tools he had at his disposal. According to two former members of Milken’s group who were limited partners of Belvedere, they believed the Treasury-stripping idea had been brought to Milken by James Regan in the late seventies—which would explain the presence of the Regan-Thorp group in these partnerships.
It was noteworthy, too, that Milken carried out this gold-mine business through a separate brokerage firm created for this purpose, its majority interest owned by him, participated in by his favored—but not by Drexel. That is not to suggest, however, that the business activities of Drexel and Belvedere were not interrelated. In the course of taking a deposition from Milken in 1982, as part of a wide-ranging SEC investigation which focused on trading in the securities of companies including Reliance, Golden Nugget, American Financial, Rapid-American, CNA and First Executive, the SEC lawyer stated (in an exchange with Milken’s counsel) that Belvedere had been selling the securities of Reliance and Leasco (another Steinberg-controlled company). The SEC lawyer also stated, “It is our understanding that there are orders placed with this firm by individuals who are members of the high-yield department for clients of the Drexel Burnham firm. Are you at all familiar with that?”
“No,” Milken replied.
Asked whether Edwin Kantor, the head of all fixed-income trading at Drexel and the person who theoretically had to approve all of Milken’s transactions, knew of the existence of Belvedere and the fact that members of Milken’s group were its limited partners, Milken replied that he did. Asked furthermore whether Kantor was aware that this brokerage firm sold securities that the Drexel Burnham firm also sold, Milken replied, “It’s quite possible. I’m not aware that Mr. Kantor gets a copy of all trades this firm does.”
Milken gave some indication of the level of wealth in these partnerships when he talked to Robert Wallace, a Drexel employee in its Palo Alto office, about joining his cadre, in mid-1983. Wallace, who would later leave Drexel to form his own San Jose, California, investment company called Gateway Advisers, liked and admired Milken but decided not to join him because, he says, he didn’t want to “jam bonds down clients’ throats.”
He was, however, tempted. “Mike told me,” Wallace recalled, “ ‘No one who has been with me for five years is worth less than twenty million.’ ”
Wallace says that Milken was referring to his core group of a dozen or so—including Gary Winnick, Peter Ackerman, Dort Cameron, Charles Causey (Causey retired in 1981) and others. These were the “loyal bodies” Milken had gathered in the mid- and late seventies, most of whom had been either adrift or relatively low-achieving when he found them. He had collected a heavy toll from them. Julian Schroeder, a former Drexel investment banker, said, “Mike sits in the middle of that X of the other desks so that he can see everyone, and then he screams and yells. He cracks the whip. It’s a slave ship out there—high-priced slavery.”
There were other compensations, in addition to the material. Many of Milken’s people felt that he extracted their very best from them—because he would tolerate nothing less. “Mike challenged you constantly in terms of your level of knowledge, and he helped you operate at the best level you possibly could,” said one former member of the group. “If it weren’t for Mike, I’d be a good high-grade-bond salesman, making a hundred thousand a year.”
Many, too, were mesmerized by Milken’s brilliance and awed by his sense of mission. The group was not unlike a cult: intensely secretive, insular, led by a charismatic and messianic leader whom many of his followers came to see as larger than life. “We owe it all to one man,” declared one member of the group, “and we are all extraneous. Michael has denuded us of ego.” One of the original cadre, Dort Cameron, added, “Michael is the most important individual who has lived in this century.” Another former member will take it a step further: “Someone like Mike comes along once every five hundred years.”
While his followers deified him, Milken resisted all outward signs of his station. He displayed an utter indifference to title, with a kind of reverse snobbism (what Drexel-given title could possibly matter, when in reality he was the King?). When questioned about his title in an SEC deposition in 1980, Milken replied, “I’m some kind of a vice-president. I’m not sure exactly whether I’m senior or executive or first. It keeps changing.”
In what long seemed almost a fetish, he refused, year after year, to have his name or picture in Drexel’s annual report. Even Drexel’s fiftieth-anniversary retrospective, in 1984, made no mention of Milken. Milken finally explained, in an interview with this reporter in late 1987, “I feel it is not fair for my picture to be there and not everyone else’s. It detracts from the community feeling. Everything we do is reflected in that. I sit with all my people as an equal. Our Christmas card lists everyone, whether it’s the person who’s parking the cars or the head trader.
“People are much more productive,” Milken continued, “when they feel they’re part of a team. It should be a collective force. No one should stand on top of someone else. I have always felt it is a human weakness to feel you’re better than someone else.
“Watch the movie Gandhi,” he added. “It is harder to motivate people if you are in a limousine and others are walking barefoot.”
Milken’s preoccupation with collectivism and antihierarchical form—more suggestive of a leftist leader of the sixties than of a financier of the eighties—was further reflected in that 1980 SEC deposition. Asked how many subordinates he had in the high-yield- and convertible-bond department, Milken obj
ected, “I don’t necessarily view them as subordinates.”
“Well, how many people are subordinate to you in the hierarchical structure of the firm?” asked the government lawyer.
“We don’t really have a pecking order.”
“How many people are assigned to the high-yield- and convertible-bond department in addition to yourself?”
“I would estimate—I don’t know exactly, but I would say between thirty-five and forty-five.”
“Now, do each of these people report to you?”
“Since I’m the manager, you could say that [but] I may not speak to them for eight months.”
“But you don’t report to them?”
“No.”
“You’re not subordinate to any of these thirty-five or forty-five people in your department?”
“By subordinate, you mean accountable?”
“Yes.”
“I’m not—I’m accountable in I’m trying to do a good job. Again, we don’t have people that check in with one another.”
“Well, do these people report to you? Are you denominated the boss?”
“Yes.”
As though to underline this desire for structural egalitarianism, Milken had no office. On the infrequent occasions when he was away from his desk in the center of the trading floor, he urged others to use it. Meetings were generally open to all who were interested. People were encouraged to perform numerous functions. In a later SEC deposition, given in 1982, Milken described some people in his group as “quasi-trader salesmen,” explaining that “on a given day he could be primarily selling, and another day he could be trading. Another day he could be doing something else.”
