by Connie Bruck
Now was the comeuppance. Howard Brenner, a member of Drexel’s Executive Committee who had been at the firm since it was Burnham and Company, admitted, “Some of our colleagues [at Drexel]—especially the younger ones—were very arrogant, and it’s come home to bite us.”
“To me, the investigation is a parable,” declared another Drexel executive. “It has brought us down for our hubris—in our not paying sufficient attention to our transactions, in our dealings with other people. Things like sending people to another city for a road show. Not giving any bonds to a co-manager. Taking a piece of business from another firm which had already filed a prospectus. Other people have occasionally done this kind of thing to us, but I have a hunch that we started it. So far, the government doesn’t seem to have evidence of anything illegal. But we are already so weakened [by the press reports of the investigation], it is as though we are paying the penalty for our other sins.”
In the months after Boesky Day, it seemed plain that even if Drexel and Milken were to survive, their idyll—in which Milken could raise billions in a matter of days for a hostile bid, in which no company in America was safe from him—would be ended. It was a time for epitaphs.
“I think the systematic realigning of corporate America, and putting parts of companies in the hands of guys who have major equity stakes in those companies, is the best thing we have done for our society,” commented corporate-finance partner Stephen Weinroth. “The cat’s out of the bag—and if the old-guard establishment puts us out of business, they’re not going to put the concept out of business, be it the LBO or the hostile takeover or valuing a company and breaking it up because the assets are worth more broken up than whole.”
Weinroth lapsed into the familiar refrain (articulated by Milken, Icahn and others of their persuasion) about the decline of corporate America in the hands of its managers, and its rescue by the new breed of manager-owners. “Old companies were started by true entrepreneurs, who had children some of whom were affected by the ills of the rich,” he continued. “They brought in professional managers, who ran the companies in a conservative fashion . . . but those professional managers didn’t have an ownership stake. Their risk-reward ratio was skewed to being a conservator, not an initiator. Then the second-generation [managers] grew to the top. And even if they were high quality as managers, they were certainly not entrepreneurial. And then that group promoted people who couldn’t threaten them, and they in turn hired people inferior to them, who lived for their perks and compensation and ran their companies conservatively because they had no upside interest. And by the time you go through several generations of these managers, you have a company run by dull-normals!
“It started to change in the fifties,” he said. “As new businesses sprang up largely out of a new spurt of technological innovation, there were some entrepreneurial guys. More recently all the LBO guys have said, ‘We want the managers to have a stake in this business, because we want them to get rich if they do well’ (typically, five to twenty percent of a deal would be owned by management).
“I think the principles are right,” Weinroth concluded, “and the fact that some of our players are venal or self-interested or unpleasant is almost beside the point. There is a greater machine going, and if these guys don’t make a go of it, then somebody else will buy the stock, and the ownership will reside very close to the helm. And Drexel had more to do with it than anyone else.”
The months after the November Boesky Day were rife with signs of Drexel’s ebbing power. The first and most symbolic was Drexel’s decision, announced in early December, to abandon its much-heralded move to the forty-seven-story tower, Seven World Trade Center, which it had agreed to lease in its entirety in June ’86. Just as the announcement of the impending move to that imposing building had been a dramatic statement that Drexel was assuming its place among the established giants of Wall Street, so its cancellation suggested that that ascension was no more.
The most mammoth publicly announced deals that Drexel had been backing when the Boesky news hit, Icahn’s bid for USX, Perelman’s for Gillette and Sigoloff’s (Wickes’s) just-announced acquisition of Lear Siegler, came to a total of roughly $14 billion. For Icahn, Perelman and Sigoloff, these deals would have represented an enormous expansion of their respective empires. In addition to collecting a king’s ransom in financing fees in these deals (in USX, for example, Drexel’s fee would have been roughly $250 million), Drexel would have reaped a golden harvest of divestiture business. But after Boesky Day, despite Drexel’s assertions that it could still place the debt for these deals, those financings were deemed sufficiently questionable that the bidders’ hands were weakened. Ultimately, all three deals foundered: Wickes abandoned its acquisition of Lear Siegler, and Perelman and Icahn were beaten back from their targets. In the next six months, the whole of the first half of 1987, Drexel did not back a single hostile bid.
Other hallmarks of the Milken regime also disappeared, casualties of this new epoch in which Milken and Drexel would be forced to live under the government’s microscope. Privately placed, unregistered bonds, for example, no longer changed hands en masse, moving from Milken’s high-rollers to the second-tier buyers in that flow that was so integral to the Milken machine. Mark Shenkman of Shenkman Capital commented about two months after Boesky Day, “Privates still trade—but now precise logs are kept, and they [Milken’s salesmen and traders] can only talk to twenty-five people about it. It can’t be a public distribution. They are reining Mike in.”
And at least some of the gold-mine investment partnerships, through which Milken had built wealth first for his own people and then for a wider group in corporate finance, were closed down. The major partnership with corporate finance, which invested in buyouts, was named Concordia. In 1985, Concordia’s return had been close to 100 percent. By the end of 1986, when it was closed out, it was flat for the year. This was strange, since 1986 had been a soaringly profitable year at Drexel. “That had to have been done on purpose,” insisted one former Drexel employee, “so that they could say, ‘See? We always knew that with the kind of risk we take we’d hit a bad year sooner or later.’ ”
Within days of the Boesky plea, rival investment bankers had begun going down the list of Drexel clients, soliciting their business. While Drexel’s traditional stable appeared still loyal, the blue-chip clients that Drexel had been struggling to win (whether by courtship or by coercion, whether by Martin Siegel or by Jim Dahl) quickly fell away. Theirs had been an uneasy alliance with Milken. In the months just prior to Boesky Day, Goodyear had brought Drexel in along with Goldman, Sachs to advise it on a defensive restructuring. Viacom had hired Drexel along with Donaldson, Lufkin and Jenrette to assist in its management buyout. Ralston Purina had added Drexel as a third co-manager, along with Goldman, Sachs and Salomon, for an investment-grade-bond issue. According to well-placed sources in each of these deals, Drexel was brought in for only one reason: so that it would not bring in a competing bidder or finance a raid on the company.
The uneasiness, moreover, had existed not only on the part of these corporate clients, but within Drexel. Such client representations were integral to Joseph’s and Siegel’s shared vision of institution-building, were in fact the mission with which Siegel had come to Drexel. But they were at odds with the gospel according to Milken—a gospel which taught that these corporate behemoths deserved to be taken over because they were being run inefficiently, so it was not only profitable to do so, but right. In the above instances, however, Milken had apparently acceded to Joseph and agreed to allow his peace to be bought.
Now Milken’s hands had been involuntarily tied. And the corporate establishment, no longer afraid, was no longer interested. Lear Siegler, for example, had followed Siegel from Kidder to Drexel. In its sale to Wickes, Drexel had been its investment banker. But about a week after Boesky Day, when that sale fell through, Lear Siegler brought in Goldman, Sachs to study the alternatives of a leveraged buyout or a corporate recapitalizati
on.
“With the Fortune 500 companies, it was all fear,” remarked one former Drexel employee. “[In the summer and fall of ’86] I would make a call to a CEO and the call would be returned in a half hour. Once Drexel started to fall, they never returned my calls.”
Now Drexel, which had used fear to wedge its way into corporate suites, was riddled with fear itself: Fear of what the government might find. Fear of losing business. Fear of seeing the value of the firm’s stock (widely held among about 2,050 employees) and its capital decimated, in the event the firm had to pay crippling damages as a result of the investigation. Fear of the damage to recruitment. And, because of all this, fear of a mass exodus of employees (draining the firm not only of talent but of capital as they demanded payout on their stock).
In the first few months, about a half-dozen associates in corporate finance and M&A did leave Drexel. This was followed by a major defection in April, when an entire group of seven professionals, including one senior-level executive—all of whom had been hired from Kidder within the past year—departed for Paine Webber.
So fearful was Fred Joseph of an exodus, according to one Drexel employee, that in December ’86 he broached the idea of soliciting signed loyalty pledges from all senior employees, promising that they would not leave the firm for at least one year. Executives reportedly tried to dissuade him, arguing that it was distasteful, a sign of weakness on the firm’s part, and in any case unenforceable. Finally, Joseph abandoned the idea.
For Joseph, who had had false starts in the business, who had dreamed back in the seventies of building an institution “as important as Goldman, Sachs,” and who had felt he was tantalizingly close to that goal, it must have been an agony to see it slip through his fingers. While Milken remained protectively cloistered as always, Joseph, the front man, had to step into the glare of the public spotlight. Looking gray and puffy-eyed, photogenic no longer, he was shown (incredibly enough) sitting on the floor in his office on the cover of a December ’86 issue of Fortune magazine, where the subtitle described him as “Floored by the crisis.” The ready and confident, albeit superficial, answers he had always produced were now replaced by ones so tentative and unsure that they invited parody among some of his partners—such as his quote in Business Week, dated December 22: “What I think I’m confident of is that we don’t know of anyone here who’s done anything wrong.”
It was Joseph’s personal crucible. He had assumed the post of CEO—from Robert Linton (who retained the title of chairman, but had clearly yielded the leadership of the firm to Joseph)—only about eighteen months before Boesky Day. Back in the early seventies, Joseph had become chief operating officer of Shearson, Hamill—which, six months later, had had to merge into Shearson Hayden Stone (through no fault of his). One Drexel executive recalled ruefully that at a meeting immediately after Joseph had assumed the top post at Drexel, John Sorte, who had been with Joseph at Shearson, quipped, “Fred, how many months do you give us before we fail, with you as chief executive?”
Joseph, more than anyone else, had been the architect of the institutional expansion of Drexel. For Milken the firm was a vehicle, but for Joseph it was an end in itself. And Joseph possessed certain traits which had, in his lexicon, added value to the firm. First, he was a supersalesman, a great complement to Milken on the corporate-finance side, especially in the early days before Milken started doing everything himself. Second, he had a front-man personality that was so good it made you forget that that was what it was: down-to-earth, good-humored, redolent with boyish charm, but all bright surface, with a veneer that never cracked. And, third, he had that overriding desire to win, which was probably the key to his and Milken’s compatibility.
His paramount contribution, however, was in a role that was much like that of a manager of a great Hollywood star. Joseph had managed Milken. “Fred grabbed onto those [Milken’s] coattails, directed them some, orchestrated them a lot to the public and to us,” commented one Drexel executive.
Now the firm’s shining star had become its greatest liability, and it was not so clear that Joseph’s dominant traits were what this crisis required. In a time of terrible uncertainty, when the firm was being publicly tarred with the suggestion that its key employees had committed crimes, its ideal leader would be decisive, strong and principled, the personification of integrity.
There were at least two views of Joseph within the firm. One was that while he came closer to monitoring Milken than anyone else, he still was kept in the dark about some things that transpired on the West Coast. Somewhat short of information, therefore, he was nonetheless seen as an honest, restraining force. Former corporate-finance partner Julian Schroeder claimed, “Mike would do anything. I would have felt naked there without Fred.”
Schroeder added that on a visit to Drexel in the spring of ’86 he had found Joseph in the midst of one of his many daily phone conversations with Milken, in which Joseph was saying, “Michael, you are the only one who can put yourself in jail—now, don’t do it.” To Schroeder, this remark indicated that things had not changed since he left the firm in 1984: Joseph was still struggling to control Milken.
Another view, however, was that Joseph and Milken, consumed by a similar, religious fire to win, were more in league than in counterpoint. And that Joseph, therefore, was more pragmatic than principled. As one Drexel employee maintained, “Fred is great in an up-market. In an up-market, the leadership, the salesmanship, the upbeatness are the important things. But all the quick moves that in good times looked like a great salesman, in bad times looked dishonest. And when things are bad, he can’t make a decision.”
Joseph, this employee said, “is the consummate rationalizer about why somebody doesn’t have to get fired.” There was a case to be made that the firm should have either fired or suspended Martin Siegel in December, after he had been subpoenaed in the grand-jury investigation and it seemed all of Wall Street was convinced that the Boesky-Siegel game was finally exposed. Siegel remained at the firm until his plea was announced in February. (Indeed, even the hiring of Siegel in early ’86 arguably attests to Joseph’s being long on pragmatism and short on principle, since Siegel was so widely rumored on the Street to be involved in insider trading with Boesky.)
A stronger case could be made for the firing of Jim Dahl, if Joseph believed that Dahl had in fact said what Staley alleged. And this was not the first complaint about Dahl. Beverly Hills Savings and Loan, in its lawsuit against Drexel and Dahl, had accused him of fraudulent misrepresentation. The same employee declared, “Dahl was a loose cannon. He has put securities in people’s accounts without calling them. We knew what he was—but Mike liked him, because he was productive. The Staley threats might not be illegal, but there should be a standard of conduct. But Fred’s attitude when it came to firing Siegel or Dahl was, If we get rid of them, they will hurt us.”
Joseph, of course, would not have been the first chief executive to keep employees on so as not to create witnesses friendly to the government, with an investigation in progress; his lawyers might well have advised him not to fire the two. But a less defensible example of Joseph’s elevation of pragmatism over principle was his decision, also urged by Milken, to bring Donald Engel back into the firm.
Engel had been a fixture at the firm since the days of Burnham and Company. As Victor Posner became a more important Drexel client in the late seventies and early eighties, Engel had handled his account on the corporate-finance side and become a director on several of the Posner-controlled companies’ boards. According to many of his colleagues, Engel knew little about corporate finance, particularly in the sophisticated way that Drexel practiced it by the eighties, but he did have a way with clients. And, since the earliest days of the Predators’ Ball, he had been extremely useful to Milken on the social side—a perpetual gladhander, a happy panderer. “Mike always respected Don’s usefulness,” declared one former member of the Milken group. “Don could make sure the clients got laid—and Mike didn’t have to dirt
y himself.”
But in 1984 Engel was forced to resign. According to one Drexel executive, Engel had taken money from a Drexel client that should have been paid to the firm. (Engel denies this charge.) Some executives wanted to sever all ties with Engel, but Milken reportedly argued in his behalf, and in the end Engel became a “consultant,” negotiating a lucrative fee arrangement for any business he originated.
Ironically enough, it was as a “consultant” that Engel saw his wealth accumulate. The clients with whom he had relationships—among them Peltz and Perelman—were Drexel kingpins by 1985. One Drexel employee said that Engel’s compensation for 1986 (probably including warrants) was about $9 million. And while Engel had had to relinquish his office at Drexel when he was forced to resign (his new business habitat was the third floor of his friend Perelman’s town house), he still presented himself as a member of the firm. To reach Engel’s office one called the Drexel switchboard.
It was, then, the cushiest of exiles. But in January ’87, when Drexel’s push for new clients had ground to a halt, and the firm seemed to be in danger of losing much if not all of the territory it had appropriated over the past decade, Engel was deemed too valuable to not be a full-fledged member of the team.
Soliciting new clients was the business of the Investment Banking Group (IBG), formed in early 1986 and headed by corporate-finance partner Chris Andersen. Even before the trauma triggered by Boesky Day, however, the IBG had been a failure (and by late 1987 the group would be disbanded). Andersen, who has a rambling, free-associating habit of mind, was considered by his colleagues to be a creative investment banker but a poor administrator and ill-suited for this management post. Moreover, Andersen’s attention to the IBG was sporadic, inasmuch as he and Stephen Weinroth in May of ’86 had bought a 13 percent stake in Centronics Data Computer Corporation, a Drexel investment-banking client. Though he and Weinroth had done this with Joseph’s permission, their move had caused bad blood among many of their colleagues, particularly when Weinroth, Centronics’ new chairman, discussed its becoming a deal-making vehicle whose deals might be in competition with some Drexel clients’.
