It was noticed at Drexel, of course, even in New York. On its face, the transaction made no sense: why would Posner pay Boesky an above-market price, when he could simply buy stock in the open market? Weinroth and others wondered uneasily whether Boesky had been promised he’d get out of the position at his cost, and if so, who had made what promises to whom. They discussed the possibilities, but let the matter drop. No one wanted to ask Milken about it.
Milken’s triumph was complete when, later that year, Fischbach announced the identity of its new chairman: Victor Posner. He promptly brought his own management style to the company, inflating his own salary, siphoning off assets, and laying off workers at the once-thriving business. Its results steadily worsened.
In the scheme of things, the Fischbach capitulation attracted little notice outside of a handful of arbitrageurs and investment bankers on Wall Street. But those who did witness the events were awestruck by Milken’s performance. Posner, on his own, had locked himself into an impossible position. But then Milken had stepped in, bursting those constraints, bringing Fischbach to its knees. This was power, and Fischbach occupied only a small corner of Milken’s imagination. At the same time he was masterminding the Fischbach triumph, he was also steering Posner through another nettlesome takeover stalemate, this one involving a bigger, tougher adversary: National Can Co.
Posner had been building up his position in National Can, a large Chicago-based packing company, for years. By 1981 his 38% stake made him the company’s largest shareholder by far, but he claimed he was buying only for investment purposes. Then, in late 1983, about the time the Fischbach maneuvering began, National Can announced a routine note offering that would raise $100 million. The offering would be underwritten by National Can’s customary investment banking firm, Salomon Brothers.
There was rage in Beverly Hills. Nothing brought out the competitive fire in Milken more than the prospect of a rival getting a piece of business that he thought was his. Drexel would do the National Can offering. If not, National Can could share the fate of other Posner victims.
Posner contacted National Can’s management and, for the first time, intervened directly in their running of the company. He said he was unhappy at the prospect of Salomon handling the bond offering. He wanted National Can’s officers to meet with Drexel. Agreeing to the demands of their largest shareholder, National Can executives met with Drexel’s Engel and others in Chicago several times that December, and Drexel proposed its own offering. But the Drexel plan called for interest costs a full percentage point higher than what Salomon was offering. There was no defensible reason for choosing Drexel over Salomon; Posner was obviously pressuring National Can into the Drexel orbit.
National Can’s executives resisted. Posner bluntly proposed that either National Can buy out his position at a huge premium—“greenmail”—or join with him in a Drexel-led leveraged buyout in which he would end up owning 80% of the company, but management would also have a 20% stake. Posner didn’t need to mention, of course, that an alternative was for him simply to take over the company and throw management out.
Never in their careers had National Can’s management, led by its revered chairman, Frank Considine, a pillar of the Chicago business establishment and a paragon of down-to-earth Midwestern values, encountered such ugly, nakedly aggressive tactics—all triggered by a routine bond offering. In conversations with Considine and National Can’s chief financial officer, Walter Stelzel, Posner constantly threatened them. Even though Posner’s 13-D filings had never mentioned that he was part of a group with common interest in National Can’s stock, he repeatedly told National Can’s officers that over 50% of the company’s stock was in “friendly” hands—in the hands of shareholders who would do as Posner told them. With the gravest trepidation, sensing no alternative, National Can committed itself to pursuing the leveraged buyout with Posner.
Drexel moved into high gear, structuring a buyout at $40 a share, or about $410 million. Posner would end up in control of the company, after earning a big profit on the shares he’d already acquired at prices far lower than $40. It would be enormously lucrative for Drexel; on top of its investment banking advisory fees, it would raise over $150 million in Milken-led junk bonds, skimming off its usual percentage, or about $5 to $6 million in financing fees alone.
And this wasn’t all. The true extent of Milken’s gains were concealed in the closely guarded partnership accounts in Beverly Hills. The Milken-led investment partnerships, originally launched to free his junk bond people from worrying about their own investments, had been thriving, moving Drexel-underwritten junk bonds in and out of their portfolios at large spreads, buying positions at favorable offering prices that quickly soared once trading in the bonds began after the offer. One of the first of the office’s partnerships was named Otter Creek. It was launched in 1979, and among its participants were Milken, his brother Lowell, and favored employees in Drexel’s Beverly Hills operation, a total of 37 people. Participation was limited to Milken’s entourage. Everyone was instructed not to mention the partnerships or their financial results to anyone in New York, for fear that such disclosures would ignite jealousies. Not even Joseph knew the scope of their activities. When Weinroth asked who was participating in the West Coast partnerships, a member of the Milken circle told him it was none of his business. Trading was monitored only in Beverly Hills, not by Drexel’s compliance department in New York.
Prior to the National Can dealings, Otter Creek had invested almost exclusively in junk bonds and related securities, such as warrants and convertible debentures, never in common stocks. But the partnership’s trading records show a huge stake of 54,200 shares in just one publicly traded company as of December 1983: National Can. These were undoubtedly some of the “friendly” shares Posner mentioned so often when threatening National Can.
National Can finally agreed to go along with the Drexel-financed leveraged buyout over the Christmas holidays. This was highly sensitive information likely to cause an immediate stock market reaction, so it was to be held in the strictest confidence by those privy to the news. Yet, on January 3, 1984, just days after the decision was made, and before any public announcement, Otter Creek bought another 10,000 shares of National Can.
On January 5, National Can’s board met and agreed to pursue the buyout plan. That very same day, exhibiting uncanny market timing, Otter Creek bought 21,300 more shares of National Can. It added 2,000 shares two days later. The decision to buy the shares was purportedly made by Otter Creek’s management committee, headed by Milken’s brother, Lowell.
Average daily trading volume in National Can was only about 4,000 shares. The sudden surge, with a corresponding increase in the share price, triggered immediate concern on the part of National Can’s management and directors that word of the proposed buyout was leaking into the marketplace. So National Can, on January 12, rushed out a public announcement that it was contemplating a Drexel-led leveraged buyout proposal. Predictably, the stock price surged on the news.
The Otter Creek trading just days before the announcement was so blatant that it triggered an insider-trading investigation by the New York Stock Exchange. Drexel dragged its heels responding to requests for information about Otter Creek, doing everything possible to throw the exchange’s investigators off the scent, calling Otter Creek’s trading an “unsolicited transaction” in a “nondiscretionary account.” After repeated questions, Drexel finally acknowledged that the investors in Otter Creek were Drexel employees, but then made what seems to be a deliberate misstatement, saying there was no other connection between Otter Creek, Drexel, and National Can, when Drexel was at that very moment financing the leveraged buyout.
The investigation made a mockery of any notion of compliance at Drexel: the exchange’s inquiries should have triggered an internal investigation as to why Drexel employees were trading in a stock of a client about to undergo a leveraged buyout. Instead, Drexel covered up. After all, the person in charge of compliance i
n Beverly Hills reported to Lowell, who was involved in the partnership trading. But Drexel’s approach succeeded: the exchange eventually abandoned the investigation, concluding in a final report that Otter Creek had “no known connections to National Can.” Incredibly, it apparently never dawned on the exchange that Otter Creek was made up of the same people who were financing the National Can buyout.
Posner, in the end, never got National Can, but he was rescued by Milken nonetheless. With Posner’s financial empire teetering by mid-1984, suffering from the overleverage and bad management that had concerned Joseph and Weinroth even before Fischbach, the banks slated to be involved in the National Can deal pulled out. Considine frantically tried to put together his own financing for a leveraged buyout, but it was really no contest. Milken simply shopped National Can to his other loyal clients, offering them the chance to seize the company in Posner’s stead, sure that they would top any bid Considine could muster.
Carl Icahn eyed National Can seriously, even taking a large position, but eventually demurred. Ultimately another Milken protégé, Nelson Peltz, bought the company. Drexel, raising a total of $595 million for Peltz, made even more in financing and investment banking fees than it would have had Posner carried through with the original plan. Who bought the National Can bonds used to finance the takeover from Milken? A familiar list, including Fred Carr’s First Executive Corporation; Thomas Spiegel’s Columbia Savings and Loan; and Meshulam Riklis, Carl Lindner, and Ronald Perelman.
As for Otter Creek, it quietly sold its National Can position into Peltz’s tender offer for $3.8 million, for an enormous trading profit. The partnership earned nearly a half million dollars on the January 1984 trading alone. Thus, in a pattern that would be repeated, what appears to be insider trading became inextricably intertwined with coercing a public company into a Drexel-financed change in ownership.
Back in New York, Fred Joseph, still head of corporate finance, knew nothing about Otter Creek or its trading in National Can. Milken still reported to Kantor, and Kantor to Linton, Drexel’s chairman. But Engel did work for Joseph, who couldn’t deny that Engel’s relationship with Posner was proving to be lucrative for Drexel. Even better, Engel had become fast friends with another member of the Milken entourage, Ronald Perelman, the head of a holding company called MacAndrews & Forbes that was becoming ideally positioned as a vehicle for Drexel-backed maneuvers. But Drexel’s compliance officers had brought Joseph some trading records that resurrected all of his apprehensions about Engel’s ethics and judgment. The trading of a Drexel salesman who, Joseph knew, was a close friend of Engel’s, smacked of insider trading on a deal Engel was involved in. Joseph wouldn’t tolerate this.
Joseph ordered Engel into his office, along with the salesman. He was angry. The records showed the salesman had been buying the stock when the transaction looked like it was going through, and then sold just before an announcement that the deal had fallen apart. Engel, Joseph knew, had been privy to these developments. “Explain this exceptional timing,” Joseph ordered. Engel remained calm, denying there was anything improper. “It was just a coincidence,” Engel insisted. The salesman backed him up. Joseph felt they were lying. “Pray to God there’s not another ‘coincidence’ like this,” Joseph said sternly, his disbelief obvious. “If there is, I’ll fire you both. You’ll be dead meat.”
Within weeks, Weinroth told Joseph that he’d learned from a client that Engel had “borrowed” $65,000 from a Drexel client, had executed a promissory note, and hadn’t reported the transaction to anyone at the firm. Joseph was disgusted. There wasn’t any formal rule, but it should have been obvious that one of the firm’s investment bankers should not be financially beholden to a client; it could affect the investment banker’s judgment and objectivity. Joseph called Engel in and fired him on the spot.
Engel went straight to Milken. He protested that the client actually owed him $100,000, that the $65,000 only partly made up that debt, and that Weinroth had gone to Joseph in an effort to get rid of him. Milken called Joseph and demanded that Engel be reinstated. Engel was “useful,” Milken argued. Milken, Joseph knew, put a huge premium on selling, and Engel could “sell” clients in ways that, however distasteful to Joseph, seemed to work. It crossed Joseph’s mind that Milken put little premium on ethics or integrity. But how many traders did?
With Milken up in arms, Joseph felt he had to compromise. He wouldn’t relent on the firing, but Milken proposed that Engel become a “consultant” to Drexel, a “finder,” as he put it. Engel would be compensated, as he had been, based on a percentage of the fees generated by clients he brought into the firm, ranging from 4% to 20%. Joseph insisted that Engel couldn’t hold himself out as a representative of Drexel, but otherwise gave in.
It was a crucial compromise on a matter of integrity. The fig leaf of Engel’s “consultancy” fooled no one inside or outside of Drexel. Milken had triumphed over Joseph, saving one of his loyalists. Engel moved his office to the third floor of the Manhattan town house used by Perelman as his headquarters. To reach Engel by phone, callers dialed the Drexel switchboard. With his new consulting arrangement, Engel earned more money from Drexel than he ever had as one of its employees. And he became even more intensely loyal to Milken.
Late in 1983, David Kay, head of M&A at Drexel, had sauntered into Joseph’s office, in high spirits, dressed as usual in a European-cut suit, looking tanned from a recent trip to Beverly Hills. “We’re doing great,” Kay said, ticking off the fees generated from his department. But Joseph wasn’t so impressed.
“Let’s look at those numbers,” he said. Drexel’s revenues, swollen by the success of Milken’s bond operations, had grown rapidly to nearly $1 billion, a tenfold increase since Joseph had come to the firm. “You only did ten percent of our revenue, or about one hundred million dollars,” Joseph told Kay. “At most firms, M&A is accounting for 30% to 40%.”
“You’re an asshole,” Kay replied.
Joseph wasn’t being entirely fair to Kay. Because of the exponential growth in Milken-generated revenues, no other department at Drexel was contributing the share of revenue that similar departments did at other Wall Street firms. Joseph wanted to diversify; he knew that overdependence on one person, one line of business could be dangerous in the boom-and-bust cycles of Wall Street. But what could he do? Every time corporate finance, M&A, or any other department managed to show some gains, Milken far outstripped them.
After his conversation with Kay, Joseph thought a lot about the role of M&A at the firm. The big firms, those like Morgan Stanley and Goldman, Sachs that Joseph had promised he would equal or surpass in fifteen years, were becoming ever more prominent in the M&A area. But Drexel had something they didn’t: Michael Milken. He could be the “edge” that Joseph was always seeking. The Posner experiences had shown how closely aligned the Milken money machine and an M&A practice could be.
Over the years, Joseph had turned to a management guru named Cavas Gobhai, a Bombay-born consultant who ran two-day, intensive sessions with businessmen intent on brainstorming and “expressing themselves.” In November 1983, Joseph convened another encounter session with Gobhai, a session aimed at finding ways to vault Drexel into the forefront of the burgeoning M&A field. In a significant acknowledgment of where Drexel’s power now resided, the meeting was held at the elegant Beverly Wilshire Hotel, just down the block from Milken’s headquarters.
A group of 11 Drexel bankers was invited. Milken had four slots; he brought Trepp, Ackerman, and Bob Davidow. From New York, Joseph brought Kay, Leon Black, John Kissick, Herbert Bachelor, and Fred McCarthy. The group quickly concluded that Drexel needed an M&A “star” to attract major clients. They listed Bruce Wasserstein at First Boston, Eric Gleacher at Lehman Brothers, and, fresh from his success in Martin Marietta, Martin Siegel, who they ranked first on their list. It was an interesting exercise, but in truth, no one in the room thought any of the candidates would give any serious consideration to an offer from Drexel.
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sp; But the group had more intriguing ideas. The big companies were fueling the M&A boom only because they were the ones with big money and borrowing power. Drexel had demonstrated that you didn’t need the money if Drexel could come up with it for you. A Posner armed with a $1 billion war chest was just as formidable as a blue-chip company with $1 billion in cash and borrowing power. Shareholders, especially the arbitrageurs who poured into stock of companies involved in takeover bids, could care less where the money came from—as long as they got paid.
The group took this thinking one step further. What if Drexel hadn’t actually raised the money, but promised that it would? The firm could issue a “highly confident” letter, a formal pledge from Drexel that it was “highly confident” it would raise the money promised in a takeover bid. As long as Drexel always followed through on the promise, the letter would be as good as cash.
Obviously, large companies with access to bank loans and the credit markets wouldn’t switch to a substitute so ephemeral as a Drexel letter. But what about people who didn’t have any options? There was one area in particular that, Drexel knew from experience. was very difficult to finance: the hostile tender offer. Banks shunned them, as did investment banks like Goldman, Sachs. The group talked about the negative publicity associated with them, and the risks to Drexel if the firm became even more closely identified with the likes of Posner. Milken had no reservations, and even the more cautious Joseph thought the firm could take the heat. If Drexel were to thrive, it really had no choice. And its reputation was hardly so sterling that a hostile raid or two would do much to tarnish it.
Joseph and his colleagues returned to New York, spreading the word around the firm to be alert to the possibility of hostile deals. But the big push, he decided, would come at the upcoming high-yield bond conference. There, Joseph and Milken would unveil their new strategy for transforming the world of hostile takeovers.
Den of Thieves Page 14