As 1985 began, Siegel was preoccupied with the twins, a boy and girl, who were born in March and quickly filled the extra rooms at the Gracie Square cooperative. His own M&A practice was thriving as the pace of deals, defying all predictions, continued to quicken. He hoped that Wigton and Tabor would be able to build on the previous year’s arbitrage successes on their own, with minimal guidance from him, but his hopes were soon dashed.
Wigton and Tabor, on their own, were only allowed to invest up to $1 million. If a takeover deal had already been announced, lowering the risk (and the profit potential) they could go up to $5 million. Even so, they were losing money. They had to have an “edge,” they kept telling Siegel. He was all too aware that they expected the edge to come from him.
By the spring, Siegel was starting to feel desperate. DeNunzio was continuing to wring his hands about the firm’s financial performance. Siegel felt the pressure to produce information for Wigton and Tabor, but he held back. He couldn’t bring himself to beg Freeman for more.
Siegel and Freeman remained in almost daily contact by phone, part of the whirlwind of information-sharing that linked Wall Street professionals like Boesky, Mulheren, Sandy Lewis (the arbitrageur who had introduced Mulheren to Boesky), and others. Toward the end of March, Freeman mentioned an investment firm named Coniston Partners, formed by a former White, Weld investment banker named Keith Gollust, and two others.
Freeman knew Gollust through one of his best friends, James Regan, who headed a maze of investment partnerships, including Princeton-Newport Partners based in Princeton, N.J. There have always been large numbers of private investment partnerships on Wall Street, but rarely have they thrived as they did in the 1980s. Virtually anyone could start such a partnership, raising capital from wealthy investors much as Boesky had done, and invest it, extracting a management fee and a percentage of any profits.
Siegel had never heard of Coniston, which had begun by investing in undervalued, closed-end mutual funds. Coniston had begun to pressure management of the funds, which had led to proxy fights and takeover threats on a broader and far more lucrative scale. At the time Freeman mentioned Coniston to Siegel, it was all but unknown and had little credibility as a would-be corporate raider. Freeman, however, vouched for them and said they were a force worth watching.
Even now, Freeman told Siegel, Coniston was building up a large position in Storer Communications, a cable television and broadcast concern, with an eye toward a possible bid for the company. Freeman was amassing his own stake in Storer, both in Goldman’s account and in his personal accounts, amounting to about 3% of the company’s stock. “They’re serious,” Freeman said of Coniston’s intentions to force some kind of major transaction.
Siegel considered it a typical conversation. He had an image of Freeman sitting alongside a rushing stream of information, plucking what he wanted like a bear fishing salmon. Still, Siegel wondered: How was Freeman privy to sensitive information about Coniston’s plans for Storer? Finally Siegel asked him. “I’m very close to the people buying the stock for Coniston,” Freeman replied. Freeman didn’t mention the names of Princeton-Newport or of his friend and former Dartmouth classmate James Regan. Regan was doing the buying for Coniston, and he was “piggybacking” on Coniston, buying for a Princeton-Newport account. All stood to reap huge profits should Storer be sold.
It didn’t even occur to Siegel to suggest to Wigton and Tabor that they, too, buy a stake in Storer, though that may have been Freeman’s hope. It’s possible he wanted to create buying pressure to soften up Storer for some kind of buyout proposal. Instead, Siegel immediately saw the possibility of a bigger role for Kidder, Peabody. Siegel had talked often with Henry Kravis at Kohlberg Kravis Roberts since representing KKR in its unsuccessful bid for Gulf. He knew Kravis was looking for a buyout. The more he heard about Storer, and the more he reviewed Kidder, Peabody’s own research on the company, the more vulnerable he thought it looked to a well-financed buyout bid.
So Siegel called Kravis, who said, “Great, can we get a meeting?” Siegel promptly called Dillon, Read, Storer’s traditional investment bankers, and they got together for preliminary discussions of what a transaction with KKR might look like. When Siegel talked to Freeman again, he was surprised to learn that he already seemed to know everything that had happened at the meeting.
On April 15, Siegel called Freeman, mentioning that he thought he’d show KKR some data on Storer, curious to see if Freeman had any objections. He didn’t mind at all.
Armed with that supposedly secret information, Freeman embarked on a Storer buying spree, adding over 74,000 shares to Goldman’s already huge stake on April 17. Freeman’s assistant in the department, Frank Brosens, also snapped up 2,000 shares for himself (an investment of close to three-quarters of a million dollars).
Siegel told Freeman he was now representing KKR, and the two discussed strategy. Storer wasn’t yet signaling it would welcome a friendly bid, and KKR hadn’t yet embarked on any unfriendly raids. Both Siegel and Freeman were hoping KKR would, and they strategized about what might be done to force a bid. They talked about the possibility of a “bear hug” letter, in which KKR would propose a friendly buyout but simultaneously convey the threat of a hostile bid if the friendly deal were spurned. It was the usual dialogue between investment banker and arbitrageur, one that yielded clues to what was likely to happen without involving the disclosure of any secret plans.
As Siegel had assured Freeman it would, KKR made its bid on April 19. The next day, somewhat to Siegel’s disappointment, Storer rejected the approach, issuing a letter to shareholders urging them to turn down any offer from KKR. Freeman called Siegel soon thereafter. “Don’t worry,” he reassured Siegel. “We’ll squeeze the board, Coniston, [Gordon] Crawford, and me. You come back with another approach.” (Freeman and his allies, however, never filed any SEC disclosures that they were acting as a group.)
Then, the following weekend, Freeman called Siegel at home in Connecticut. Freeman sounded beside himself. He couldn’t stand the suspense, he said. He had to know: Was KKR going to make the bear hug? The day before, Kravis had agreed to Siegel’s suggestion that he make what Siegel termed a “teddy bear pat,” a very mild form of the bear hug in which the threat was deliberately left vague. Siegel knew that if he answered Freeman’s question and Freeman traded, they would again cross the line of legality he had vowed to respect. But he also felt that letting Freeman know was in the interest of his client. Freeman was one of Storer’s largest shareholders, and he could help pressure Storer into reacting favorably to a KKR approach. Siegel answered: Yes, KKR would send the letter.
Siegel went back to Kravis, and they added some warrants to buy stock at a later date as a sweetener for the deal. Siegel went back to Freeman, who wasn’t happy. He wanted a higher bid. “This is the bottom line,” Siegel said. “We’re not going up on this.” KKR made its revised offer on April 22.
Then Storer threatened to throw a wrench in all of their plans. It again rejected the KKR bid, offering shareholders a recapitalization plan instead, but one that was hard to value. With Freeman and Regan continuing to buy Storer stock and options, Coniston announced it would launch a proxy fight to thwart Storer’s recapitalization plan and force Storer into the hands of the highest bidder.
Freeman and Siegel continued to stay in close touch on the Storer affair, even as it moved into the stalemate of a drawn-out proxy fight. Then, about July 4, rumors swirled that yet another bidder was about to surface for Storer. Freeman warned Siegel, who immediately passed on the valuable information to Kravis, who was attending the British Open tennis matches at Wimbledon. A week later, a company called Comcast launched its own bid, and Freeman called Siegel. “Will KKR compete with Comcast?” Freeman wanted to know. Siegel assured him it would. He believed Kravis wouldn’t mind his leaking the information. He’d told Kravis in general about his conversations with Freeman, and though Kravis never endorsed leaking inside information, he had agreed that it wa
s in his interest to keep the pressure on Storer. Freeman was now so privy to secret information that he might as well have been a member of the KKR team.
Finally, late in July, as the bidding reached levels no one had expected, Freeman called again. “I’ve got a large personal position” in Storer, he said (though by now that was obvious to Siegel). “I’ve just sold the August 90 calls at two dollars.” (Selling the calls is a bet that the final price won’t go above a certain level—in this case, the strike price of the call, $90, plus the option price, $2.) “Did I do the right thing?” Freeman asked.
Siegel knew the final, secret price KKR was bidding. Somehow, Freeman had hit it exactly: it was $92. “It sounds good to me,” Siegel said, and Freeman gave a satisfied chuckle. Siegel had no way of knowing just how many millions of dollars Goldman, Freeman, and his network of friends and contacts like Regan, Gollust, and Coniston Partners had just earned; but he knew that the profits were vast, since the network wielded a combined capital that went way beyond anything that even Boesky could muster.
KKR was delighted with Siegel’s performance. It bought Storer for cash and stock valued at $92 per share and, despite the rich price, Storer became one of the firm’s most successful buyouts.
After this battle, Siegel once again felt that Freeman owed him something in return. Without his making a conscious decision, Siegel’s resolve to stop the information exchange with Freeman had eroded. Their arrangement had simply picked up where it left off. Freeman soon had ample opportunity to pay Siegel back.
Freeman had gained considerable stature within Goldman, and was now being included in top-level strategy sessions for some of the firm’s most important clients, such as Unocal, the target of the latest oil company raid by Boone Pickens. In what soon became one of the most bitter, hotly contested takeover battles ever, Goldman defended Unocal. Peter Sachs, Goldman’s head of M&A, often spent two to three hours a day consulting with Freeman about the situation. Freeman had valuable insights into how various defense alternatives would be interpreted by his colleagues in the arbitrage community. While such communications tended to undermine any notion of a Chinese wall, Sachs had no way of knowing that Freeman might betray Unocal’s confidence.
Shortly after Siegel first leaked details of KKR’s bid for Storer, Siegel mentioned that he’d taken a position in Unocal. Freeman assured him there’d be an “economic solution”—meaning value would be realized for shareholders—so Siegel had Wigton and Tabor increase the size of their position. When Freeman leaked the details of Unocal’s plan to create a separate master limited partnership of some of its oil-producing properties, Siegel urged them to buy more.
Many of Freeman’s tips to Siegel in Unocal showed how important seemingly arcane details of financial transactions can be in the hands of sophisticated investors. As part of its defense, Unocal offered to buy back 50% of its stock at $72—but none of Pickens’s stake—leaving the stock it didn’t buy to fall to whatever price the market would support. Word of the plan sent panic through the market, because Pickens was likely to sue. Siegel was en route from Dallas to Tulsa at the time, and when he got into the airport, he called Wigton and Tabor, who were frantic, given the huge size of Kidder, Peabody’s position in Unocal. So phone records wouldn’t show a direct call to Freeman’s office, Siegel called his secretary, who connected him to Freeman’s office. “Don’t worry,” Freeman said. “It doesn’t matter. We [Unocal] are going to buy the stock anyway in the partial tender.” That meant that even if a court said Pickens had to be included in the share buyback, Unocal would go forward (as eventually happened).
Siegel immediately hung up and called Wigton and Tabor. Knowing now that the tender offer would proceed, he suggested a strategy to sell calls to lock in their profit on the half of the position that wouldn’t be subject to the offer. (Wigton and Tabor actually bought puts, the right to sell Unocal at a fixed price, which implemented the same strategy.)
When he hung up, Siegel felt elated. He knew the Unocal battle was nearing a climax, and now he had guaranteed a huge profit for Kidder, Peabody using Freeman’s information. He’d more than recouped all of Wigton’s and Tabor’s losses, and the department would be well on its way to another big year, maybe even better than the one before. The pressure on him from DeNunzio would ease off. Siegel felt the same surge of adrenaline he’d sometimes felt in his dealings with Boesky.
Siegel was stuck in the Tulsa airport until he could get a flight back to New York, and he was bursting to share the good news. So he got back into a phone booth. Recklessly, he called DeNunzio at home. He told him about everything, including the call to Freeman, and how they’d come up with the strategy to lock in their profits. DeNunzio seemed thrilled. Siegel felt the warm comfort of a father figure’s approval.
Unocal’s Goldman-crafted buyback gambit worked. After the partial tender offer, the so-called pro ration factor—the percentage of the shares tendered by each shareholder that would actually be purchased—had to be calculated based on the total number of shares actually tendered. Freeman obligingly shared the supposedly confidential percentage so Siegel could precisely tailor Kidder, Peabody’s final options trading. It was like shooting fish in a barrel. “You guys are all going to be happy,” Freeman told Siegel, and he was right.
The Siegel-Freeman relationship continued through the year. They talked constantly, often two or three times a day, and inside information didn’t even figure in most of their conversations. Their dialogues were an increasingly seamless tapestry of mutually beneficial information useful in recruiting clients, in triggering deals with reluctant parties, in getting higher sale prices and accompanying investment banking fees, and in generating profits for their firms. It was all, of course, a secret from the rest of the world.
The exchange of inside information also continued unabated. Gray as the lines sometimes were, Siegel was almost never in any doubt about when the line was crossed. He always felt at least a twinge of guilt and anxiety. Siegel gave Freeman details of International Controls Corporation’s bid for Kidder, Peabody client Trans-way International; Freeman told Siegel he had taken a big Transway position for his children. While Goldman was involved in the Philip Morris acquisition of General Foods, Siegel asked Freeman, “What do you think of the stock? [General Foods]?” Freeman replied, “It looks good to me.” This meant that Siegel should buy it, which he did, through Wigton and Tabor.
Freeman also gave Siegel details of Baxter Tavenol Laboratories’ bid for American Hospital Supply, and in the 1986 R. H. Macy leveraged buyout handled by Goldman, Freeman told Siegel that the market had overreacted to rumors that Macy would lower its offering price: Macy was lowering its price, but to a smaller extent than the market expected. The financing was secure.
Freeman was similarly generous with information about R. H. Macy when Boesky called him, asking the same questions as Siegel. Freeman assured Boesky the financing would be secure. In any event, Boesky had yet another source inside Goldman, Sachs on the Macy deal, someone in the firm’s real estate area.
Such leaks were all too common, making a mockery of any notion of a fair marketplace. Participants were rarely as explicit in their leaks as Freeman and Siegel; they knew it wasn’t necessary. Nor did they reveal all that they knew. Meanwhile, Siegel continued to rationalize much of what he gave Freeman as being in his clients’ interests.
Nowhere was this more apparent than in the Beatrice deal, the biggest LBO ever, 1985’s deal of the year. It was the pinnacle of Siegel’s work for KKR, the deal that established KKR as the premier leveraged buyout force in the country, a name to be feared. It was also a deal shot through with illegal and questionable behavior by Wall Street professionals.
Beatrice was KKR’s first “hostile” deal. KKR had always considered its approaches friendly, working with management to take a company private or entering a hostile takeover battle as a white knight rescuer. In the case of Beatrice, however, KKR, advised by Siegel, had joined forces with Donald Kelly, a
former Beatrice chairman. If Beatrice resisted KKR’s embrace, KKR would acquire the company, oust its current management, and install Kelly and his team in their place. The plan was such a sharp departure that KKR’s senior partner, Jerome Kohlberg, soon withdrew from the partnership that bears his name, citing “philosophical differences” with his partners, cousins Henry Kravis and George Roberts.
Despite Kohlberg’s reservations, the bid went forward. Freeman was soon amassing huge positions for himself, for his children, and for Goldman. He was in his usual daily contact with Siegel throughout the deal, but Siegel stopped short of conveying inside information. At times, it seemed as though Freeman didn’t need information from Siegel; his stature had reached the point where he could simply pick up the phone and talk to Kravis himself. On Halloween, for example, after John Mulheren unloaded a fourth of his huge Beatrice holdings on rumors that the KKR bid was encountering problems, Freeman called Kravis and asked him why the stock was dropping. “Everything is fine,” Kravis told Freeman. In this exceptionally valuable communication, Kravis added, “We’re not pulling out.” Minutes later, Freeman went on a Beatrice buying binge, adding 60,000 shares and hundreds of call options to his holdings.
Beatrice’s board eventually succumbed to KKR’s final November 1985 bid of $50 a share. Soon thereafter, KKR learned from its investment bankers at Drexel, who were arranging the financing on the deal, that they couldn’t finance the deal at $50. The price would have to be lowered or the financing restructured. There were obvious market implications. The decision was supposed to be so confidential that not even Siegel was told. Arbitrageur Richard Nye, a New York socialite and member of the inner circle of establishment arbitrageurs, showed uncanny prescience, disposing of his 300,000 shares of Beatrice the very next day. Later that day, Freeman and Nye talked on the phone. Freeman also called Kravis.
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