Den of Thieves

by James B. Stewart

  Joseph dismissed the incident as a quirk in Milken’s character. Milken had always been obsessive about his work, and apparently this trait extended to his earnings.

  In any event, Joseph had more important matters on his mind. He’d staved off congressional outcries over the Unocal attack, and legislation to curb the use of junk bonds was languishing. The press had also discovered Drexel, and largely laudatory accounts of the firm began to proliferate, not only in the financial newspapers and magazines, but in general-interest publications. Most reporters liked the people at Drexel—the affable Joseph, his circle of advisors, and press relations people. They made for a terrific story of conflict and success, the old guard against the new.

  Joseph shrewdly decided to court the press, throwing lavish semiannual luncheons. Milken, however, took the opposite tack. He refused all requests for interviews, was contemptuous of reporters, refused to return their calls even to say “no comment,” and hated the thought of publicity. He maintained his invisibility to a surprising degree. Living on the West Coast helped. Milken never attended any of the firm’s press luncheons in New York, which only heightened his mystique.

  New large competitors were soon trying to emulate Drexel’s success, developing their own junk-bond divisions, plunging into hostile takeovers and LBOs with growing abandon. Staid Goldman, Sachs negotiated the over $4 billion leveraged buyout of Macy’s. Morgan Stanley, with Gleacher at the helm of M&A, had stunned the establishment by joining with Drexel on the conquest of Revlon by Ronald Perelman (lending a Drexel-backed hostile raid a respectability none had had before). Merrill Lynch moved aggressively, as did Shearson Lehman and, especially, First Boston, with its merger star Bruce Wasserstein.

  Milken, determined not to cede any of Drexel’s huge market share, competed ever more aggressively. Drexel threatened to break up pending Goldman, Sachs–led leveraged buyouts of Warnaco and National Gypsum with higher bids from Drexel clients backed by the Milken money machine. When Drexel wrested the business of Wickes Companies away from Salomon Brothers, an irate John Gutfreund, Salomon’s chairman, sent one of his top lieutentants to see Milken in Beverly Hills. “If you don’t stop this, we’re going to fry you,” the Salomon banker warned.

  In the case of Staley Continental, the giant midwest corn processor, Drexel tried to bludgeon the company into a leveraged buyout. Drexel had begun acquiring shares in Staley in late 1986, and a Drexel official called Staley’s chief financial officer, Robert Hoffman, to indicate its interest in “establishing an investment banking relationship with Staley.” Two days later, the Drexel official called again, saying “our guys” in Beverly Hills had acquired a “large position” in Staley’s stock. Then Dahl called Hoffman, stating firmly that Drexel “wants to be Staley’s investment banker.” He said that Drexel owned 1.5 million Staley shares. Hoffman asked why Drexel hadn’t filed required 13-D disclosure forms with the SEC. They’re “bad for business,” Dahl retorted, then suggested a Drexel-led leveraged buyout. “We can take Staley private in 48 hours,” he boasted.

  Hoffman was stunned, and rebuffed the suggestion. Later, Dahl called back, urging that they all meet at Drexel’s New York offices to look over the numbers in a leveraged buyout. Hoffman again resisted, and this time Dahl became angry, arguing they should “sit down and talk” before “I do something that hurts you.”

  Staley looked like it might be about to suffer the fate of a Pacific Lumber, but Joseph intervened, rushing to calm the nearly hysterical Staley executives, assuring them that Drexel wouldn’t take any hostile steps against Staley. He had to take similar steps with another victim of the high-yield department’s hardball tactics, Winn-Dixie, a large Southern retail food chain. He worried that such tactics were getting out of hand. Joseph knew that with this level of competition, Drexel’s dominance of the junk-bond market couldn’t last forever.

  Joseph had tried to build up other departments in the firm in his attempt to create a full-service giant like Goldman or Morgan Stanley. Under his brother, Stephen Joseph, Drexel’s mortgage-backed securities department had thrived, becoming one of the top five such departments on Wall Street. In municipal finance, Drexel had moved almost into the top ten, from nowhere before. It was eighth in the trading of government securities. Its equity research department was highly respected. Yet none of these departments could rival Milken as an engine of earnings and growth. The more they improved, the faster Milken surged ahead of them.

  This was causing growing tension between what were known internally as the East Coast faction, led by Joseph, Weinroth, and corporate finance head Herbert Bachelor, and the West Coast faction, led by Milken, which also included Engel, Kay, and Black in New York. The Milken camp criticized the performance of corporate finance, arguing that they weren’t generating clients and were only riding the West Coast’s coattails. They went so far as to urge Bachelor’s ouster. Joseph wouldn’t consider it. But he knew he needed at least one other “star,” preferably more, in New York to help offset the growing dominance of the Milken camp. Dennis Levine was not going to fill the bill.

  David Kay continued to praise Levine, but others at Drexel and outside the firm considered him something of an embarrassment. During the 1985 Pantry Pride bid for Revlon, Levine was the senior New York investment banker assigned to the deal. Yet Milken, who was handling the financing, insisted that others from Drexel be present, including Ackerman and Engel. While they were in a conference room with Perelman, Levine was usually outside on a telephone, sometimes all day. Every once in a while he’d dart into the room and repeat a rumor. Ackerman, in particular, found him embarrassing, telling others in Beverly Hills that he was a phony. Gleacher, who had once offered Levine a job, now dismissed the idea. In New York, Levine boasted to colleagues that Revlon was “his” deal.

  So Joseph again began to recruit. Four years earlier, Drexel couldn’t have dreamed of recruiting top-tier investment bankers. Now the idea didn’t seem so farfetched. And Joseph had an idea: He would approach both Martin Siegel and Bruce Wasserstein, the two biggest M&A stars, and invite them to forge a powerhouse such as Wall Street had never seen, a power center in New York that could truly serve as a counterbalance to Milken in Beverly Hills.

  This time, when Joseph phoned Siegel at Kidder, Peabody, he found a receptive listener.

  Joseph first called Siegel in June 1985, and they agreed to meet. Joseph emphasized Drexel’s growing capital strength, the financing capability that Kidder, Peabody sorely lacked, and the potential for extending Drexel’s client base into Kidder’s blue-chip, establishment territory. As things were developing, Joseph argued, Wall Street would soon be dominated by only a handful of capital-rich firms. Kidder, Peabody, it seemed increasingly obvious, wouldn’t be one of them.

  Within Kidder, Peabody, even Al Gordon, the firm’s patriarch, had come around to the view that Kidder, Peabody should be sold. He was prepared to cash in his large stock position for enormous profits. But he was blocked by DeNunzio, who over the years had shrewdly bestowed stock on his own allies. He had recognized early on that a man like Gordon would almost inevitably clash with his hand-picked successor.

  Others at the firm favored other solutions. Max Chapman, Jr., the head of fixed income and financial futures, had turned Kidder, Peabody into a major player in the field of index arbitrage and program trading (using options on broad market indices traded in Chicago and computer-driven trading strategies). He had become DeNunzio’s heir apparent. DeNunzio had tried to set up a rivalry between Chapman and Siegel, but Siegel had told DeNunzio that he wasn’t interested in administering the firm. “Don’t tell Chapman that,” DeNunzio insisted. Now Chapman, recognizing the need for more capital, wanted to sell a 20% minority stake in the firm, probably to the Japanese. This would raise capital and allow him to run a still-independent firm.

  Other executives favored going public. This would allow them eventually to cash their shares in at market prices, and would preserve the firm’s independence. Morgan Stanley had
successfully sold part of itself to the public earlier that year. But Siegel and others doubted Kidder, Peabody could mount a successful stock offering, given its growing problems. Even if it did, it probably wouldn’t stay independent for long; like any other publicly traded company, it would be vulnerable to a takeover bid. DeNunzio seemed content to let the factions fight among themselves, thus preserving the status quo he cherished.

  Now, at the end of 1985, Kidder, Peabody faced a financial crisis that crystallized Siegel’s thinking and caused him to despair for the firm’s future. The firm was carrying a record year-end inventory of municipal bonds and other securities. In an effort to boost returns on those and other operations, the once-conservative firm, lacking a large capital base, had pushed itself into a highly leveraged position. Much like Boesky, it had fallen out of compliance with minimum capital requirements. It couldn’t meet end-of-year cash demands; any default could be ruinous. The banks all said no. Kidder, Peabody’s chief financial officer, Richard Stewart, spent New Year’s Eve frantically phoning the firm’s banks and traditional lenders. Only at 10 P.M. did he nail down a syndicate of foreign and U.S. investors willing to make short-term loans to carry the firm through the crisis. A measure of Kidder, Peabody’s desperation was its willingness to pay exorbitant short-term interest rates of over 15%.

  The firm scrapped its ambitious plan to expand its retail brokerage network. Stewart quit, partly in protest over the firm’s undercapitalization, and moved to Merrill Lynch. There had been other defections of top executives. The head of municipal finance defected to First Boston. Yet DeNunzio was doing nothing.

  As the year-end crisis continued, Siegel’s talks with Joseph accelerated, and he signaled, for the first time, that he was leaning seriously toward accepting a Drexel offer. Even though Siegel would be joining Drexel as co-head of M&A (with David Kay and Leon Black) he would report directly to Joseph. But he still had to receive Milken’s blessing.

  Siegel flew to Beverly Hills in January 1986 and checked into the Beverly Wilshire Hotel, just down the street from Milken’s offices. Milken spared Siegel the 4:30 A.M. interrogation most job applicants went through. Instead, he came to Siegel’s suite in the hotel late in the afternoon, well after the markets had closed on the East Coast. Siegel had never met Milken before. He was immediately struck by the intensity of Milken’s gaze, the tension and energy that seemed to emanate from his slight frame.

  Siegel gestured for Milken to take a seat on the plush sofa, but Milken ignored him. He began talking rapidly, pacing back and forth in front of the seated Siegel. He moved rapidly from topic to topic, giving his view of the markets, elements of his standard spiel on junk bonds, and dwelling at some length on his views of money. “I don’t want anyone keeping score” of what I make or of what other people make, he told Siegel. “If people here ever know how rich they are, they’ll get slow and fat. You must never count your money; you have to keep driving yourself to make more.”

  Milken told Siegel that customers and clients had to be exploited financially as much as the market would bear. The issue, he insisted, wasn’t how profitable they were. No margin was too large. “If our costs are here,” he said, lowering one hand, “and the market will bear a price here”—he held his other hand high above—“then we should price our services here.” He lowered the upper hand almost imperceptibly. “We’ve earned that spread. You price one penny below the competition, whatever the cost to you.”

  Milken told Siegel he’d just been meeting with Marvin Davis, the wealthy oilman who’d moved to Hollywood and bought 20th Century–Fox. “I’m bringing together all these pools of capital,” Milken boasted. The buying power would be beyond anything the world had ever seen. His only challenge, he said, pausing momentarily to look at Siegel, “is finding people like you.”

  Milken left after 45 minutes, without having sat down. He had talked almost constantly and was so hyperactive that Siegel wondered whether he was on some kind of medication. After that meeting, Siegel thought of Milken as a kind of sun god. “Don’t get too close, or you’ll get burned,” he warned himself.

  That night, Siegel went out for dinner with the top executives from Carnation to celebrate their acquisition by Nestlé. Siegel had leaked the deal to Boesky, but his conscience felt unusually clear. With the move to Drexel, such sordid dealings would be behind him forever.

  When he returned to New York, Joseph told Siegel that he’d passed muster in Beverly Hills. Over the next few weeks, they worked out the financial details. It went without saying, of course, that Siegel would be promised more than the $2.1 million he’d made for 1985 at Kidder, Peabody. Siegel also argued that his Kidder stock would have to be sold back to the firm at a price far beneath its true value, which was a hardship given the likelihood, in Siegel’s estimation, that Kidder, Peabody would be sold soon.

  Joseph was prepared to pay Siegel what seemed an exorbitant sum: a guaranteed base compensation of $3.5 million, a $2 million sign-on bonus, and a block of Drexel stock. Siegel valued the package at well over $6 million—three times his earnings at Kidder, Peabody. For Drexel, of course, the pay level was hardly out of the ordinary, even for investment bankers far less accomplished and well-known than Siegel.

  The following Tuesday, the same day the Challenger space shuttle exploded, Siegel went down to DeNunzio’s office and told him, for the first time, that he was in negotiations with Drexel. DeNunzio seemed shocked. He began to fidget and perspire. He begged Siegel not to make a decision until he’d had time to prepare a counteroffer.

  Siegel was in no mood to wait, however. That Friday night, he visited Al Gordon at his apartment in Manhattan. Gordon was gracious, offering Siegel a drink, perhaps recognizing that the news made his own plan to sell the firm a much greater likelihood. After Siegel told Gordon he’d decided to join Drexel, Gordon’s only comment was, “All good things must come to an end.” Privately, however, he was more upset that Siegel was joining a firm like Drexel than he was over Siegel’s departure. Gordon loathed Drexel and all it represented.

  The next day, Siegel drove out to Greenwich to meet with DeNunzio at his home. DeNunzio had already heard from Gordon, and was furious that Siegel had gone to Gordon before completing their discussions. But DeNunzio’s remonstrations had no effect on Siegel. The encounter was a painful one for him, but he held to his decision.

  Siegel also felt he owed Boesky the call. Boesky seemed disappointed and hurt that Siegel hadn’t consulted him about the decision.

  Word of Siegel’s decision to defect now coursed through the ranks of Kidder, Peabody, causing grave concern and, in some cases, near panic. John Gordon, who’d been with Siegel ever since Gordon arrived, was in San Francisco for the weekend when he heard the news from his father on Saturday night. He boarded a “red-eye” flight and came into the office Sunday for an emergency meeting of the corporate finance and M&A groups. Hal Ritch was there; Siegel had called him at home over the weekend to break the news, adding, “I’m not supposed” to recruit, but “I’ll answer the phone.” Ritch realized Siegel would be talking huge numbers, but rejected the idea out of hand. “I wouldn’t work for those dirtbag liquidators,” he said of Drexel. John Gordon, too, was disgusted. He thought everyone had gotten too money-conscious; that’s all anyone wanted to talk about: the size of their bonuses. Loyalty was dead.

  Kidder, Peabody’s annual shareholders’ meeting was held the following week. Even as he unveiled the firm’s record 1985 profits, DeNunzio had to announce that Siegel was leaving. No one knew better than DeNunzio how large a percentage of those profits would be walking out the door with Siegel. DeNunzio, vacationing over the holidays at his Vermont ski house, had reluctantly recognized that without a star like Siegel, the firm could only compete on the basis of capital. Since the firm’s capital was precariously low, he announced that Kidder, Peabody would “explore” sources of additional capital. Publicly, he explicitly rejected any notion that the firm would be sold. But he knew something had to be done, a
nd fast—before it all came crashing down around him.

  As the gloom darkened, Kidder, Peabody tried desperately to stave off more defections. For the first time in the firm’s history, DeNunzio guaranteed that everyone would at least earn as large a bonus in 1986 as he or she had earned in 1985. But not everyone believed that would be possible. Just six weeks after Siegel’s departure, on Good Friday, a crown jewel of the firm’s corporate finance department, the high-tech group, quit en masse, also to go to Drexel.

  For John Gordon, this was the last straw. He went to his father, saying he had to force DeNunzio to take bold action. The lack of leadership was “insane,” he argued, concluding, “I’m going to leave the firm.” The prospect that his own son might bail out of Kidder, Peabody was almost more than the senior Gordon could bear. He mustered all his still-considerable authority and went to see DeNunzio.

  The result of Gordon’s visit was all but inevitable. Within a few weeks, in late April, DeNunzio convened Kidder, Peabody’s directors and announced, with tears in his eyes, that the firm would be sold to General Electric. GE paid $600 million for an 80% stake, leaving 20% in the hands of Kidder, Peabody officials who stayed at the firm, and promised to add an additional $130 million in capital. Al Gordon retired a rich man, selling his entire 6% stake for over $40 million. The Kidder, Peabody he had known was gone. But not even he could have forecast how fast its remnants would disintegrate.

  Siegel was too busy at Drexel to dwell on the sale of his old firm, even though he realized that, had he stayed, his stock would have been worth millions. When he arrived, he’d been assigned an office directly adjacent to Levine’s. He plunged into his new life as co-head of M&A with Black and Kay. He quickly discovered that there had been virtually no management of the department. Black worked on deals and cultivated his relationships with the West Coast; Kay, in Siegel’s view, contributed little. Siegel instituted controls and procedures for dealing with issues like conflicts of interest, which, astoundingly, had never been formally addressed within the department at Drexel.