Eagle on the Street

by Coll, Steve; Vise, David A. ;

  They ended at nine-thirty Sunday night, in the darkness of Halloween night. During his questioning, Hewitt never returned to the point where Milken had unaccountably paused when asked about his relationship with stock speculator Ivan Boeksy. Later, looking back on it all, it was clearly a missed opportunity.

  That fall of 1982, when Hewitt flew west to interrogate Michael Milken, the first signs of an epochal change on Wall Street—a new kind of cowboy capitalism—were beginning to appear. Hewitt was unsettled by what he saw of Milken’s business, and by his demeanor during the interrogation, but he couldn’t be sure that the parallels with the 1920s that kept jumping to mind were valid. Besides, reaching such grand conclusions wasn’t generally part of an SEC investigator’s job.

  But they were certainly part of John Shad’s responsibilities, and for his part, in his chairman’s suite at the Securities and Exchange Commission’s headquarters in Washington, and on weekends with his friends and family in Manhattan, Shad saw no reason to be worried.

  The truth was that Shad did not grasp what was happening now on Wall Street. He had been away from the Street for less than two years. He might just as well have been away for twenty.

  It was the SEC’s primary charter to supervise and regulate Wall Street, and certainly there was no one at the commission who knew Wall Street more intimately than Shad. The trouble was that the Wall Street Shad knew—the place where he had worked for thirty years—was disappearing. There were those who said afterward that Shad’s Wall Street died in August of 1982, when the most bizarre and controversial corporate takeover fight in U.S. history was launched, and simultaneously, the greatest surge in stock prices since World War II began.

  As an investment banker. Shad had made his fortune as a specialist in corporate finance, the business of advising companies on the best ways to raise money to pay for their future growth. Should a company borrow funds for a short term or a long while? Was it better to issue new stock or new bonds? Should it build a factory this year or wait until next year? Did bad news about an unprofitable subsidiary have to be disclosed to public investors through the SEC or could it be concealed? These were the kinds of questions with which Shad grappled. In many ways it was a comfortable, slow-moving world, with business conducted under the same general guidelines and principles set down in the 1930s, when SEC rules governing corporate finance were first established. Personal relationships and trust were paramount. A handshake was all that was required to complete a deal and the ties between Wall Street firms and the companies they advised were informally binding. If a corporation’s top officials forged a relationship with investment bankers at a particular Wall Street firm, the relationship usually became a hallowed tradition that lasted decades.

  Besides corporate finance work, Shad also served as an adviser to companies on mergers and acquisitions. Many of these deals were an outgrowth of the financial advisory work he was already doing. Shad thought takeovers could be beneficial for all parties involved, provided they were prudently financed and made sound business sense. He also had a reputation among his Wall Street and corporate colleagues for opposing mergers he thought were overpriced—he put the long-run interest of his corporate client above the large fees he might earn as an adviser on any given deal. In general, the takeover work Shad had done involved a friendly agreement between a party who wanted to sell and another who wanted to buy. Shad’s standards of conduct were evidently so high, and his financial analysis was so thorough, that during a highly litigious period, he was never the subject of any lawsuits arising out of investment banking transactions in which he had played a major role.

  It was the relationships, not just the individual deals, that mattered—the clubs, the friends, the corporate clients, the classmates from school. Shad arranged deals of significant magnitude for former Harvard Business School classmates who had risen to senior positions in major corporations. But Shad was not bound by tradition. He also did deals with small companies whose growth he shepherded. His role was clear; as an investment banker he was an agent, a provider of financial services to a client—the corporation was the principal, and its people made the decisions. There was a sense of paternal duty attached to the profession: Shad became a mentor for the young men he hired out of Harvard, personally responsible for their progress. Investment banking was like some medieval craft guild, with carefully planned apprentice and master stages. Some complained that the system favored the well-born and the well-connected, and discouraged free competition based on merit, but Shad’s own personal history—his rise from the dirt farms of Utah to the duplex on Park Avenue—showed that in some cases, at least, a man could forge his own success on Wall Street. (A woman would have more trouble. Finance in those days was exclusively a boys’ club.) The centrality of personal relationships and the primacy of the client were evident in Wall Street’s lexicon. In the prime of Shad’s years there, a stockbroker often was referred to as a customers man.

  In 1975, not long after Shad assisted his firm, E. F. Hutton, in selling shares in itself to the public, the brokerage business underwent dramatic change. Sales commissions, which had been fixed at set levels for generations, were deregulated at the urging of the SEC. A new era of aggressive competition erupted between established Wall Street firms and start-up, cut-rate discount brokerage houses that emphasized price, not quality. The flowering of competition made it cheaper for individual investors to buy and sell stocks, and it put the squeeze on some of the comfortable Wall Street investment firms. In the late 1970s, attitudes about clients, customers, and the nature of investment banking began to shift. The imperatives of profit loomed larger at the big firms than they had before.

  Those changes paled, however, beside the forces unleashed in August 1982.

  It started with William Agee, the ambitious chairman of a Michigan-based company called Bendix Corporation. The problem was that Agee was getting bored. Running a giant auto parts and aerospace company near Detroit apparently dulled his senses, which were otherwise stimulated by his Ivy League—educated young wife, Mary Cunningham, who had been Agee’s assistant at Bendix until their personal relationship became a notorious corporate affair. (Cunningham took a job at another company.) Egged on by his Wall Street advisers at venerable Salomon Brothers, Agee had Bendix secretly accumulate an almost 5 percent stake in Martin Marietta Corporation, the giant Bethesda, Maryland–based defense contractor that was several times the size of Agee’s company. On August 25, Agee declared war on Martin Marietta, announcing a $1.5 billion, $43-per-share hostile takeover bid for Martin Marietta’s publicly traded stock.

  A retired Navy admiral named Thomas Pownall was the proud, deeply conservative chairman of Martin Marietta. Adhering to the precepts of his Annapolis training, he decided to fire back at Agee. At Pownall’s side was a young, brown-haired, strikingly handsome, Harvard-educated Wall Street investment banker who would do much in the coming years to alter the way his profession operated.

  Martin A. Siegel’s story was reminiscent in some ways of Shad’s—he had been raised without riches or privilege, his father had struggled in business, but Siegel had exhibited enough talent to zip through Harvard Business School. There the similarities ended, however. Siegel had the charm and élan of a smooth investment banker that Shad lacked. He commuted to Wall Street by helicopter from his seaside Connecticut estate; he relished press attention; and he seemed to find his wardrobe in the pages of Gentlemen’s Quarterly. Everyone called him Marty, and though he was a talented strategist when it came to developing a takeover defense, his most obvious skill was as a salesman. He could work a corporate boardroom like a bible-toting preacher at a southern revival meeting. In part he preyed on the fears of staid, comfortable corporate chief executives like Martin Marietta’s Pownall, when they were threatened by the possibility of a corporate takeover. Pownall might be an admiral, but Marty Siegel was known on Wall Street as the Secretary of Defense.

  After Agee’s hostile takeover bid was announced, Siegel huddled with
Pownall for a week and then disclosed his stunning plan: in response to Bendix’s takeover offer for Martin Marietta, Martin Marietta would issue a hostile takeover offer for Bendix. It became known as Marty Siegel’s Pac-Man defense, named after the popular video game in which glowing goblins try to eat each other. The astonishing spectacle of two corporate behemoths trying to devour simultaneously one another’s assets attracted front-page headlines across the country. The fire spread. Agee, annoyed and in the curious position of both bidder and target, turned to a new team of Wall Street advisers, Bruce Wasserstein and Joe Perella of First Boston Corporation. Agee understood that to fight someone of Siegel’s youth and audacity, he needed investment bankers who were similarly unconstrained by Wall Street traditions—and in the dynamic duo of Wasserstein and Perella, Agee chose the right pair. Wasserstein, a former public interest lawyer who had once worked for Ralph Nader’s Raiders but had decided to devote his life to the acquisition of capital, thought the ancient Wall Street order of trust and friendship should be torn down, to be replaced by a new system of free and aggressive competition. Wasserstein started fighting Siegel furiously and publicly. The game was now about winning, not preservation of past relationships.

  There were offers and counteroffers, press releases, and pompom girls leading pep rallies at Bendix headquarters in Michigan. More companies and Wall Street firms piled on—United Technologies Corporation, advised by the ostensibly conservative Wall Street house Lazard Frères, launched a rival billion-dollar takeover bid for Martin Marietta. Allied Corporation, advised by Lehman Brothers, considered a rescuing bid for Bendix. By September, four major corporations, five Wall Street investment firms, and a host of New York lawyers were jetting around the Eastern seaboard at a dizzying pace, for a purpose that increasingly escaped conservative business leaders and congressmen in Washington. In the end that September, Bendix bought about 70 percent of Martin Marietta, Martin Marietta bought about 50 percent of Bendix, Bendix agreed to sell all its shares to Allied, Allied bought the Martin Marietta shares owned by Bendix, and the fight was over.

  There were few outside of Wall Street who understood what had happened. The newspapers figured out this much: Allied would end up owning all of Bendix; Agee would lose his job; Martin Marietta would remain independent; Pownall would keep his job; and, in the process, the Wall Street advisers would become exceedingly rich.

  The fees billed by the investment bankers were staggering, typically calculated as a financial advisory fee plus a percentage of the money involved in the deal. For one month’s work, Lehman Brothers earned about $6 million for advising Allied; Wasserstein’s First Boston Corporation made $8 million; Salomon Brothers $3 million; Lazard Frères and Siegel’s Kidder, Peabody & Company $1 million each. And there was a magic about this money—it came without risk. Wall Street firms had been long accustomed to putting their own capital at risk in stock and bond trading, making millions of dollars one quarter and losing millions the next if the markets took an unexpected turn. But in the Martin Marietta–Bendix fight, there was no capital invested, nothing at risk, only millions of dollars in quick advisory fees.

  It became obvious that summer that whatever their consequences for the nation, hostile takeovers were certainly good for Wall Street, which had seen its profit margins erode in the retail brokerage and traditional corporate finance businesses because of deregulation during the 1970s. The generation of investment bankers and traders that rose to influence on the Street in the early 1980s, when Shad came to the SEC in Washington—the generation led by Siegel, Wasserstein, Milken, and the rest—wanted to ensure that the takeover game continued. In the aftermath of the Martin Marietta–Bendix spectacle, there were some calls for reform in Washington and a bit of publicly voiced self-criticism on Wall Street. But behind closed doors at the nation’s leading investment houses, there spread a strong hunger for the next deal.

  In the lobby of a Manhattan hotel late in 1982, Martin Siegel nervously awaited a courier dispatched by Ivan F. Boesky, the independent stock trader whose audacity and wealth were beginning to attract attention on Wall Street. When the man arrived, Siegel uttered a password, and the courier turned over a briefcase containing $125,000 in cash.

  It was, in the annals of Wall Street, as blatant a crime as had ever been concocted by respectable men of finance. It was also carried out well beyond the reach of the Securities and Exchange Commission.

  During the chaotic, controversial public fight between Bendix, Martin Marietta, and the others, John Shad had sounded no public warnings about the potential dangers of hostile corporate takeovers. It wasn’t just that he considered mergers and acquisitions to be essentially good for the country, it was that he was occupied that summer and fall with other concerns. The Dingell investigations into Shad’s personal finances continued. And in September, when Agee’s cowboy antics reached their zenith, Dingell convened days of embarrassing public hearings, not to discuss Wall Street’s bizarre new takeover tactics, but to rehash the Citicorp case.

  There was much that John Dingell and Jack Shad did not know that fall. They did not appreciate how the operations and priorities of the biggest Wall Street investment firms were changing. And certainly, they did not know that Marty Siegel and Ivan Boesky were crooks.

  In August 1982, in the midst of the battle between Agee and Bendix, Siegel and Boesky met at the Harvard Club in midtown Manhattan. Boesky hadn’t gone to Harvard, but he apparently wished he had, because he spent nearly every afternoon at the club, conducting meetings and playing squash. Siegel, too, was vastly insecure—and he was, to his way of thinking at least, financially strapped. Siegel found the cost of maintaining a home on the Connecticut shore, an apartment in Manhattan, and a lifestyle appropriate to both places too much to handle on his six-figure Kidder salary and bonus. But Siegel had something to sell: inside information about the takeovers he worked on, such as Martin Marietta’s fight with Bendix. At the Harvard Club, Siegel agreed to leak secrets about upcoming takeover events to Boesky in return for a percentage of any stock-trading profits Boesky earned. Siegel wanted the money in cash. It helped to make ends meet; he would eventually use some of the money to pay an off-the-books salary to his child’s nanny.

  It was hard sometimes for Siegel to see what was wrong with his arrangement. By leaking information to Boesky about Martin Marietta’s planned bid for Bendix, he was able to stimulate massive trading in Bendix stock, driving its stock price up and giving his client’s offer greater credibility. That sort of trading greased the skids of the deal, making Siegel’s defense strategy more effective, and if it produced stock-trading profits for Boesky as well, who was the loser? Presumably, whoever sold his stock to Boesky without the benefit of Siegel’s inside information did so voluntarily. And there were some conservative economists who thought the trading by Boesky only increased market efficiency, rapidly driving the Bendix stock price closer to the level it would eventually reach anyway when the offer for the company became public.

  As chairman of the SEC, Shad had already considered such arguments and dismissed them. Insider trading was unfair and hurt the integrity of the market, he believed. Shad had vowed publicly to crack down on insider trading, even as he encouraged the very corporate takeovers that provided Siegel and Boesky with their opportunities.

  Almost inadvertently, the commission’s policies that summer and fall of 1982 began to revolve more and more around corporate takeovers, though the thrust of the policies sometimes seemed at odds. In the enforcement division, Fedders was attacking Swiss-bank secrecy that blocked inquiries into takeover-related trading. Jack Hewitt had embarked on an investigation of Michael Milken’s trading in takeovers and other deals, one of many insider trading probes under way. With one hand Shad pushed Fedders to press his ambitious law-enforcement campaign, while with the other hand he paddled in a different direction. He began to implement a new, hands-off policy at the commission toward corporate takeovers, even hostile battles like the one between Bendix and Martin M
arietta.

  That fall Shad took a major step in promoting a free market approach to takeovers by hiring Texas A&M economics professor Charles Cox to be the agency’s first “chief economist.” Shad’s view was that the commission had too many attorneys who applied convoluted legal thinking to issues that begged for a simpler, more economic, approach, including the quantification of the costs and benefits of regulation. By creating the new office of the chief economist, Shad sought to reduce the SEC’s reliance on legal reasoning and increase its emphasis on economic analysis.

  Shad’s hiring of a free market economist sent a clear signal to Wall Street that new priorities were being set in place at the SEC. The hiring also sent a distinct message of a different sort through the commission’s bureaucracy. When Cox arrived at the SEC to take up his post, Shad told his top aides that he wanted the new chief economist to report directly to him. To accommodate Cox in an office near Shad, a decision was made to move Phil Savage, the SEC’s equal-employment-opportunity officer, to the basement. The impression created by Savage’s move to the basement—that Shad and his top staff cared most about free market economics and least about equal opportunity—wasn’t lost on some blacks and women at the commission. Savage, a former civil rights worker, complained that Shad wouldn’t even meet with him. Some senior SEC staff vigorously defended Shad against charges of racism or sexism, noting for example that he appointed women to several key staff positions and relied on them heavily for advice. But it was also true that during Shad’s watch, with Savage relegated to the basement, several serious harassment and discrimination cases arose that deeply embarrassed the SEC after Shad was gone.