Eagle on the Street

  Shad’s takeover advisory committee hadn’t suggested any fundamental program to slow mergers—the members of the committee profited enormously from the takeover boom. But in the months since their report was completed, the SEC staff had gone to work on it, and some of the lawyers and consultants who gathered in the commission basement that Tuesday weren’t sure whether Shad and his colleagues had capitulated to the outcry for sweeping new regulations.

  “Any commissioners … have any dissent or comments on the first eight recommendations of the advisory committee?” Shad asked from the platform. “Mr. Treadway or Mr. Cox?”

  Members of the audience shuffled through their papers—what eight recommendations was Shad talking about? they asked each other. Many of them had nothing to follow, but Shad was not going to slow things down by providing special explanations. And the commission’s senior staff, who had helped to organize the meeting, sat at a table near the front of the room, facing the commissioners but with their backs to the public.

  “On the general proposal about [takeover bids] being a valid method of capital allocation, which regulation should neither promote nor deter, I agree completely with that,” answered Charles Cox, the conservative economist who, with Shad’s backing, recently had been elevated from chief economist to SEC commissioner, by President Reagan. “I think there’s a substantial body of empirical evidence assembled by financial economists showing that combining firms … is in general economically beneficial.… It is not the place of regulation to determine which is a beneficial [takeover bid] and which is not.”

  “I would essentially concur in what Commissioner Cox has said,” added Treadway.

  Shad began to race through the list like an actor anxious to get off the stage. Number nine.… Number ten.… Numbers eleven through nineteen.… Any objection? None was voiced. Murmurs rose in the audience—few people were sure exactly what the commission was voting on, or whether it was voting at all. Piles of paper rested before the three Republicans on the platform, and some in the audience were able to follow the rapid decision-making by looking at old copies of the takeover advisory committee report, but there was no substantive debate about controversial issues, no back and forth. Virtually every vote was unanimous, seemingly scripted. It wasn’t always clear whether the three commissioners were adopting a rule, making a recommendation to Congress, or suggesting a proposal to SEC staff for future consideration.

  In part, the proposals had been designed by Shad and his senior staff to reduce political pressures on the commission through the adoption of a middle course—recommendation to Congress of laws that would eliminate the most egregious takeover abuses, without interfering fundamentally with the takeover process or disturbing the flow of profits to Wall Street. But when it was over that Tuesday, Shad’s commission had managed to please few outside of its own staff. Partly it was a failure of presentation. So accustomed were the commissioners and senior staff to the casual intimacy of their private meetings that they had difficulty adjusting to the demands of public scrutiny. Skillful grandstanding and speech-making and contrived debate so common on Capitol Hill were rarely practiced at commission headquarters. The open meeting that day marked the first in a series of public-relations failures for the SEC in the area of takeovers and insider trading—failures that built one upon the other, sometimes putting Shad and the commission on the defensive even at moments of unqualified triumph. The commissioners and senior staff were like a breed of regulatory bat: In the pitch darkness of their own cave, they flew with precision and skill, but in open spaces they seemed to grow disoriented.

  Shad’s problems, however, were not wholly in the realm of public relations. Amid mounting calls for the SEC to do something, anything, about takeovers, he was being tugged and pulled from four sides—from his friends and former colleagues on Wall Street, from the conservative intellectuals in the Reagan administration, from Democrats in Congress, and from his own staff. In the months since his takeover advisory committee completed its work, Shad had become increasingly convinced that the public outcry surrounding certain abusive takeover practices demanded a measured response. He also was growing more concerned about the risk to the economy posed by heavy reliance on borrowed money to finance takeover bids. He was intrinsically uncomfortable with anything so drastic as a moratorium on mergers, such as the one proposed by Metzenbaum, but in private discussions that spring, he also rejected the arguments of Chicago School economists like Gregg Jarrell, who had written in his dissent to the advisory report that terminating federal regulations of takeovers was “the best of all possible worlds.”

  In part, Shad’s views had been influenced by Linda Quinn, a top official in the SEC division of corporation finance whom he admired greatly and who had served as the staff link between the takeover committee and the commission. In the months leading up to the open SEC meeting in March, Quinn had been analyzing the committee’s proposals and crafting compromise positions among the three Republican commissioners. She was closest to Shad’s. Quinn and other senior SEC staff wanted to see the commission take some action on takeovers to end perceived abuses and enhance the agency’s regulatory clout. Quinn argued vocally with Jarrell, who saw her as the embodiment of the bureaucratic instinct to meddle. But Shad viewed Quinn in contrast to the legal-minded staff at the SEC who he thought had little appreciation for the financial markets. The chairman listened to Quinn that spring. She had worked for several years at the top-drawer Wall Street law firm of Sullivan & Cromwell, and Shad considered her brilliant.

  In a series of meetings in Shad’s office, Quinn proposed in March that the SEC adopt dozens of recommendations made by its takeover advisory committee, and that it reject others. As the SEC essentially was a bottom-up agency, no substantial takeover proposals came to a commission vote without staff recommendations, which only were made after considerable analysis at levels in the hierarchy far below the commission. Since the takeover panel recommendations had been limited in the first place, there were those to the left of Shad’s views inside the SEC who thought that the votes taken at the open meeting—once it was deduced what the votes meant—were ineffectual. But even some Democrats in Congress were cheered by the unusual unity Shad mustered at the open meeting. Nearly all the recommendations made by the three commissioners were adopted unanimously. Proposed takeover laws were being introduced almost daily on the Hill, and the SEC’s recommendations, however limited, added the weight of the Reagan administration to the momentum for reform. The SEC was ostensibly an independent agency, and it wasn’t clear where the White House would come down on the issue, but the support of a loyal Reagan man like Shad added credibility to the Democrats’ cause. Any final legislative package might be far more aggressive than what Shad’s SEC proposed—the important thing now to the Democrats, in the midst of a hothouse election year, was to create the political impetus to move all the takeover bills through Congress.

  And as a baseline for political debate, the proposals adopted by Shad and his fellow Republicans on the commission were, at the least, a far bolder regulatory program than anything previously proposed by members of the Reagan administration. Among the proposals was one that would force takeover bidders to disclose more rapidly their holdings of 5 percent or more of a public company, a change that would give target companies more time to mount defenses. Another SEC staff recommendation supported by Shad would restrict “golden parachutes”—lucrative severance agreements for executives who lose their jobs in a takeover—and “greenmail”—the payment of a premium to a corporate raider who agrees to sell his stock in the target company and drop his takeover bid. In the case of greenmail, Shad thought such payments should be permitted only with stockholder approval, and not simply at the whim of a corporate management wishing to rid itself of a suitor and preserve its power and perks.

  Greenmail had become a lightning rod for controversy in the capital—that March, St. Regis Corporation, the giant paper manufacturer, had paid tens of millions of dollars to Angl
o-French financier Sir James Goldsmith to encourage him to drop his takeover bid. The payment seemed a rank form of extortion, and as a political issue, it cut through the complex, delicate arguments about whether mergers were good or bad for the economy. Nobody was in favor of greenmail—yet Shad was ambivalent. His “middle course” recommendation that managements seek shareholder approval for the payments was consistent with Shad’s view that stockholders were the SEC’s most important regulatory constituent. But Shad knew, too, that corporate managements possessed wide powers to control shareholder votes, and that even if his proposal became law, it would have a marginal effect in many instances.

  Amid all the public rhetoric about reining in the wild corporate takeovers that spring, the complexities of the commission’s role—the personal and ideological connections linking Shad, some senior SEC staff, the practitioners of the takeover game on Wall Street, and the conservative intellectuals in the Reagan administration—escaped notice and comment. The commission’s public and private dealings with T. Boone Pickens—who even more than Goldsmith had become in Washington the symbol of a new, and to many people a distressing, trend in finance and the economy—encompassed all of that.

  One month after the commission meeting on takeovers, the SEC’s enforcement division filed charges against the oil company Pickens headed—Amarillo, Texas-based Mesa Petroleum Company. The case involved Pickens’s relationship with Drexel’s Michael Milken. Several months before, in January 1984, Pickens asked for Milken’s help in financing the first-ever junk-bond-backed multibillion-dollar hostile takeover bid, ushering in a new era of debt-driven merger mania. His target was Gulf Oil, one of the nation’s leading refiners and marketers of crude and a familiar citadel of the country’s corporate establishment.

  The SEC possessed only a handful of legal and regulatory tools with which to examine and review corporate takeovers. One of the most important was a rule known as 13D, which required a bidder, once he accumulated 5 percent of his target company’s stock, to disclose the size of his stock holdings and the nature of his intentions—whether, for example, the stock was purchased for investment purposes only, or whether he intended to seek control of the target. Typical of SEC regulations, the rule left wide latitude for interpretation as to what a bidder like Pickens actually had to say in his filings at the commission—the rule required him, among other things, to disclose his state of mind, which presumably was known only to Pickens. In the Gulf deal, Pickens had initially tried to win stockholder support through a proxy contest, and the 13D statements he filed at the SEC said that a proxy fight, in which shareholders cast ballots, was what Pickens intended. In a volatile atmosphere of lawsuits, mutual recrimination, and accusations, Gulf had defeated Pickens by persuading 53 percent of its shareholders to vote in favor of the incumbent management. Soon afterward, Pickens and his wife boarded their private jet in Houston and flew to Los Angeles, where Pickens had arranged an “audience” with Milken in Beverly Hills.

  I want to explore the possibility of raising billions of dollars to finance a new takeover bid for Gulf, Pickens told Milken in a fourth-floor conference room off the Drexel junk bond trading floor in Beverly Hills.

  “That’s a lot of money,” Milken answered succinctly.

  I deal with a lot of money, but do you realize how much the $2 billion we are talking about is?

  “Anything we have attempted we have performed,” Milken answered.

  This was exactly the deal Milken had been looking for—only weeks earlier he had met with Fred Joseph and other Drexel officials in Beverly Hills to discuss the use of junk bonds in hostile takeovers. Now Pickens was offering Drexel a foothold in the biggest, albeit the most politically controversial, takeover available. Milken said he would send his people down to Texas to get to work on the deal.

  Pickens’s meeting with Milken, and his decision to dip into Drexel’s junk bond war chest, was a potentially decisive event in the battle for control of Gulf, its $20 billion in assets, and its 40,000 employees. After buying a nearly 9 percent stake in Gulf, Pickens declared that Gulf management needed to take steps to increase its stock price. But the company didn’t budge until Pickens mounted a credible threat with Milken’s help. Yet the meeting and Milken’s financing work remained a secret—Pickens did not promptly amend the 13D statements in the commission’s public-filing room to disclose that he had changed his tactics, that, in the aftermath of his defeat in the proxy contest, he now planned to launch a junk bond—financed hostile-takeover bid. Pickens did not make the change even after Milken took steps to raise $2.2 billion from his network of junk bond buyers. Not only did Gulf Oil, its executives, and employees know nothing of Pickens’s alliance with Milken, neither did anyone at the Securities and Exchange Commission.

  Inside the commission bureaucracy, daily review of developments in the fight for Gulf Oil was bifurcated between two divisions, enforcement and corporation finance. The latter had responsibility for reviewing all the paper filed at the SEC, while the former attempted to prosecute securities-law violations. Often they tried to work in tandem, since irregularities in public filings spotted by the lawyers in corporation finance provided tips for the enforcement staff. Even within corp fin, as the division was called inside the SEC, review of takeovers was split and segregated. In the most important section, the office of tender offers, SEC lawyers spent much of their time on the phone with Wall Street bankers and takeover attorneys embroiled in takeover fights, answering questions and providing informal advice about commission rules. But the office of tender offers competed for regulatory supremacy with other sections of corp fin—the office of chief counsel, the office of disclosure policy, and corp fin director John Huber’s front office. Cooperation was difficult, not so much because of the occasional personality clashes, but because responsibility was split through the bureaucracy like light through a prism.

  Some of the lawyers who dealt with day-to-day SEC regulation of takeover fights inside the corporation finance division were talented and dedicated—the increasing number and quickening pace of new deals, and the evolution of questionable tactics devised by Wall Street advisers forced staff like Joseph Connolly, who headed the office of tender offers, to work late into the night and through weekends and holidays. Yet even the best of them were aware of an uncomfortable truth: They were treading water, struggling each day just to return the phone calls that poured in from Wall Street takeover lawyers. There was barely time to review the mounds of new filings carted by the ream into the commission filing room downstairs. And there was certainly not enough people or time to conduct a systematic review of even the most controversial takeover fights to be sure that the participants were playing by the rules, or to consider new interpretations of existing regulations in order to curb abuses.

  In a case like the battle for Gulf, where a corporate raider had failed to disclose a key change in his plans, one of the only ways lawyers inside the SEC could realistically hope to learn of the omission was if somebody ratted on Pickens. Indeed, belligerents in protracted takeover fights were discovering, that spring of 1984, that it was possible to use the SEC to gain an advantage against an opponent. If one side in a takeover battle discovered that the other side might be in violation of an SEC regulation, its lawyers inundated the corp fin and enforcement staffs in Washington with telephone calls and documentary evidence, urging them to bring an enforcement action that might alter the outcome of the takeover. Lawyers in corp fin looked carefully at the evidence that came in, but they were sometimes reluctant to act unless the purported violation was clear and egregious—they sensed correctly that the ordinary balance of power between regulator and regulated had been reversed, that the SEC was in danger of becoming a tactical pawn in a game controlled by lawyers and investment bankers on Wall Street. Pickens suspected that the SEC’s investigation of him had been initiated because of allegations made by Gulf.

  Then, too, even if the evidence of a violation was clear and compelling, it wasn’t easy for th
e SEC to act fast enough to make any difference. By the time evidence was passed over to the enforcement division that spring, demonstrating that Pickens had failed to disclose properly his financing arrangements with Milken, and by the time the enforcement lawyers prepared their case, offered Pickens a chance to submit a defense, and at last secured approval for the action in a closed SEC meeting, the destiny of Gulf and its employees was decided. On March 5, 1984, to dodge the threat posed by Milken and Pickens, Gulf agreed to be acquired for a premium price of $80 per share by Chevron Corporation. At $13.3 billion, it was the biggest corporate merger ever. Milken and Drexel made millions of dollars in fees for arranging financing for Pickens’s bid, including securing a loan of $300 million from raider Carl Lindner. Pickens and his investor group made a whopping $760 million profit, before taxes, on their Gulf stock. The SEC case charging Pickens with improperly keeping secrets about his plans during the battle—charges Pickens agreed to settle without admitting or denying wrongdoing—wasn’t filed until April. If the case had been filed earlier, it probably wouldn’t have changed the outcome of the takeover or deprived Pickens of his riches, but at the least, it would have provided the SEC with meaningful authority in the midst of the biggest merger deal on record. Pickens felt the SEC was unfair, because he was merely exploring a junk bond bid and had not yet made up his mind. The SEC, for its part, was trying to force bidders to disclose key relationships earlier so that all stockholders had access to information that could affect stock prices.