Eagle on the Street

  As it was, the Gulf deal only fueled suspicions that the commission was being left behind by a new and powerful alliance linking Milken, the corporate raiders he was beginning to finance with junk bonds, and the arbitragers on Wall Street who profited by speculating, spreading rumors, and acquiring inside information on the outcome of takeover deals. The SEC investigated suspicious trading in Gulf stock which appeared linked to Milken’s communications with potential junk bond buyers, but it brought no case. Merely by threatening Gulf, and without actually raising a dime of capital from Milken’s junk bond investors, Pickens had been able to earn hundreds of millions of dollars in stock trading profits, and force Gulf into a merger that would throw thousands out of work and add billions of dollars of debt to Chevron’s balance sheet. Moreover, the success of the Gulf deal made it easier for Milken to sell $500 million in junk bonds to help Pickens plan his next raid, and to stake other corporate raiders, such as Saul Steinberg, who launched a hostile raid on Walt Disney Company that spring. It was reported that in a single week Milken raised $1.3 billion for Metromedia, $1.2 billion for Occidental Petroleum, $325 million for Steinberg, and $100 million for a new client, a leveraged-buyout firm called Kohlberg Kravis Roberts & Company. Drexel doubled in size between 1979 and 1984, from 3,000 to 6,200 employees. Milken didn’t go unrewarded; he earned $123.8 million in salary and bonus that year. Ivan Boesky, the arbitrager who in 1982 had begun to bribe investment banker Marty Siegel for inside information about takeovers, took home a reported $70 million in stock-trading profits from Pickens’s raid on Gulf. To many of the commission staff in Washington, who lived on salaries of $25,000 or $30,000 annually and struggled with the banalities of checkbooks and mortgages, the scale of this instant wealth was numbing.

  The SEC case against Pickens was minor and it seemed clear even to Shad that much of the illegal trading and dealing on Wall Street went unchecked. “In law enforcement,” Shad said, “what you don’t know is the extent of undetected fraud.” Early in 1984, the SEC did bring an impressive insider trading case. But the case wasn’t against a sophisticated stock market professional. Instead, the defendant was Paul Thayer, deputy secretary of defense, whom the SEC charged with violating the insider-trading laws by leaking information to a ring of friends and associates, including his mistress. (Before joining the administration, Thayer had access to inside information about takeover plans because he was chairman of the board of LTV Corporation, and a director of the Anheuser-Busch and Allied corporations.) The Thayer case generated a lot of favorable publicity for the SEC, but the fact remained that unlike the savvy traders on Wall Street who knew how to cover their tracks, Thayer was a relatively easy target. The rule-13D fraud charges filed publicly against Pickens in April provided a glimpse of only one aspect of the corporate raider’s complex, multifaceted relationship with the SEC. That spring, Pickens traveled to Washington frequently to lobby against a merger moratorium on Capitol Hill and to appear before various congressional committees. In private meetings and public testimony, Pickens justified his raids in language that appealed intuitively to SEC Chairman John Shad—he used the vocabulary of the shareholder. Takeovers, even hostile takeovers, were good for the country because they helped shareholders reclaim control of large corporations from “entrenched” management coddled by big salaries and country club perks. Pickens proclaimed loudly that Gulf Oil wasted millions of dollars a year exploring for new oil and paying salaries to legions of expendable executives. Pickens understood that it was cheaper to buy control of an oil company in the stock market than it was to go out and drill for new oil—cheaper, that is, if the government would permit you, in the first place, to borrow billions of dollars to buy the stock. Gulf’s stock price was undervalued and did not reflect fully the value of the company’s known oil reserves. Pickens’s rhetoric about shareholder rights, and the way his basic strategy seemed to rest on an insight about the free market system, appealed to Shad in many respects.

  Pickens had another link to the SEC—through the conservative economist Gregg Jarrell. After Charles Cox was promoted, with Shad’s assistance, from chief economist to commissioner, Cox recommended Jarrell to be the next SEC chief economist. Shad agreed. Even more than his predecessor, Jarrell was committed to the doctrine and empirical work of the University of Chicago, where he had received his doctorate in economics. Soon, with Shad’s blessing, he was churning out studies at the SEC purporting to demonstrate that takeovers were good for shareholders and the country. Jarrell’s studies attracted widespread attention in the capital and across the country.

  Pickens noticed, and he telephoned Jarrell one day to tell him how much he admired the economist’s work. Soon they became friends—Pickens liked to call Jarrell the “boy economist” because of his youthful face and puckish manner. When Pickens came to Washington, he would call Jarrell and invite him to play racquetball. At lunchtime, Jarrell would stand out on Fifth Street, gym bag at his side, waiting for the sleek limousine in which Pickens invariably traveled to pick him up. The slick concrete veranda before the entrance to SEC headquarters was a popular picnic ground for commission staff on sunny days in spring and summer, and Jarrell sometimes felt that he was the target of icy, disapproving stares from enforcement lawyers when he climbed into Pickens’s limo. Jarrell didn’t mind. He thought the whole scene was funny. He was committed deeply to the cause of free market deregulation, and he generally thought of his colleagues in the SEC bureaucracy as amiable but confused people who didn’t understand what was good for the country. If the limousine coasting down Fifth Street and the racquetball games and the casual telephone calls from Pickens were a symbol of how much was changing at the SEC, Jarrell thought it was all for the better.

  As he flew to New York that June, miles above the familiar corridor—fingers of the Chesapeake poking the Maryland shoreline, the gray brown grid of Philadelphia, down over the muddy industrial wasteland of northern New Jersey, banking finally into LaGuardia—Jack Shad must have understood that, for the first time, he was about to change the nature of the political debate in Washington over corporate takeovers.

  The speech he carried in his briefcase represented a major departure from the SEC’s public posture about corporate takeovers. There could be no doubt about its impact. In the months since the SEC’s open meeting in March, the political controversy about Milken and Pickens and junk bonds had only deepened. Reform legislation, some of it drastic, was moving quickly through the House and Senate. It still wasn’t clear where the White House stood—amid the volatility of the continuing election campaign, some strategists in the administration were urging caution. Since Reagan wasn’t inclined to push for drastic curbs on mergers, it was hard to see how his campaign could capitalize on the political controversy over takeovers. A potentially large number of blue-collar workers and others felt that their jobs and communities were threatened by the takeover boom, but there was no political constituency in favor of takeovers, other than wealthy corporate raiders, investment bankers, stock traders, and conservative intellectuals—a narrow spectrum of Reagan loyalists. Silence from the White House on the takeover issue heightened interest in the SEC’s position, not only because of the agency’s regulatory jurisdiction, but also because Shad was a Reagan appointee who had toed the administration’s line on other controversial issues, such as the budget.

  The SEC was supposed to be an independent agency and the truth was that so far, Shad had developed little intimacy with the White House. Perhaps if Pat hadn’t fallen victim to the stroke, if they had taken the house in Kalorama and worked their way onto the right social lists, it would have been different. But commuting every week between Park Avenue and Georgetown, Shad had little time for Washington society. On week nights, he buzzed in and out of cocktail parties, quickly returning to the SEC or to his hotel room to work and to eat alone. So divorced was Shad from doings on Pennsylvania Avenue that once, when he wanted to discuss financial regulation with Vice-President Bush, he had to dial directory assis
tance to get the White House phone number. When he reached Bush’s office, Shad had trouble persuading the aide who answered the phone that he was actually the chairman of the SEC. Those who knew who Shad was generally considered him a loyal soldier, but Shad was not a member of Reagan’s cabinet and was not required by law or custom to submit to the administration’s views on political or economic issues.

  Yet Shad felt acute pressures that spring to take a bold stand on takeovers. Ever since the takeover frenzy on Wall Street had begun, Shad had been worried about the debt being amassed on corporate balance sheets—that was the one aspect of the new merger game that didn’t square with the way Shad approached corporate finance during his own career on Wall Street. Moreover, two of the social and professional friends he respected most, Wall Street takeover lawyer Marty Lipton and former SEC commissioner A. A. Sommer, continually urged him in private to stop the takeover wave before it undermined the nation’s economic base. Sommer even gave Shad an antitakeover article he had written, titled “Hostile Tender Offers: Time for a Review of Fundamentals,” as a key part of his effort to spur Shad to action. Executives from the powerful Washington lobby called the Business Roundtable, whose corporate members were directly threatened by takeovers, also urged Shad to speak out, to fill the political vacuum created by the White House.

  Shad began to write a speech—a bold new assessment of the takeover boom. Before he left for New York to deliver it before a gathering of the New York Financial Writers Association, Shad circulated a draft to several of his senior staff.

  “The Leveraging of America” was its title, and when he saw it, Gregg Jarrell was stunned and alarmed. “B.S.!” he scribbled in the margin, making so many marks on the page that he turned his copy red. “You’ve got no evidence.” Commissioner Cox, Jarrell’s soul mate from the Chicago School, told Shad outright that delivering the speech was a bad idea.

  A lot of the things in that speech don’t have any sound economic basis or support, Cox told Shad. They seem to be out of character with the stance you have taken on takeovers in the past.

  Shad defended himself. He said he was going to deliver the speech.

  “My purpose is not to sound a note of alarm,” he said when his audience in the midtown-Manhattan ballroom of the Sheraton Centre Hotel had quieted, “but to ventilate some of the major issues.” Few paid much attention to this disclaimer. Shad’s speeches tended to repetition, and a phrase like “ventilate some of the major issues” sounded like a euphemism for “put everyone to sleep by telling them things they already know.” The SEC staff made fun of Shad because he not only talked about the same topics over and over, but also used the identical words in speech after speech. He sounded like an old political sound truck, repeating a single message as it circled the streets.

  But this night was different. “In today’s corporate world, Darwin’s ‘survival of the fittest’ has become: ‘Acquire or be acquired,’” Shad intoned boldly. “… The more leveraged takeovers and buyouts today, the more bankruptcies tomorrow.”

  Shad acknowledged that shareholders reaped huge economic benefits from the premiums paid for stock in takeovers, but he warned that if the effect of mergers was to substitute debt for stock across the economy, not only shareholders but also the nation would be at risk. “The leveraging-up of American enterprises will magnify the adverse consequences of the next recession,” he said. Shad’s analysis ranged far beyond the normal purview of the SEC, to a discussion of global economic policies. He argued that highly leveraged takeovers—and there could be little mistake on that early-summer evening in 1984 that Shad was referring in large part to Drexel’s roaring junk bond machine—hurt the ability of U.S. companies to compete abroad effectively because they had to devote too much cash to paying off debt.

  Most startlingly of all, Shad attacked the central theory on which Pickens and Milken and the rest politically justified their debt-financed hostile takeover bids.

  “The theory that contested takeovers discipline incompetent managements is of limited veracity,” he said. “Corporations have momentum. Today’s corporate performance and stock prices are in large measure a function of yesterday’s decisions by prior managements—whether good or bad.… Outstanding executives are often engaged to turn around ailing enterprises. The market prices of such companies’ shares often lag their improving prospects, and they become attractive takeover candidates because of the competence—not the incompetence—of the managements. Also, contrary to a discipline, the increasing threat of being taken over is an inducement to curtail or defer research and development, plant rehabilitation and expansion, oil exploration and development, and other programs which entail current costs for long-term benefits.… Companies that do not replace aging facilities and declining resources become increasingly inefficient.”

  Shad hedged by adding that “it would be as wrong to overreact to these issues as it would be to ignore them,” but that qualifier did little to alter the impact of his speech. As the first serious public doubts about the efficacy of the takeover boom voiced by a member of the Reagan administration, Shad’s remarks made news worldwide. For anyone who had followed his career at the SEC, it was clear that he had journeyed far beyond the usual tired phrases about liquidity and efficiency and the United States having the best, the broadest, the fairest capital markets in the world. Instead, the chairman of the SEC had delivered a major economic-policy statement and come down clearly on the side of those who said that, in the long run, the leveraging of America through corporate takeovers was perilous to the nation’s health. So proud was Shad of his address that when he returned to Washington, he asked an aide to mail copies to business leaders throughout the nation, including the chief executives of the Fortune 500—the largest corporations in the U.S.

  That mailing list suggested that Shad understood the constituency for his manifesto: not most of his old colleagues in Wall Street investment banking but, rather, their clients, the chieftains of the corporate establishment. They were the ones who feared the power of Milken’s junk bond warhead most of all, just as Boone Pickens had been saying all spring on Capitol Hill. As the import of Shad’s speech filtered and circulated through the capital, it was hard for some to reconcile its ideas with the oft-stated views of the SEC chairman. In some ways, “The Leveraging of America” mirrored precisely the lobbying pamphlets of the Business Roundtable and the position papers of congressional Democrats. To them, the speech provided the clearest endorsement yet for the takeover reform legislation pending in the House and Senate.

  Even those closest to Shad professionally were dumbfounded by his speech. They didn’t understand where it had come from—it was like a shot from the blue. In nearly every other way, Shad had guided his tenure at the SEC by the lights of Chicago School theory. What could have prompted him to deviate now? Chicago School adherents like Jarrell speculated that Shad must have been influenced by the Wall Street friends he saw on weekends—lawyers and investment bankers who earned their livings defending large corporations against takeovers, and who were looking to help their cause by restricting the availability of debt for their opponents in the game. Friends of Shad on the Business Roundtable side of the issue saw it differently: After much effort, they thought, some people Shad trusted, such as takeover attorney Martin Lipton, had finally knocked some sense into the SEC chairman. But the truth was that Shad’s speech was an enigma. It was in many respects inconsistent with other policies he believed in, and it was unsupported by other speeches or private comments by Shad expressing serious doubts about takeovers.

  Did Shad understand the political implications of his speech, coming in the midst of a volatile election year? What if legislation to curtail mergers, implicitly endorsed by Shad, somehow spooked Wall Street, leading to a sharp fall in stock prices and fears of a recession just as the election approached? The possibilities were myriad—and to more than a few senior Reagan administration officials, disturbing. Whether or not Shad appreciated the full political cons
equences of his speech, some key conservative officials in the administration and at the SEC were determined to make him understand. Within weeks after Shad delivered his remarks in New York, a private campaign was under way within the administration to alter drastically the SEC chairman’s public approach to corporate takeovers.

  11

  Leaking

  When Jack Shad started seeing stories in the newspapers about confidential SEC studies on takeovers, he suspected he knew the source of the leaks. The way to figure out where leaks came from in Washington, Shad had learned from his early experiences with Dingell, was to pinpoint who stood to gain. Sometimes that was difficult, because the bureaucratic competition or office politics from which a leak arose might be hidden entirely from public view. But in the case of the stories about corporate takeovers that began to appear after Shad’s “Leveraging of America” speech in June 1984, the calculation was relatively simple. The point of the stories was that the SEC had begun to discover, through careful and empirical study, that hostile corporate takeovers—even those involving such controversial practices as greenmail and golden parachutes—actually were beneficial, not potentially harmful, to the economy. Confidential studies undertaken by Jarrell’s office of the chief economist were quoted from in the newspaper stories, and it was clear that somebody familiar with Jarrell’s work was talking regularly to reporters in violation of SEC policy. Shad thought the source likely was Jarrell himself.