Eagle on the Street

by Coll, Steve; Vise, David A. ;

  Jarrell was disappointed when, at the SEC open meeting in March of 1984, Shad and the other SEC commissioners responded to the advisory report by recommending new laws to Congress. But he was horrified three months later when Shad traveled to New York to deliver his “Leveraging of America” speech. Jarrell feared Shad’s speech would add momentum to the push for sweeping takeover restrictions in Congress.

  Shad’s speech set off alarm bells across the Reagan administration, and within weeks there was talk that Shad had met with Treasury Secretary Regan to clarify his position on takeovers. For months prior to the speech, the White House had done nothing about the swelling debate over takeovers in Washington. The election campaign was in full swing and an air of caution had settled over administration policymaking. Shad’s speech, which was received as a major economic policy pronouncement by the Reagan administration even though it was never cleared by the White House, helped to shake the administration from its lethargy. A task force was formed hastily at the White House—Shad wasn’t invited to join—to develop an official administration position on takeover policy and legislation. And privately, unofficially, relentlessly, Gregg Jarrell began a campaign inside the SEC to influence Jack Shad about takeovers and pull the commission back from any attempt to restrict or regulate them. “I tried to move him wherever the administration wanted to go,” Jarrell said later. “The administration’s view was that Shad was off the reservation.” In conversations with Ginsburg, DeMuth, and others, Jarrell assured his allies that he would do everything he could to prevent Shad and the SEC from pushing tough new laws or regulations restricting junk bonds or corporate takeovers.

  Jarrell’s private campaign was multifaceted. Leaks of his economic studies to the press attracted attention for Jarrell’s free market theories supporting takeovers and helped to undermine the public impact of Shad’s caveats about debt and junk bonds in his “Leveraging of America” speech. Working within the SEC, Jarrell began to arrange lines of informal communication between Shad and key economic policy makers in the administration. Jarrell thought he was only helping Shad by putting him in closer touch with the White House, which held the keys to Shad’s political future. In June, shortly after Shad’s speech, Chris DeMuth at the Office of Management and Budget had sent a memo to the cabinet recommending that the administration study takeovers and speak out against unnecessary curbs—action was necessary, DeMuth’s memo noted, not only because the Democrats were pushing drastic legislation in Congress, but also because John Shad and the SEC supported new rules and laws with which the administration might be uncomfortable. Jarrell wanted Shad to understand how key policy makers and economists in the administration reacted to his speech. He invited Doug Ginsburg to a brown-bag lunch in Shad’s office with the chairman and some of his senior staff. One of the topics discussed over lunch was the danger of attempting to regulate greenmail, and Ginsburg was articulate, forceful, and persuasive. Later, Shad invited Ginsburg to testify at a public SEC meeting called to reevaluate the commission’s position on pending takeover reform bills in Congress. Jarrell considered the budding intellectual alliance between Shad and Ginsburg one of his greatest achievements in government, though others at the commission thought Jarrell’s role in this and other matters was not as important as Jarrell tended to view it.

  Jarrell wanted to do more than lobby Shad and issue studies in favor of takeovers, so he developed relationships with key senior SEC staff who had responsibilities for takeover regulation. Among them was Joe Connolly, who headed the Office of Tender Offers in the corporation finance division. Connolly had come to the SEC straight out of law school in Washington, and had worked his way up through the bureaucracy to a position just beneath division director John Huber. Connolly’s father had been a staff attorney at the SEC during the 1940s, before embarking on a career as a securities lawyer in Manhattan—Connolly, then, was a second-generation SEC bureaucrat. Because he talked daily with the Wall Street lawyers involved in takeover fights, Connolly and his small staff wielded considerable authority over the commission’s day-to-day approach to takeover regulation. His office also proposed technical changes to the SEC’s takeover regulations, changes that sometimes had a significant influence on the merger game.

  Jarrell watched Connolly carefully, and he kept his eye on the commission’s calendar of closed meetings. Whenever a takeover rule change came up for an SEC vote, Jarrell would rush down to Connolly’s office and try to obtain from him in advance the staff memos and other documents that would eventually be submitted to the commissioners. If he succeeded, Jarrell would promptly draft a rebuttal paper promoting his free-market viewpoint, and at times he would meet with his intellectual ally, Commissioner Cox, to discuss his position on the issue. Connolly opposed Jarrell on takeover issues occasionally, but Jarrell considered him compliant. “Joe was a guy who knew where his bread was buttered,” Jarrell said. For their part, Connolly and other senior staff who supervised takeover regulation within the corporation finance division viewed Jarrell as the single most influential SEC official on takeover issues, and as someone who exercised increasing influence over Jack Shad’s positions.

  It wasn’t just Jarrell’s personal energy and influence that intimidated senior SEC staff who were otherwise inclined to take a bolder approach to takeover regulation, in 1984 and 1985, as more and more mergers and greater amounts of debt swept through the nation’s economy. When the staff tried to check abusive takeover tactics through direct, hands-on regulation and law enforcement—as opposed to the changes in rules and laws backed by Shad at the open meeting in March 1984—they were handed a series of devastating defeats in court.

  In one case initiated by Connolly’s office and backed enthusiastically by John Fedders and other attorneys in the enforcement division, the SEC sued the Los Angeles–based retailer Carter Hawley Hale for allegedly violating SEC rules governing the purchase of large blocks of its own stock during a takeover fight. To defend itself against a hostile takeover bid from The Limited, an Ohio-based competitor, Carter Hawley Hale purchased stock in the open market equal to more than half of its own shares, thus defeating Limited’s attempt to buy a majority of Carter Hawley Hale’s stock. Connolly, Fedders, and Gary Lynch, who had replaced Ted Levine as the number-two attorney in the enforcement division, agreed that Carter Hawley’s aggressive tactic was a shortcut that violated SEC rules—the company shouldn’t have scooped up its shares on the floor of the New York Stock Exchange, but should have conducted a formal tender offer to all of its shareholders that would have enabled Limited to continue to press its takeover bid.

  The lawsuit attracted widespread attention because it marked one of the few times the SEC had intervened in the midst of an ongoing takeover fight. Since the commission chose to take the side of the raider, The Limited, the suit fueled congressional criticism that the SEC under Shad favored bidders over targets in takeover fights. Connolly and Fedders rejected that criticism, although Fedders conceded that on a personal level he tended to have more sympathy for raiders than for their corporate targets. Like Jarrell, Fedders thought takeovers were good for the economy and the country. During the Carter Hawley Hale case, the excitement of a contested lawsuit and the potentially decisive role the SEC played in the takeover created an atmosphere of camaraderie inside the commission. Old rivalries were set aside. Jarrell testified for the enforcement division that Carter Hawley Hale should be subject to the SEC’s takeover rules. Enforcement attorneys worked late into the night for days in succession to draft their legal briefs, and Lynch led a team to Los Angeles, where the suit was heard in federal court.

  But the excitement lasted briefly. The commission had asked the court in its suit to order Carter Hawley Hale to drop its antitakeover defense by ending the purchase of its shares in the open market. But federal judge A. Wallace Tashima ruled against the commission, saying the SEC had misinterpreted some of its own highly technical rules governing the conduct of takeovers.

  The defeat was thorough, deva
stating, and in the tightly knit world of takeover law and investment banking, deeply embarrassing for the SEC attorneys. At first they blamed Tashima, muttering that since he lived and worked in Los Angeles, he was a hometown judge biased in favor of Carter Hawley Hale and its executives and employees. Later, however, the federal appeals court in California affirmed Tashima’s ruling in all of its important aspects. Stung again, the SEC staff retreated. They grew increasingly reluctant to intervene directly during takeover fights for fear that they would be embarrassed again.

  In effect, the SEC took Tashima’s advice—instead of attempting to control the boom in takeovers and junk bonds through direct regulation or law enforcement, Shad and his colleagues focused increasingly on the economic policy debate about takeovers raging in Congress and within the administration. That was the forum Jarrell preferred. There he could influence Shad’s positions; Shad relied on Jarrell for data and information and he sometimes asked Jarrell to draft the testimony he delivered before Congress.

  Slowly Jarrell built connections between the ostensibly independent SEC and the key economic policymakers in the Reagan administration. He sent raw statistical data and advance copies of the studies about takeovers his staff produced to economists working in the Office of Management and Budget, and those economists in turn used Jarrell’s work to bolster the Chicago School’s position within the new administration task force on takeover policy.

  Jarrell believed strongly that in the battle for Shad’s heart and mind on the takeover issue, he and his Chicago School allies were competing against some of Shad’s closest friends on Wall Street, people like takeover attorney Martin Lipton. An outspoken skeptic about hostile takeovers and junk bonds, Lipton clashed openly with Jarrell as a member of Shad’s takeover advisory committee and later at SEC roundtable meetings in Washington, where experts were assembled to discuss takeover reform. As Jarrell explained it to his allies at Justice and OMB, the problem was that Shad flew each weekend to Manhattan, where he relaxed and dined with “these old cronies from Wall Street who were slamming Drexel and putting down junk bonds.” Lipton was one of the people Jarrell had in mind. To counteract the effect on Shad’s thinking of Lipton and other old Wall Street friends who were unnerved by the growth in takeovers—the value of corporate mergers more than doubled in 1984 to $126 billion, up from $52.6 billion in 1983, and there was about $90 billion in new corporate debt—Jarrell knew that Shad would have to be persuaded by his generational and political peers in the Reagan administration, men such as Regan and Federal Reserve Chairman Paul Volcker, with whom Shad consulted regularly about economic issues.

  For Jarrell and the cabal, the biggest breakthrough came on September 25, 1984, three months after Shad’s stunning speech about leverage, when with the approval of the administration’s takeover task force, Treasury Secretary Regan sent a letter to John Dingell, setting forth, for the first time, an official Reagan administration stance on pending takeover legislation.

  “Although some abuses have undoubtedly occurred, it is not sensible to enact legislation without more complete consideration of the consequences,” Regan wrote. “We urge Congress to refrain from adopting legislation governing this area until there has been a full public debate.… Corporate takeover attempts perform several beneficial functions in our economy. First, they provide a means—sometimes the only feasible means—of policing management conduct in widely held public corporations. Second, they help identify undervalued assets and permit shareholders to realize the true value of their investments. Third, successful takeovers help realize efficiencies by reallocating capital and corporate assets into more highly valued uses; enabling merger partners to generate joint operating efficiencies; and providing companies with access to financial, management, and other resources not otherwise available.”

  The stylized language—the references to “realizing efficiencies” and “reallocating capital … into more highly valued uses” and “joint operating efficiencies”—was drawn straight from the doctoral theses of the Chicago School economists. Takeovers were a beneficial symptom of the invisible hand of capitalism at work, Regan’s letter declared. Jarrell and his cabal were ecstatic. Just six weeks before a presidential election that already was shaping up as a massive triumph for Reagan, the administration had taken a public stand against the concerns about takeovers articulated by Jack Shad the previous June. Under the circumstances, a landslide win for President Reagan would implicitly endorse the positions in Don Regan’s letter. Moreover, Jack Shad never again publicly repeated the warnings sounded in his “Leveraging of America” speech—in the end, his speech was seen by friends and opponents alike as a puzzling aberration, a brief moment of doubt, or truth, expelled almost as quickly as it was voiced. Of course, few but those at senior levels of the SEC understood the effort Jarrell and his allies among the movement conservatives made in the attempt to change Shad’s position. Nor did they understand what a dramatic difference it made that Shad, having been rebuked for his words, forever abandoned his tough talk about the dangers of takeovers. Without the support of either the chairman of the SEC or the president of the United States, the takeover reform bills moving through Congress in the fall of 1984 died.

  And in the conduct of mergers and acquisitions, at least, the lid on Wall Street came off.

  12

  Dr Pepper

  Ivan Boesky sat in the back of a long, black limousine on a weekday morning in 1984 as his chauffeur negotiated the congested avenues of the capital, heading toward the corner of Fifth and D streets. He chattered on his car phone, speaking in short and sometimes cryptic bursts, as if this were just another trading day in the business of risk arbitrage, the arcane game of Wall Street stock speculation at which Boesky excelled. As his limo approached the SEC’s headquarters, Boesky called his office in Manhattan, checking in with his secretary for messages one last time. He was late. It was nearly 11:00 A.M., almost an hour past the scheduled start of Boesky’s interrogation by lawyers from the commission’s enforcement division.

  While Boesky cruised in his limo, his lawyers and aides had been milling around the SEC’s cavernous lobby, wondering what had happened. They kept checking their watches—10:15, 10:30, 10:45—and still, no Boesky.

  It’s not a good idea to keep the SEC lawyers waiting, one of them had remarked anxiously.

  Finally, they saw the stretch limo. Boesky hopped out and strode into the lobby. He wore a dark three-piece suit with an antique gold watch chain draped across the vest. With his silver hair, sunken eyes, and long, beaked nose, he seemed a caricature of the Victorian man of finance. In truth, it was an image Boesky cultivated assiduously.

  “Gentlemen,” he pronounced grandly as he entered the Securities and Exchange Commission, “I’m sorry I’m late. My plane was late.”

  There was no hesitation in his voice, no blinking or sideward glances, but several of the group suspected Boesky was lying. Some of them had taken commercial flights that morning from New York to Washington and had arrived without delay. Boesky had flown in his private jet, telling one of his advisers that he had some other business to attend to in Washington before the SEC deposition. Nevertheless, no one in the entourage challenged Boesky’s account. After all, Boesky was a multimillionaire, he paid their six-figure salaries and exhorbitant fees, and he had risen to become one of the most powerful traders on Wall Street during the 1980s. There was nothing to be gained by confronting him.

  Led by Boesky and Henry King, a prestigious trial attorney from the Wall Street firm Davis, Polk and Wardwell, who had agreed to represent Boesky before the SEC, the group passed a security guard’s station and entered a restricted area within the commission building.

  “Hi, Mr. Boesky,” a young man piped up, stopping them in their tracks.

  Boesky appeared puzzled; he looked at the fellow as if his face seemed vaguely familiar. The young man identified himself as the son of one of Boesky’s friends.

  I’m just finishing up with law school and doin
g an internship here at the SEC, he told Boesky proudly.

  Boesky smiled indulgently. This was a chance to talk about himself, the sort of invitation Boesky rarely refused. His voice acquired the peculiar tone of the successful man who tells embroidered stories about his past.

  When I graduated from law school, Boesky said, I wanted to intern at the SEC just like you. But I had a clerkship with a federal judge that I had to take.

  Boesky made it clear to all within earshot what a far more prestigious honor he thought his clerkship had been. He neglected to mention, however, that the judge he clerked for in his hometown of Detroit—The Honorable Theodore Levin—happened to be his wife’s uncle. He also didn’t mention that it wasn’t a particularly prestigious clerkship.

  Boesky and his attorneys left the young man in the hallway and proceeded to the end of a corridor on the fourth floor. A group of SEC enforcement-division lawyers was waiting for them in a small conference room. Boesky’s appearance at the commission that day was voluntary, in the technical sense that the enforcement lawyers had not issued him a subpoena compelling him to testify. But there was no question that Boesky was a key subject of an insider trading investigation by the SEC.

  The commission’s interest had been piqued by suspicious trading in the stock of Dr Pepper, the soft-drink company, which recently had been involved in a complex takeover deal. Records obtained by the commission’s staff lawyers showed that Boesky had made millions of dollars by trading in Dr Pepper stock before a takeover of the company was announced. At the same time, Boesky was an investor in the Wall Street firm that bought Dr Pepper. The circumstantial evidence raised an obvious question: Had Boesky acquired his Dr Pepper shares before the takeover because of illegal, inside information about what was about to occur?

  It was the sort of question the SEC enforcement staff had asked again and again about Ivan Boesky, yet they never seemed able to prove a case against him. Commission lawyers had questioned Boesky about suspicious stock trading on numerous occasions, dating back to 1974. There was no program in the division to target Boesky, but his name kept popping up in records of stock trading before and after announced corporate takeover bids. Of course, it was Boesky’s business to trade in the stocks of companies involved in takeovers, so it was only natural that his name would arise in records subpoenaed by the SEC, but the suspicious timing of his purchases and the huge sums of money he put into takeover stocks raised questions about where he got his information. For several years, Fedders had been frustrated by his division’s inability to prove an insider trading case against Boesky or any other big-time Wall Street arbitrageur, and his frustration was shared by senior enforcement lawyers such as Associate Director Gary Lynch. Some of the staff thought the Dr Pepper case offered the chance for a breakthrough.