Eagle on the Street

by Coll, Steve; Vise, David A. ;

  Fedders’s enforcement staff, despite their devotion to prosecutions of insider trading, had not been able to present evidence to Shad that Boesky engaged in illegal conduct. Boesky had been a subject of enforcement inquiries since before Shad arrived at the SEC. An early commission investigation, in 1974, was typical of those that followed. SEC staff noticed that Boesky, then an employee of the Wall Street firm Edwards & Hanly, had aggressively purchased shares of the movie company Twentieth Century Fox and then sold them at a profit to an investor named David Merrick, before it was known that Merrick was considering a takeover bid. The SEC asked Boesky to testify about where he had gotten his information, but during the interrogation, which occurred two months after Boesky’s suspicious trading, the arbitrager claimed that he could not remember much of anything about the deal. “I specifically don’t recall any of my discussions with anyone, but I probably had some discussions,” Boesky testified. “If you asked me fifty-eight days ago what my conversations were, I probably would have had a more specific response.” He even denied knowing who it was he had sold his stock to at a profit. He only found out it was Merrick, he said, “when I read about it in the newspaper.”

  The investigation went nowhere, for the same reason that most SEC insider trading probes of active Wall Street traders like Boesky went nowhere. Boesky was trading in the stock market all day long, buying and selling shares, talking to lawyers, chatting with investment bankers, trading gossip with other arbitragers. When asked during an investigation how he learned a particularly profitable piece of information about a takeover, Boesky could claim that he read it in a newspaper, that he did not recall, that he overheard two men talking in an elevator, or that he pieced it together from random conversations with numerous market professionals—all perfectly innocent explanations. In most insider trading cases filed by the SEC, the defendant was someone who rarely traded stocks and got caught because he made an exceptional purchase based on inside information, a purchase that was difficult to explain if the buyer didn’t have an inside tip. Boesky, though, always had a reason to be trading the stocks of takeover targets. After all, that was his business.

  Driven by Shad’s edict to crack down on insider trading, Congress passed a new law in 1984 that substantially increased the financial penalties for insider trading. Instead of a slap on the wrist that involved only giving up illegal profits, inside traders could be forced to pay treble damages. While the SEC filed as many as two dozen insider cases each year during the early 1980s, none were against the powerful market professionals who operated at the heart of Wall Street. Without a cooperating witness, a stool pigeon who could contradict the memory lapses and vague claims of witnesses like Boesky, many of Fedders’s top enforcement staff felt there was nothing they could do. All they typically had was sketchy circumstantial evidence, certainly not enough to take to court.

  Many of the enforcement lawyers who questioned and investigated Boesky did not doubt his word or consider him dishonest. On the contrary, though Boesky could be arrogant and difficult, he also was regarded by some enforcement lawyers as a highly knowledgeable and exceptionally valuable source of information about how the stock market really worked. Boesky testified in more than ten confidential SEC investigations during the 1970s and 1980s, but usually he appeared voluntarily and provided what was believed to be useful data about events and patterns of trading in specific takeovers. During the late 1970s, the SEC questioned Boesky about trading in takeovers involving United Technologies and British Oxygen Corporation, and in the early 1980s, he was questioned as part of an investigation into a takeover battle involving the Wall Street firm Paine Webber. But Boesky was not the sole target of these SEC investigations, and the commission never filed insider-trading charges against him.

  In its two principal areas of responsibility—making regulatory policy and enforcing the securities laws—John Shad’s SEC had done little by 1984 to hinder Ivan Boesky’s extraordinary rise on Wall Street. The Dr Pepper case, the investigation that brought Boesky to SEC headquarters in his limousine on a weekday morning in 1984, was supposed to be different.

  Not only had Boesky profited enormously by trading in Dr Pepper stock in advance of a public takeover announcement, not only did he have a web of personal and financial connections to people involved in the takeover, but Fedders’s staff had developed credible evidence that Boesky had tried to obtain inside information about the Dr Pepper deal before he traded in the company’s stock.

  The enforcement attorneys had pieced together a colorful, detailed chronology of Boesky’s involvement with the Dr Pepper takeover even before Boesky arrived at SEC headquarters and began to blow cigar smoke at the staff. The chronology was based on records subpoenaed by the commission and testimony provided by some of the executives and Wall Street bankers who had participated in the deal.

  The story, as the SEC staff understood it, began in 1978, when Ted Forstmann, a former Yale hockey goalie with a knack for sales, visited Boesky in his lower-Manhattan office and asked if he wanted to become a limited partner in a new investment firm called Forstmann Little & Company. The firm, Forstmann said, would specialize in leveraged buyouts, deals in which public companies were acquired using mostly borrowed money. The goal was to identify stocks of public companies that were undervalued, seek control of those companies through friendly takeovers, and then try to make money.

  The profits would come in several ways, Forstmann explained. Generally, an investor like Boesky could expect to make a hefty financial return of five to ten times his money within three to five years. In some cases, the profits would come when Forstmann Little sold the companies it acquired. In other cases, after improving operations and giving the managements of the acquired companies ownership incentives to run their businesses more efficiently, Forstmann Little would profit by selling shares in the companies back to the public. Though the deals were risky, Forstmann was cautious—he was fearful of doing a bad deal and wanted to proceed carefully.

  Boesky agreed to become a partner. Not only could he make a lot of money, he figured, but working with Forstmann would widen his network of contacts and keep him attuned to the flow of information about takeovers on Wall Street.

  Boesky and Forstmann had never met before Forstmann solicited the arbitrager’s investment, but in the next few years they developed a closer personal relationship, especially as Forstmann Little grew and prospered, becoming one of the most successful leveraged-buyout firms in the country. Forstmann Little’s first acquisition—the $420 million purchase of a North Carolina furniture company in 1980—had led to a public sale of stock that reaped ten times the initial investment for Forstmann’s partners. Boesky decided that he wanted to know Forstmann better, so he invited him to appear as a guest lecturer at a finance course Boesky taught at Columbia University.

  Boesky pressed to get even closer. In the fall of 1983, he invited Forstmann and corporate raider Boone Pickens, along with some Wall Street executives, to a Sunday dinner at Boesky’s Westchester County estate. (Boesky told Pickens to dress casually, so he wore an open-neck shirt and blazer. Boesky, clad in a double-breasted navy blue suit, offered to lend Pickens a tie. “I don’t borrow ties or shotguns,” Pickens replied.) Before dinner, Boesky asked Forstmann to take a walk with him through the sculpture gardens he maintained behind his mansion.

  “Are you guys busy these days?” Boesky asked Forstmann as they strolled past Renaissance busts and ancient Greek torsos.

  “Yes.”

  “What are you working on?”

  “Dr Pepper,” Forstmann answered.

  “What do you think it is worth?”

  “I don’t know, I have no idea,” Forstmann said.

  In the weeks that followed, Boesky pelted Forstmann with telephone calls, asking him how things were going. For Boesky to buy Dr Pepper stock on the basis of confidential information about an upcoming Forstmann Little takeover bid would violate insider-trading laws. But Forstmann, who thought of Boesky as a partner an
d investor in his firm, rather than as a professional speculator who might buy Dr Pepper shares, often answered Boesky’s questions.

  On November 17, 1983, Forstmann and his partners submitted a $22 a share, $623 million cash offer to take control of Dr Pepper. The company’s directors approved the Forstmann offer and a final agreement was signed on December 3. Boesky earned millions of dollars in stock trading profits by selling the Dr Pepper shares he had accumulated before the takeover was announced.

  It was the walk in the sculpture garden that most intrigued the SEC enforcement staff. It seemed clear to the commission lawyers that Boesky had acquired inside information about Forstmann Little’s interest in Dr Pepper. The question was whether the SEC could prove in court that Boesky had used that information to purchase Dr Pepper shares.* One problem was that the Wall Street Journal had published a story before the walk in the sculpture garden saying Dr Pepper was for sale. Fedders’s staff knew that Boesky might claim he had bought the stock on the basis of rumor or newspaper reports or the phases of the moon. “I swear I didn’t know Forstmann Little was going to make a [$22 a share] bid,” Boesky told a colleague in New York before he flew to Washington for his interrogation at the SEC. To this colleague it sounded more as if Boesky were rehearsing for a play.

  Boesky parroted that denial in the fourth-floor conference room clouded with cigar smoke that day in 1984. The commission lawyers pressed him about his Dr Pepper trading. Why had he bought the stock? How had he learned of an impending takeover at the company? What did he make of Ted Forstmann’s responses in the sculpture garden?

  Boesky refused to yield. He told the SEC lawyers that he hadn’t traded a single share of Dr Pepper stock on the basis of inside information. About the details of the enforcement staff’s chronology, Boesky was somewhat vague. Witnesses in SEC insider trading investigations often were.

  Ivan Boesky understood this much: Without an inside witness against him, without a Marty Siegel or Michael Milken, there was no way the Securities and Exchange Commission could touch him.

  When the deposition was over that afternoon, Boesky and his entourage rode the elevator back down to the commission lobby. Boesky climbed into his black stretch limousine and rolled away—he planned to fly back to Wall Street on his private plane. To his lawyers and colleagues, he appeared confident about how things had gone. None of them knew about Boesky’s secret, criminal alliances. None of them knew, either, whether Boesky had told the truth upstairs on the fourth floor.

  For their part, the senior attorneys in the enforcement division, led by Fedders, felt frustrated. They felt it was important for the division to mount an insider trading prosecution against a major market professional. The Dr Pepper case had seemed promising, but after Boesky’s deposition, the investigation was stymied—the circumstantial evidence was so limiting, and if charges were filed, the trial would come down to Boesky’s word against the commission’s. That wasn’t enough for Fedders to make a positive recommendation to Shad and the other commissioners. Besides, Fedders’s staff had only its suspicions, no real proof that Boesky had traded Dr Pepper stock specifically because of his sculpture garden talk with Forstmann. In effect, Boesky had employed successfully the same defense he offered during the early SEC investigation of his trading back in 1974—“I read it in the newspaper.” In ten years, nothing much had changed.

  * After the SEC investigation of Boesky’s Dr Pepper trading, Forstmann Little & Company asked Boesky to sign an agreement promising that he would not be an active trader of the stocks of companies that Forstmann Little was pursuing. Boesky initially resisted signing such an agreement, but later did. However, it is believed that he did not live up to all of the agreement’s terms, and continued trading in certain situations where Forstmann Little had an interest in making an acquisition.

  13

  Confrontation

  “Be reasonable,” Fedders told him over the telephone, but the words only seemed to make Bobby Lawyer angrier.

  There is no question but that Merrill Lynch and Company deserves to be publicly charged with fraud, Lawyer kept saying, his voice rising each time he had to argue the point again.

  Yet he couldn’t get through, and he was frustrated. Lawyer was in San Francisco, where he headed the commission’s Bay Area branch office, while Fedders was on the fourth floor of SEC headquarters in Washington. Lawyer could only defend himself and the work of his office by telephone, a limited means of communication for an attorney used to prancing and arguing in a courtroom. It was late in 1984—more than two years after Lawyer’s office had initiated a major confidential investigation into alleged securities fraud by a Merrill Lynch broker in San Francisco, and into the failure of the largest Wall Street brokerage firm to detect and stop the broker’s wrongdoing. Now Fedders was telling Lawyer that one of the San Francisco office’s main recommendations, that Merrill Lynch be named in the case as a defendant, was meeting stiff opposition in Washington.

  All Lawyer had was the telephone, so he kept using it. He peppered the commission’s headquarters with calls—to Fedders, to the general counsel’s office, to the staffs of individual commissioners, to the commissioners themselves. He argued, prodded, questioned, and generally made himself a nuisance. Lawyer and some of his colleagues in San Francisco had decided that even if their stridency somehow hurt their careers by angering their superiors at headquarters, they would push as hard as they could. Within weeks they had set the stage for a tumultuous confrontation over commission policy with SEC Chairman John Shad.

  It came just as Shad was consolidating an uneasy truce with the SEC bureaucracy. The senior staff who on most days of the week drifted in and out of loosely structured meetings in the chairman’s expansive office suite in Washington were loyal to Shad. Fedders had a tight grip on the policies of the enforcement division, and he consulted regularly with the chairman. Linda Quinn, who had managed the takeover advisory committee and then become Shad’s chief of staff, was indefatigably efficient, able to match the chairman’s relentless pace. Dan Goelzer, Shad’s first chief of staff, had moved over to become general counsel, a job he had always coveted, and his personal rapport with Shad along with his unique skills as a politician within the bureaucracy gave the chairman a new control over the commission’s legal policies. Rick Ketchum in the market regulation division seemed more amenable to Shad’s deregulatory approach than his predecessor had been.

  There were new and friendlier faces among Shad’s four commission colleagues as well. When free market economist Charles Cox came on board as a commissioner, he replaced John Evans, the Republican and former SEC staff member who had so often opposed the chairman on enforcement matters. Shad’s rival on budget issues, Barbara Thomas, also was gone. The two Democratic commission seats were occupied by newcomers, former congressional staffer Charles Marinaccio and Los Angeles attorney Aulana Peters. Neither of them shared Shad’s ideology but they had no history at the commission, either; no emotional ties to the staff or its agenda. One of the Democrats had replaced Bevis Longstreth, the Manhattan attorney whose friendship with Shad had helped to bridge the political differences between them.

  Longstreth’s 1984 farewell party in commission headquarters had focused attention on the friction in Shad’s relationships with the other commissioners and especially with the staff. At the party, Longstreth had a piano hauled into the room and he serenaded Shad and the gathered staff with an original solo—“Ruler of the SEC”—to the tune of “When I was a lad” from Gilbert and Sullivan’s H.M.S. Pinafore.

  When Shad was a lad he served a term

  As office boy to the Hutton firm.

  He crunched the numbers and made deals galore

  And fed himself abundantly on free market lore.

  He praised the free market so zealously

  That Reagan made him ruler of the SEC.

  He signed on Fedders as enforcement mate

  And pledged him sternly to deregulate.…

  In laying plans John fail
ed to note

  That Congress allotted him just one vote.…

  Yes, the Congress had decreed for the SEC

  A five-headed beast to act collegially.

  How we would vote was hard to tell:

  Each wanted power, had no vote to sell.

  ’Gainst inside trading there was broad concensus

  But on the budget Shad stood against us.

  In budgetary matters we agreed to disagree

  With the Reaganomic ruler of the SEC.

  Our Chairman said I’m for competition,

  But on 415 to the Street I’ll listen.…

  Yes, shelving the rule might be the key

  To industry affection for the SEC.

  Commissioners come and Commissioners go,

  Hemming in their Chairman, be he John or Joe.

  And Congressmen, feigning oversight,

  Holler to the press and pretend to fight.

  Yet to each comes this discovery:

  It’s the staff who rule the roost at the SEC.

  “Bevis,” Shad declared amid resounding laughter, “leave us.” They could laugh with and at each other in SEC headquarters, bound by mutual dependence, familiarity, and genuine affection. Yet in some respects the import of Longstreth’s lyrical insights was greatest for those staff who never heard his song. Out in the SEC’s far-flung bureaucracy, among a number of the staff who did not meet with Shad daily, whose careers were not lifted by his patronage, resentments festered. This was especially true in the fifteen SEC regional and branch offices scattered around the country, where hundreds of attorneys, accountants, and investigators worked on enforcement cases and inspections that often seemed tedious and unappreciated by headquarters. Nearly all the headline-grabbing insider trading cases were managed by an elite group that worked closely with Fedders and Shad in Washington.