Eagle on the Street

  This investigation already has gone on six months longer than it should have, Einhorn told his staff. It is time to do something where we have a chance to make a case.

  By that, Einhorn meant the smaller, simpler, more obvious insider trading and financial fraud cases that received too little attention in the office because there wasn’t enough staff. Einhorn and his staff felt in their guts that Milken had violated the securities laws, but they had only circumstantial evidence. As a regional administrator, Einhorn’s performance would be measured by Shad and the others in Washington largely in terms of the number of successful cases he filed in a given year. Far from providing a basis for a renewal of morale in Los Angeles, the Milken case was proving to be a debilitating drain.

  The case has to be closed, Einhorn said. Let’s forget about it and do something else.

  John Shad liked to repeat over and over that trillions of dollars of stock changed hands in the United States each year and that most of the transactions depended on trust and honesty. In Caesars, RCA, and scores of other deals, the day-to-day experience of the enforcement division tended to undermine Shad’s assumptions. The commission filed only about two-dozen insider trading cases a year, despite all the inquiries, all the charts and memos and phone calls from the stock exchanges alerting the SEC to suspicious trades. To some of the lawyers who worked so many months on investigations that yielded only memos for the file, the lesson seemed to be that only the bumblers got caught by the commission. That year it seemed that Shad understood—he surprised his colleagues at the SEC by suggesting that the agency should pay informants for information about insider trading. The enforcement lawyers who needed such help could almost write an Abbie Hoffman–like handbook about how to avoid detection by the SEC. If you were a lawyer or an investment banker, don’t trade the stocks of companies involved in deals on which you worked. If you do, make sure you trade in a foreign account beyond the SEC’s reach. If you don’t work on Wall Street, but you have a pipeline to provide you with inside information every now and then, your chances of getting caught, especially if you trade in small quantities and can invent halfway plausible alibis, seem very slim. The demoralizing truth was that on both Wall Street and Main Street that 1985, the calculation of risk and reward was tilting against the commission—the risk of getting caught by the SEC seemed minuscule compared to the enormous profits available by trading the stocks of takeover targets on inside information.

  John Shad was losing the war.

  16

  The Manipulation

  “If I find out who is leaking our positions,” Boesky warned, “I’ll kill.”

  He glared at them, so angry he seemed about to pop right out of his costume—the dark, vested suit with gold chain, the tailored white shirt, the worn loafers. There were moments like this when all of the props and trappings of legitimacy Boesky had so carefully arranged in his suite of offices high above Fifth Avenue seemed on the verge of collapse, like the rickety set of some off-Broadway play. (The Manhattan suite’s previous occupant, fugitive commodities trader Marc Rich, had been forced to flee hurriedly to Switzerland when federal investigators came knocking one day, so while the office was opulently appointed, it did not reek of solidity or permanence.) Something about the way Boesky pronounced his threat—the way he said the word kill—both frightened and intrigued his gathered staff of researchers and traders.

  It was just after New Year’s Day, 1985, but Boesky wasn’t feeling festive. The immediate cause of his distress was a newspaper report that the master speculator had suffered heavy losses in recent days when he was forced to dump millions of shares of Phillips Petroleum, the oil giant based in tiny Bartlesville, Oklahoma. Boesky had to sell because Boone Pickens, who had been pursuing a hostile takeover of Phillips, reached an unexpected peace treaty with the company’s management that caused the price of Phillips stock to fall below the price that Boesky had paid. The crisis had pushed Boesky into a kind of maniacal overdrive, a pace and fury even more exaggerated than his usual inhuman routine. He seemed to be shrinking into a haunted, almost skeletal figure. The embarrassment he felt over public disclosure of his financial loss apparently was the last straw.

  No one in this office is to talk to anyone outside of this office about what I am doing or why I am doing it, Boesky declared.

  The leak only added to Boesky’s paranoia, driving him to keep secrets from his own staff by leaving certain stock positions off the daily list distributed in the office. Those among his small senior staff who had reason to suspect the real basis for Boesky’s paranoia—illegal dealings—said nothing. They were well paid, and thus loyal, although perhaps more ambivalent about Boesky than the junk bond traders and salesmen in Beverly Hills were about Milken. (Boesky was not nearly so charismatic, and it was more difficult to think of him as an inspirational or innovative genius.) Many of them were young, in their twenties and thirties, although a few were a bit older and had been with Boesky since his early days on Wall Street. For all of them, these were good times. The business of speculating on the outcome of corporate takeovers had never been better.

  In fact, that January of 1985, the political and economic forces steadily gathering over the previous three years had finally achieved a kind of critical mass. Chicago School–inspired deregulation at the SEC, the triumph of free market theory in the debate over takeover legislation in Congress, the accelerating and largely unexamined growth of Milken’s junk bond operation, and the unrestrained use of capital for arbitrage speculation on Wall Street at last coincided in a frenzy of events. So much was happening at once. The deals piled one upon the other. But there was one deal—the contested, five-month battle for control of Phillips Petroleum—that seemed even in the midst of so much chaos to symbolize how much had changed.

  In Washington, they thought of the Phillips deal as a model for the continuing debate about the theory of unregulated takeovers. In little Bartlesville, a company town where Phillips was the principal employer, a benevolent but sleepy management was under siege by corporate raiders who said they could make Phillips better, richer. Was this good or bad for the country? they asked in Congress and at the SEC. Senators from Oklahoma bellowed that the good people of Bartlesville were suffering an assault no less egregious than rape. Defenders of Chicago School theory in the Reagan administration answered that if Boone Pickens could squeeze more value from Phillips than its present management, then Bartlesville and the nation would benefit in the long run. Jack Shad, pressured by both sides, indicated that he saw little to be corrected. He had raised his questions about the dangers of debt in corporate takeovers the previous June, alarming his allies in the administration, and he would stir controversy no more. He instead retreated to his earlier position that battles such as this ought to be left to the free market’s takeover warriors on Wall Street and in Corporate America, and that the ultimate arbiter of any contested takeover ought to be a company’s stockholders, not the SEC.

  Of course, it was what Jack Shad’s SEC did not see, what it could not see, that actually drove the Phillips takeover toward completion. Partly because of its embarrassing courtroom defeat in the midst of the earlier Carter Hawley Hale fight and partly because the headquarters staff was distracted by Fedders’s resignation, the commission didn’t investigate the Phillips deal until it was over, and even then the probe was desultory and unsuccessful. What the SEC missed was an elaborate manipulation, in some aspects clearly illegal and in others merely abusive, that defined and exemplified the corruption prevalent in influential quarters of Wall Street during 1985.

  At the core of the corruption was the intricate financial web that connected Ivan Boesky and Michael Milken. By the time of the Phillips deal in early 1985, they had grown accustomed to providing each other with favors, legal and otherwise, whenever the need arose.

  The Phillips deal began in Amarillo, Texas, where Boone Pickens reported to work at his corporate park each day, late in 1984, to face a taxing challenge: how to spend the $500 m
illion junk bond war chest raised for unspecified corporate purposes by Michael Milken.

  That fall, Pickens began to buy shares in two oil companies—Los Angeles-based Unocal Corporation and Phillips—trying to decide which one he wanted to put into play first. By purchasing the shares through partnerships, Pickens was able legally to evade certain federal disclosure requirements, enabling him to conceal his intentions and accumulate shares at relatively low prices. But word about what Pickens was doing began to leak to Wall Street, as it nearly always did, and by December 4, when Pickens finally announced his intention to raid Phillips, saying in an SEC filing that he owned 5.8 percent of its stock, the news surprised few of the professionals involved in takeover speculation. If the deal followed the pattern of Pickens’s previous bids, there would be a flurry of excitement and rumor and threats, and then Phillips would escape into the arms of a friendly merger suitor, a white knight, enriching Pickens and his allies with stock-trading profits but denying them their prize. In Bartlesville, the battle for Phillips was described as a mortal war over jobs and community and the future, but on Wall Street the truth was that Phillips was regarded as little more than a flickering green symbol on a Quotron trading machine, important because it was likely to vanish into electronic oblivion as soon as Pickens’s hostile bid played out and made the speculators rich.

  The terms of Pickens’s bid suggested that he was too poor to actually pay for Phillips. But this was only an inconvenience, easily overcome. For example, Pickens’s initial offer was to buy about 15 percent of Phillips for sixty dollars a share in cash. After that, he promised that somehow, he would buy the rest of the stock, worth billions of dollars. Pickens’s imprecise plans for this multibillion dollar transaction didn’t matter too much to speculators on Wall Street, since Pickens had never before actually bought the companies that he bid for. And if it did actually become necessary to pay for Phillips, Milken’s junk bond department could probably raise the funds by selling a new issue of risky debt or convincing Phillips stockholders to exchange their shares for junk bonds. In another era, the SEC would almost certainly have raised immediate questions about the vague financing arrangements in Pickens’s publicly filed takeover disclosures. When anybody asked Stanley Sporkin at the CIA about this sort of thing, he said that he would have ended the whole deal at the beginning by declaring that vague promises were not enough to start a takeover, that you actually had to have the money in place. But in late 1984 and early 1985, the commission’s policy under Shad was that as long as you disclosed your poverty honestly to the public, then it was up to the free market, and not the government, to decide whether your takeover bid should be taken seriously.

  Phillips took Pickens seriously—its management, led by chairman William Douce, was petrified. Douce attacked Pickens’s offer in the press and in the courts, trumpeting the usual themes about preserving jobs and community and country, but in secret his advisers called Pickens on the phone and asked if Phillips could buy back his stock at a profit and make him go away.

  Pickens was in a bind. He had promised publicly when he announced his bid that he wouldn’t accept greenmail from Phillips. But Douce’s offer was sweet. Moreover, the Organization of Petroleum Exporting Countries (OPEC), the international oil cartel, was having trouble propping up the price of oil, and Pickens feared that if he didn’t sell out soon, he might take a bath as world oil prices tumbled. So he wrestled with his conscience and mulled his dilemma for a few days, and on December 23, agreed to sell out to Phillips and break his promise to Wall Street.

  To relieved employees in Bartlesville, who had organized prayer vigils and donned BOONE BUSTER T-shirts to ward off the unwanted raider, Douce announced the deal: Pickens would renounce his takeover bid and sell his stock to Phillips for fifty-three dollars a share, handing the raider an $81 million profit for about two months’ work. At the same time, to discourage other raiders from launching debt-driven hostile takeover bids and to preserve the power and perks of top management, Douce said the company would replace 38 percent of its stock with new debt, establish an employee stock plan controlled by management, and take other vaguely articulated steps to keep its stock price up. To finance this wall of defense, Douce said Phillips would have to sell off about $2 billion of its assets. The company would survive, but it wouldn’t be the same. The plan was set for a stockholder vote in February 1985. As part of the deal, Pickens announced he would support mangement.

  Ivan Boesky heard the news over a crackling telephone line in Barbados, where he had fled the Manhattan chill for a brief Christmas vacation at the beach with his family. Livid, he rushed to the airport and clambered aboard a jet bound for New York.

  He was too late. By mid-December, Boesky’s firm had gobbled up Phillips stock madly, purchasing about 5 million shares. Boesky didn’t always have inside information about takeover deals, and sometimes he gambled heavily. This time, to buy so much Phillips stock, he had borrowed to the hilt. He had been comforted by Pickens’s public declarations that he would never sell out to Phillips in a greenmail deal that would hurt other stockholders. Moreover, because of his secret arrangement with Milken, Boesky had a pipeline to Drexel for information about hostile takeover bids. But Drexel wasn’t involved in Pickens’s decision to sell out, and in any event, Boesky had no advance word of Pickens’s decision to drop his takeover bid.

  Phillips stock plunged in price more than ten dollars a share when Pickens’s greenmail deal was disclosed on Christmas Eve. Those who had bought the oil company’s stock anticipating that Pickens, as he had done in the past, would force a merger at an exhorbitant price, now rushed to dump their holdings. When Boesky, panicked and furious, returned to Fifth Avenue, he joined right in, selling as fast as he could. The loans he had taken to finance his stock purchases were coming due minute by minute as the fall in the price of Phillips shares reduced the value of his collateral. Between December 24 and December 28, Boesky sold 2.3 million Phillips shares, suffering a loss of more than $22 million.

  He was angry—not only at his staff, for leaking the details of his calamity to the newspapers, but also at Pickens and Phillips and everyone else whom Boesky held responsible for his disaster. Among the tightly knit community of takeover speculators that had grown up so suddenly on Wall Street, there was a deeply emotional if utterly inconsistent code of conduct—basically, it was captured by the assertion, “He who causes me to lose money is morally wrong.” That January, this conviction about Phillips was shared by a large number of bereft speculators on Wall Street, many of them clients of Michael Milken. Around New York and by telephone to Beverly Hills, they began to discuss the possibility of revenge: Why not find another takeover bidder, back him up with junk bond financing, and put the heat on Phillips again?

  Milken and his salesmen and traders in Beverly Hills were intrigued. Virtually every takeover deal they put together, whether completed or not, generated tens of millions of dollars in advisory and financing fees. Because of the billions of dollars required to finance even a partial attempt for Phillips, the potential for fees in this deal was greater than usual. Then, too, because of the personal investment by Milken and his employees in Boesky’s arbitrage partnerships, Milken had a personal interest in creating an opportunity for Boesky to recover his losses.

  A series of meetings at Drexel’s Wall Street headquarters and at 9560 Wilshire ensued. Initially, Drexel officials telephoned several oil companies and suggested that they bid for Phillips. But Drexel’s relations with mainstream corporations were relatively weak, and in the fraternal oil industry, none of the major companies was willing to undertake an unwanted takeover.

  No matter—Milken wasn’t necessarily concerned about whether the bidder for Phillips knew anything about the oil business. Guts was just as important. Drexel flirted with the idea of backing Boesky, who seemed mad enough to make a run. But Boesky preferred to speculate on takeover deals rather than initiate them. For one thing, as a hostile bidder, he would be subjected to myriad l
awsuits and private investigations that might expose the secret arrangements he had with Marty Siegel, Milken, and others—arrangements Boesky worked hard to protect. So Boesky demurred. Instead, he called up his friend Carl Icahn and encouraged him to make a bid for Phillips with Drexel’s backing.

  Icahn, a blunt-spoken former options trader from Queens, New York, who had a reputation for making greenmail takeover raids and conducting tough negotiations, didn’t know the difference between an oil well and a fire hydrant. However, he knew a great deal about how to pressure a vulnerable corporate management team such as the one at Phillips. On Icahn’s Manhattan office walls were framed annual reports of all the public companies he had threatened with takeovers, and in every deal he had profited either through greenmail or the arrival of a white knight to rescue his target. As Pickens had been when he first began to accumulate Phillips shares the previous fall, Icahn was flush with cash from a recent junk bond financing engineered by Milken.

  On December 28, with Phillips’s stock price sagging from all the hurried sales by speculators, Carl Icahn began to buy.

  Shortly after he made his first purchases, Boesky called him up.

  “I hear you are involved with Phillips,” Boesky said.

  Yes, I bought some stock, Icahn replied.

  Boesky said he was angry at Phillips management, for reasons Icahn could appreciate. He suggested that Icahn join forces with him and launch a proxy fight at the meeting of Phillips shareholders scheduled for February, when the Pickens greenmail deal was to be put to a vote. In a proxy fight, Icahn and Boesky would attempt to win enough shareholder votes to defeat the greenmail plan.

  The best way to run an effective proxy fight is to do it in conjunction with a takeover bid, Icahn told Boesky. That way you put more pressure on the company’s management, which otherwise has unfair advantages in a proxy fight against outsiders.