Eagle on the Street

by Coll, Steve; Vise, David A. ;

  Boesky thought that was an interesting idea. He began to call Icahn every day, urging him relentlessly to lead a fight against Phillips management. In those same conversations, Boesky pressed and needled and maneuvered to learn everything he could about Icahn’s plans. The more he knew about what Icahn intended, the better off he would be when deciding whether to buy or sell Phillips shares.

  As part of his campaign, Boesky invited Icahn to his huge Westchester estate early in January. He said that he wanted to discuss strategies the pair could undertake to drive up the price of Phillips stock.

  Icahn arrived by car and settled in for a talk, surrounded by the Renaissance art and eighteenth-century furniture and ancient sculpture Boesky had acquired so voraciously during the previous three years.

  If we’re going to make a joint takeover bid for Phillips, Icahn told Boesky, you’re going to have to put up $100 million or $150 million in cash to help pay for it.

  Boesky indicated that they could discuss financing in detail later if they chose to go down that road. The truth was that Boesky often borrowed aggressively because he was short of cash. In fact, Boesky was so strapped for money, and so heavily leveraged, that at one point during the Phillips fight he was as much as $50 million in violation of SEC rules governing how much cash a registered broker-dealer must keep on hand. Boesky had been able to evade detection, and buy more and more Phillips shares, because of his secret trading arrangement with Milken. When Boesky exceeded the limit of his allowable stock holdings, he just called upon his arrangement with Milken and asked to transfer some of his Phillips shares to Drexel’s accounts, with the understanding that Boesky would buy them back at a fixed price and would protect Drexel against any losses it incurred while holding the shares. Moreover, Boesky agreed with Milken to split any profits made during the time Drexel held the shares. So even though he lacked the capital required by the SEC, Boesky kept borrowing and buying more. Given the importance of the upcoming shareholder vote at Phillips, it was like stuffing the ballot box to win the election. The more shares Boesky owned, the more power he could wield and the greater the likelihood he could shape, or help to rig, the outcome.

  Not long after meeting with Boesky in Westchester, Icahn decided he was going to make a takeover bid for Phillips, or at least that he was going to give the appearance of making one. Icahn’s bid would require about $8 billion in junk bonds, generating fees for Milken’s operation that could easily exceed $100 million. Milken said that he was so confident about this deal that, in a break with precedent, there was no need for Icahn to seek even a dime from commercial banks. Milken wanted to finance the entire $8 billion with junk bonds.

  All of them—Milken, Icahn, Boesky, the other Wall Street arbs who had bought large amounts of Phillips stock—understood that it was possible to make enormous sums of money just by threatening the takeover, even if it never was completed. The announced junk bond bid combined with an aggressive proxy fight would probably be enough to force Phillips into a “friendly” merger with another oil company or into sweetening the terms of its pending financial restructuring.

  On January 28, Icahn bought 2.74 million Phillips shares from Boesky. For weeks, Boesky had been talking almost daily with Icahn about becoming his cobidder, and at the same time he had discussed selling his stock at a profit to assist Icahn’s takeover plans. It was a technique for trading on confidential information similar to the one Boesky had used with Ted Forstmann in Dr Pepper, where Boesky gleaned inside information about Forstmann’s takeover plans because of his access as an investor in Forstmann Little and then used the information to make stock-trading profits as an arbitrager. Icahn didn’t mind. He needed Boesky’s shares to make his threatened bid for Phillips more credible. Because there was no reporting system at the New York Stock Exchange or the SEC sophisticated enough to identify immediately the buyers and sellers in specific stock transactions, no one at the commission knew for certain that day that Boesky and Icahn had made such an enormous private trade.

  Six days later Icahn announced a junk bond-backed, $55-a-share, $8 billion hostile-takeover bid for Phillips. He had relatively little cash to actually pay for the deal. Instead, Milken issued Icahn a letter saying Drexel was “highly confident” it could raise the money if called upon to do so. Icahn paid Drexel $1 million for the letter. Peppered with phone calls and other protests from Phillips headquarters in Oklahoma, the SEC voiced no objections.

  For his part, Milken was eager to begin raising the funds by obtaining firm commitments from junk bond investors. But Icahn was reluctant to move so quickly, because if he did he would have to pay Drexel millions of dollars in “commitment fees” even if he never used the money Milken raised. Since the principal goal of Icahn’s bid had all along been to drive up Phillips stock price, rather than to actually acquire and manage the oil company, it was unlikely the $8 billion in funds would ever be needed, and Icahn wanted to hold his costs down.

  Milken saw that in exchange for a mere $1 million “highly confident” letter, Icahn was now in a position to reap huge trading profits without actually selling any junk bonds. So as part of his deal with Icahn, Milken extracted a concession: Icahn reluctantly agreed to give Drexel 20 percent of his stock-trading profits whether he succeeded with a takeover or not, and regardless of whether a single junk bond was sold. Drexel was now an investor in the takeover attempt, a partner of Icahn’s rather than merely his investment banker or his agent.

  About five days after Icahn announced his bid, he met with Boesky again, this time over dinner at Icahn’s home north of Manhattan. Boesky wanted to discuss the Phillips situation.

  I’ve purchased another four million Phillips shares, Boesky told him.

  Icahn was pleased. Although Boesky’s disclosure marked a turnabout from two weeks before, when Boesky had sold more than 2 million shares to Icahn, Boesky’s new purchases provided Icahn with 4 million new votes for the upcoming proxy fight with Phillips management, scheduled for February 22 in Bartlesville. Icahn said plans were well under way for the proxy vote.

  Meanwhile, Douce, the Phillips chairman, convened meetings daily that month in Bartlesville and sometimes in Manhattan, working with his own stable of Wall Street advisers to thwart Icahn, Boesky, and Milken, and in the process, preserve the jobs of Phillips management at all costs. (Douce’s advisers, from the most blue-chip investment banks on Wall Street, charged Phillips millions of dollars in fees. They deplored Drexel’s role in the deal, they said, but in truth the crumbs from Milken’s table scattered far and wide.) With the pressure mounting early in February, Douce and his board of directors decided to greet Icahn with a blow to the ribs: They announced a “poison pill” antitakeover device designed to force Icahn to negotiate directly with Phillips management, compromising his right to take his offer directly to Phillips shareholders. The “pill” was a shareholder-rights plan that provided anyone who owned Phillips stock with the right to receive sixty-two dollars per share at the moment Carl Icahn bought 30 percent of the company’s stock. Icahn and Boesky denounced the plan as a management abuse, since it was designed to take fundamental rights away from Phillips’s stockholders and give them to the company’s entrenched management.

  The maneuverings grew so complex as the shareholder meeting approached that even Phillips’s sophisticated institutional shareholders found the tactics difficult to understand. Their bewilderment was compounded by the blistering pace at which Phillips shares changed hands, due in part to the side agreements and private meetings among Milken, Boesky, and Icahn that drove the deal.

  On Valentine’s Day, Icahn and Boesky took the stage at a meeting at the University Club in Manhattan, called to explain the upcoming vote in Bartlesville. The 150 Wall Street professionals gathered before them, some of whom managed portfolios containing billions of dollars of stock, would decide with their ballots whether the scheme to pressure Phillips would succeed.

  “I’m not telling you I’m Robin Hood,” Icahn said, adding that he had a
greed to pay Milken $7.5 million to line up the first $1.5 billion in financing. “I’m not doing it because I want to just save everybody. The trouble with corporations today is management. And the reason that management doesn’t really function that well is because they are just not answerable.… A guy like me comes along and stands up to them.”

  Crowds formed around Icahn and Boesky in the lobby and out into the street when the meeting was over. The atmosphere was charged—that day, Harrison J. Goldin, the comptroller of the city of New York, had declared that he was forming a new group, the Council of Institutional Investors, to explore the issues Icahn and Boesky raised and to stand up for the rights of shareholders. The twenty-two public pension funds in Goldin’s new group had more than $100 billion in pension assets at their disposal. Goldin alone controlled the enormous amounts of stock owned by New York City pension funds, and his declaration, following a meeting at City Hall with Icahn, Boesky, and Pickens, indicated that the raiders were winning powerful institutional allies. The buzz Goldin created at his press conference extended to the lobby of the University Club.

  Somebody asked Boesky if he considered himself a pirate.

  “That’s a euphemism for people who seek a profit,” Boesky replied. “By God, in America one of the great things about this nation is that we can seek profit. And I’m proud of that. And if you can gain profit, that’s even better and that’s not a dirty word.”

  When the day arrived, Bartlesville was alive with energy and crowds and bunting and banners. Employees carried picket signs and stood outside the auditorium where the shareholders would vote, urging that Icahn and Boesky and Milken be defeated. The lawyers and bankers poured past them in dark suits, many of them unsmiling. Only a few stopped to talk and hear what the pickets wanted to say.

  Inside, one by one the shareholders waited to speak. Some, mainly the institutional investors who controlled large blocks of voting stock, spoke up for Icahn, denouncing Douce and describing his tactics as desperate. A few of the smaller shareholders and local citizens urged that something besides profit and loss should decide the election. “We are afraid ownership will change to people who don’t care. And without care there is no community,” said Joel R. Benbow, pastor of the town’s Our Savior Lutheran Church.

  That afternoon, Phillips announced it was suspending the meeting to allow the votes to be counted. Experts took the suspension as a sign that Icahn had prevailed and that Phillips management was going to explore a compromise settlement.

  They were right. Icahn began to talk about a deal. He wanted Douce to improve the announced financial restructuring for all shareholders, including himself. He wanted Phillips to pay his $25 million in “expenses,” helping cover his fees to Drexel, among other things. Douce and his advisers were willing to go along—giving Icahn a quick $50 million stock-trading profit—but they wanted a guarantee that there would be no third time, that after Pickens and Icahn, there would be no new raider on the horizon with Drexel’s troops behind him. Phillips insisted that Drexel sign an unprecedented standstill agreement, saying it would not represent any other bidders for Phillips for a period of three years. Drexel, already well-compensated for its troubles, went along.

  “Drexel is in one sense the most powerful financial institution in the country today,” said Martin Lipton, the takeover attorney who had built his reputation protecting major corporations and who had advised Phillips on its takeover defense.

  To extricate himself profitably from the deal Icahn had negotiated, Boesky still needed to do some private business with Drexel. The problem was that, because of the losses he incurred in December and the huge sums he borrowed afterward to buy Phillips shares, Boesky was in violation of SEC capital requirements governing how much cash he needed to maintain in his accounts. As a registered broker, arbitrager, and manager of funds, Boesky periodically was required to report his stock holdings to the commission. To conceal his capital problem before filing papers at the SEC, Boesky turned to his arrangement with Milken.

  The pair mapped an elaborate series of transactions designed to make Boesky’s books appear legitimate to the commission. Between March 7 and March 11, 1985, Boesky sold more than 4.1 million Phillips shares to Drexel, which in turn sold them to several of its most loyal clients, including Gibraltar Savings Association and Executive Life Insurance, and to private accounts in which Milken or his brother Lowell had an interest. Boesky agreed to protect Milken against any losses he incurred and to divide any profits. The arrangement allowed Boesky to reduce his net capital deficiency by tens of millions of dollars, and when he filed the required papers at the commission, he showed more than enough cash to be in compliance with SEC rules. The capital filings were a snapshot of Boesky’s holdings, so once the filing date passed he was free to take back his Phillips stock from Drexel. (The SEC had the authority to inspect a firm like Boesky’s between the filings, but it never inspected Boesky during the Phillips transaction, although newspaper reports suggested the arbitrager suffered heavy losses early in the deal.) On April 12, Boesky bought back 1 million Phillips shares from Drexel, and more shares the following week. He unloaded the stock in the open market over the next few months. Under the terms of his secret agreement with Milken, Boesky was later compensated for stock-trading profits made by Drexel and others during March and early April.

  In the midst of these complex transactions and the preparation of his false filings for the SEC, a reporter asked Boesky what he thought about the success he and Icahn and Milken had enjoyed in the stockholder vote that forced Phillips management to capitulate.

  “For the first time,” he answered, “we see a clear recognition that big financial institutions and individual stockholders have expressed their view on what was fair.”

  17

  A Big Fish

  They sat around the conference table by the window in Gary Lynch’s corner office on December 17, 1985, eight lawyers buttoned up in the uniform of their trade—crisp white shirts, dark or gray suits, suspenders, silk ties. Lined yellow legal pads were spread before them. The oldest wasn’t yet forty-five, and most of the group were in their thirties. They knew each other well. Harvey Pitt, one of the two defense lawyers in attendance, had been SEC general counsel during the late 1970s, and now he made a handsome living defending banks and corporations and financiers who had trouble with the commission. Though Pitt was an aggressive adversary, there was a way in which he remained intensely loyal to the SEC and its rules even while in private practice. He accepted the sanctity of the commission’s traditions and the gravity of its role. He was a “member of the club.”

  “We’ve been working with you guys, and it’s taken a fair amount of time,” Pitt was saying. He had asked for this meeting with Lynch, and the enforcement director had invited five other commission staff lawyers to hear what Pitt wanted. “We want to deal first with the things we feel we are ethically obliged to discuss. Then we’d like to engage in what I would refer to as an off-the-record discussion.”

  “What do you mean by off the record?” Lynch asked skeptically.

  “Basically, you’ll see when we get to that point.”

  Pitt kept talking. Bearded and rotund, he was regarded as a brilliant attorney, but he could also be quick-tempered and elliptical. He reveled in gamesmanship. As he spoke that morning, glancing at a legal pad that seemed to contain detailed, scripted notes, he kept referring to his ethical obligations and his desire to avoid a confrontation and to other things that seemed to make little sense under the circumstances. Pitt represented a Zurich-based Swiss bank named Bank Leu whose Nassau, Bahamas, branch was the subject of an SEC insider trading investigation. The commission knew that someone at the bank, or else the bank itself, had earned millions of dollars by trading stocks in advance of takeover announcements. For months, while negotiating to turn over some of the bank’s documents to the commission, Pitt had told the enforcement staff that its investigation appeared to be a big mistake, that the trading of takeover stocks might
look suspicious, but it actually was the product of sophisticated and systematic research by the bank’s stock market professionals. All through the fall, Pitt had repeated this defense, but he had been slow about turning over any documents to back up his claims, and the SEC staff had grown angry over his procrastination. The investigation was like so many others—slow, frustrating, stymied by lawyers, bureaucracy, and in this case, Swiss banking-secrecy laws. Now, after so much time, Pitt had asked for an unusual meeting with Lynch. Yet he had again come to the commission without any of his client’s records.

  “Based upon our actual review of the documents and recent discussions with our clients, we are now obliged to tell the staff that you should not rely upon our prior factual representations,” Pitt finally blurted out. All of the negotiations between the SEC and Bank Leu during the past five months, Pitt was saying, had been based on lies.

  “What?” one of the enforcement lawyers shouted at him.

  “That is why we are here.”

  Pitt said he now wanted to go “off the record.” By this, he had earlier explained, he meant that while he couldn’t “help your knowing what I’ve told you, once I’ve told it to you,” he didn’t want anybody at the SEC ever to claim that he had told them anything. “I don’t want you to ever attribute what has been said here either to my client or to my client’s lawyers. That is, you can use whatever I tell you for what you think it’s worth.” In short, Harvey Pitt—voluntarily, unsolicited by the SEC—was about to play the role of a confidential government informant.

  Gary Lynch listened intently. It seemed clear from Pitt’s bizarre and convoluted windup that a big pitch was coming—a major breakthrough for the SEC was about to be dropped onto Lynch’s conference table. For Lynch, the gift was welcome. The truth was that before Harvey Pitt telephoned and asked to meet, Gary Lynch had begun to feel increasingly frustrated by the trend of his short tenure as chief of the SEC’s enforcement division. The spring and summer had been awkward enough. First, he inherited a job he had long coveted from a friend, Fedders, who was beset by personal troubles. Then, annointed with “interim” status by Shad, he had been forced to compete and prove himself to win the permanent position, and he had felt acute pressure to avoid any mistake that might jeopardize his goal. Finally, Shad named him as director, but then in a sense Lynch had to begin all over again, building loyalty among his senior staff, familiarizing himself with cases he had not previously supervised, and attempting to resurrect the feeling of purpose and morale in the division, which had been shaken by the circumstances of Fedders’s resignation. By the fall of 1985, Lynch was in command—but in command of what? Wild takeovers raged on Wall Street and stock prices of big companies like CBS and RCA zoomed up before merger events were announced, seemingly reflecting massive trading on inside information. On some days that autumn, takeover rumors and computer programs and new financial instruments seemed to turn the markets into a swirling kaleidoscope of speculation, fueled, Lynch suspected, by trading on inside information and market manipulation by professional arbitragers who bought shares and then profited after planting rumors about corporate takeovers. Yet there was little he could do about it. When, in November, he issued a bold and public warning that the SEC would crack down on arbitragers who manipulated stock prices, Wall Street’s traders and executives paid little attention. After such a long stretch of desultory and ineffectual investigations of major players in the markets, the commission’s credibility was on the wane. Lynch felt the SEC was doing everything it could, indeed that it had mounted an effective deterrent to insider trading through its prosecutions of individual wrongdoers away from Wall Street, but he was frustrated because he sensed that the commission was falling behind and lacked respect from some of the most influential institutions in American finance.