Eagle on the Street

  That a balloon so inflated would burst two months later was, looking back on it, not such a perplexing mystery. Yet the pin that pricked it seemed to reveal a great deal about the culture that had grown up on Wall Street during Shad’s reign at the SEC. As the stock market began to buckle, early in October, the fall was led by shares whose prices were inflated by speculation about takeovers. During the week before the crash, the same sort of volatile, high-profile takeover stocks that had led the market up during the 1980s suddenly plunged in value. Some takeover speculators feared that a new bill introduced in the House Ways and Means Committee—a bill that wasn’t close to becoming law—might eliminate certain tax benefits associated with takeovers. In the aftermath of the Boesky scandal, mere consideration of such an initiative was apparently enough to spook the arbitragers on Wall Street, who promptly dumped their shares. To what extent the early collapse of takeover stocks was a significant factor in the Black Monday debacle was widely debated during 1988, but the discussion itself pointed up how fragile the relationship between Wall Street speculation and Washington regulation had become.

  For a while after the crash, it was widely feared that 1987 augured a repeat of 1929, that the stock market collapse, in which $1 trillion in paper value was wiped out from August through October, would plunge the country into a depression. Shad worried aloud that negative publicity in the aftermath of the crash would dampen consumer and business spending, pushing the nation into a dangerous economic and psychological tailspin that could be difficult to reverse. But the U.S. banking and credit system, which had collapsed during the 1930s, held firm, mainly because the regulators in Washington who controlled the money supply had absorbed important lessons from the Great Depression. By loosening credit supplies and publicly indicating its intention to pump funds into the banking system where needed, the Federal Reserve made sure, late in 1987, that there was enough cash coarsing through the economy—enough of Shad’s cherished liquidity—to soothe those banks wounded by losses in the crash. The New York Stock Exchange and its biggest member firms voluntarily curbed the most egregious forms of computerized program trading in an effort to quell volatility, restore investor confidence, and perhaps most importantly, stave off legislative fixes from Washington. The securities industry also went to work on expanding and improving its trading systems, which had been overwhelmed by the extraordinary October volume, leaving many small investors unable to execute trades as the value of their once hot takeover stocks and other holdings vaporized amid the panic. (Had Rip van Winkle dozed off at the beginning of 1987 and glanced at the Dow Jones Industrial Average when he woke at year end, he would have wondered what all the fuss was about. Though it peaked in August at 2,722 and hit bottom nearly 1,000 points lower on October 19, the Dow opened the year slightly below 1,900 and closed the year slightly above, at 1,938.) By the summer of 1988, the markets had steadied and the economy was chugging along. The Republican party, John Shad included, breathed a collective sigh of relief. And yet, because he had unleashed the forces that overwhelmed the market system, Shad’s reputation had been tarnished somewhat.

  Shad and his tenure at the SEC had come under scrutiny for other reasons, too. In May of 1988, the long-simmering sex-discrimination lawsuit filed by SEC attorney Catherine Broderick finally erupted into public view. Following a trial in open court in Washington, federal Judge John H. Pratt ruled in Broderick’s favor, against the SEC, and ordered that she receive overdue promotions and compensation and be restored to a job of her choosing because the sexual harassment in the commission’s Washington Regional Office (WRO) “was so pervasive … that it created a hostile or offensive work environment which affected the motivation and work performance of those who found such conduct repugnant and offensive.” Pratt said he found the testimony of some SEC officials to be “less than forthright.” None of the men was sanctioned by the SEC; one of them had been promoted by Shad before the trial.

  Judge Pratt was unimpressed by Shad’s role in the Broderick case. The judge asserted that even though Shad and other high-level SEC officials knew of the problems in the nearby Washington Regional Office for years, they “made no serious effort to enforce the guidelines prohibiting sex discrimination.” (Shad had testified that he only became aware of Broderick’s allegations years after the events in question, on the eve of her lawsuit. His supporters also pointed out that, during the 1980s, the SEC increased the number of women in senior executive positions from 2 percent to 24 percent.) When contacted in the Netherlands for comment at the time of Judge Pratt’s ruling, Shad referred back to the internal investigation that SEC staff lawyers had conducted. “They advised the commission that no conduct rule violations had occurred,” he said.

  For many of the senior bureaucrats at the SEC, the embarrassment of Judge Pratt’s ruling in 1988 was obviated in part by the continuing success of the commission’s enforcement division. Shad, though, appeared to take little solace in the commission’s revelation that corruption and insider trading had been widespread on Wall Street during the 1980s. In fact, during his informal talks at the dinner table in Holland, it was often clear that Shad didn’t believe the ongoing, massive SEC investigation of Drexel was as serious a matter as the U.S. press made it out to be. Despite what he knew of the evidence about Michael Milken’s illegal conduct, which Ivan Boesky had provided confidentially to the SEC, Shad continued to admire Milken and his work deeply. Milken should be punished if he had broken the law, Shad believed, but that didn’t change his feeling that Milken was a genius who had accomplished much that was praiseworthy. Moreover, Shad thought that if Milken had cut any corners while running his powerful junk bond operation in Beverly Hills, his illegal conduct had been incidental to Drexel’s success.

  Shad’s decision to give away his fortune to the Harvard Business School to establish a program on ethics suggested that he believed American finance was beset by serious problems. And yet at the same time, privately and publicly, he continued to insist that things really were not so bad, and that certainly there was no need for the government or the SEC to change its approach. It wasn’t clear whether Shad said this so often because he believed it was correct or because he wanted to convince himself that it was true. None of the events that had so shaken Wall Street and the country after his departure from the SEC—the stock market crash of October 1987; the spread of the Wall Street corruption scandal to nearly every major investment bank; the shattering, at least temporarily, of investor confidence in the fairness and integrity of the financial markets—deterred Shad from repeating his rhetorical speeches at the dinner table in The Hague during 1988. He told his visitors that the raging hysteria over the crash and the corruption cases was overblown, exaggerated, that the United States still possessed the “richest and fairest and most efficient financial markets in the world.” To those who had heard him before, Shad sounded like a broken telephone answering machine that repeated the same message over and over without ever stopping to listen. Some thought his soliloquies in the Netherlands were a coping device, that he simply could not acknowledge how he actually felt.

  In any event, it became clear during 1988 that neither the Justice Department nor the SEC shared Shad’s beneficent view of Drexel and Milken. In September, following nearly two years of active investigation—and long after two earlier SEC probes of Milken led by Jack Hewitt and Irving Einhorn had been dropped—the SEC filed a massive lawsuit accusing Drexel and its junk bond chief of rigging corporate takeovers, trading on inside information, evading taxes, manipulating stock prices, and bullying clients. True to form, Milken and Drexel vowed to fight the SEC and to continue serving clients and making money.

  “For the past 22 months I have been the subject of a shadow trial of systematic leaks and innuendo based upon false accusations,” Milken said in a statement released the same day as the SEC charges. “Drexel Burnham and I have a record of ethical dealings with thousands of community leaders, customers and clients of which I am proud.… When the truth is
substituted for false accusations, I am confident that I and my colleagues will be fully vindicated.”

  Drexel Chief Executive Officer Joseph joined Milken, aggressively attacking the SEC’s case in a letter to clients. “We believe, based on information available to us, that the charges filed by the SEC are wrong,” the letter from Joseph said. “After an examination of 1.5 million pages of documentation and interviews of scores of Drexel Burnham employees, we continue to believe that neither Drexel Burnham nor any of our employees named in this matter have engaged in any wrongdoing. We expect to be vindicated.”

  Though the commission faced vigorous opposition from Milken and Drexel, the filing of the charges was a testament to the prowess of the SEC’s enforcement division under Gary Lynch. With the crucial help of Boesky and other cooperating witnesses, the division of enforcement finally had succeeded in mounting the type of case it had failed to make twice before when the earlier Milken probes were dropped inconclusively. Yet the case also highlighted flaws in the SEC’s regulatory and enforcement efforts during the 1980s, especially the way in which the agency’s various divisions under Shad had worked at cross-purposes when it came to takeovers. Shad had sounded warnings about debt-driven takeovers in his 1984 “Leveraging of America” speech, but neither he nor anyone else at the commission had acted upon those words. While state court judges became increasingly active—occasionally acting to block the most abusive hostile takeovers—the SEC’s role as a serious takeover regulator in the 1980s diminished, in large part reflecting Shad’s view that takeovers were good for shareholders. One effect of the commission’s hands-off attitude was to encourage investment bankers, corporate raiders, and arbitragers to employ increasingly aggressive takeover tactics. Had there been somewhat more balanced regulation of takeover financing, disclosure, and trading practices by the SEC’s divisions of Corporate Finance and Market Regulation in the early 1980s, there would have been less police work for the agency’s enforcement division to do later. Even the most successful enforcement division prosecutions could not undo the damage done years before when companies were acquired in rigged takeovers.

  Whatever the limitations and obstacles, Lynch and his team in the agency’s division of enforcement seemed more determined than ever to nail Milken and his employer. They worked closely with criminal prosecutors in pursuit of that goal. On the same day the SEC charged Drexel, the Manhattan U.S. Attorney’s office sent “target letters” to Milken, his brother, and other Drexel employees in Beverly Hills, informing them it was likely that they would be charged with criminal fraud under the powerful federal racketeering statute known as RICO. To many it seemed that prosecutors were using the threat of RICO, a law originally enacted to attack organized crime and that permitted the freezing of a target’s property even before a trial was held, as a sledgehammer and unfairly attempting to coerce guilty pleas out of Drexel and Milken. But the government argued the threat was justified given the scale and systematic nature of Drexel’s crimes. On Wall Street and in Corporate America, some of Drexel’s competitors and targets privately enjoyed the confrontation. After all of the hardball tactics that Drexel and Milken had employed in pursuit of investment banking and junk-bond-trading fees, they seemed to be getting a taste of their own medicine. Within weeks, James Dahl, the junk bond salesman who had sat across from Milken for nearly a decade in the Beverly Hills office, was granted immunity from criminal prosecution in exchange for his testimony about Milken and Drexel. In addition to corroborating aspects of Boesky’s story about Milken’s fraud, Dahl’s testimony provided the government with new descriptions and allegations about illegal practices at Drexel. Rushing to avoid criminal charges, other key employees from Drexel’s Beverly Hills office lined up against Milken and Drexel and became witnesses for the government. Milken and Joseph reacted to the swelling tide against them by making claims of innocence and charges of prosecutorial abuse even more stridently than before.

  When he finally caved in late in 1988, Joseph went down defiantly, scrapping like the boxer he had once been. Saying that he had finally seen hard evidence from government prosecutors that there had been serious wrongdoing at Drexel, Joseph cut a plea bargain on Drexel’s behalf with Manhattan U.S. Attorney Rudolph W. Giuliani. Drexel agreed to plead guilty to criminal charges, forfeit $650 million and cooperate with the government in its prosecution of Milken. Joseph hardly sounded contrite. He said a big factor in the decision to plead was the potentially catastrophic financial consequences of racketeering charges. He implied that but for the threat of RICO property seizures, Drexel would have stood firm against the prosecutors.

  After teaming up with Milken for so long, Joseph’s decision to cut a plea bargain was controversial within the firm because it seemed to betray Drexel’s most important money-maker, leaving him on his own to fight SEC and criminal charges. After negotiating the deal and ensuring there were enough votes on the Drexel board to approve it, Joseph cast a symbolic vote against the plea bargain at the climactic board meeting in New York. It was an effort, transparent and duplicitous to some, to appease the factions in the firm that remained loyal to Milken.

  Joseph next turned his attention to making peace with the SEC and to bolstering Drexel’s future prospects. What he needed, his top advisers said, was someone the SEC would trust, a “white hat” who could serve as Drexel’s chairman and restore the firm’s credibility in Washington and elsewhere—someone who could make corporations feel comfortable about hiring a brokerage that was now an admitted felon.

  From his distant perch, Shad admired the way his former protégé Joseph handled himself. Though there were serious questions about Joseph’s apparent naïveté and his failure to supervise Milken and the others in Beverly Hills, no one had accused him of intentional wrongdoing, and he had deftly preserved his power at the helm of the firm, reassuring employees regularly in pep talks over an internal communications network and publicly asserting Drexel’s innocence—at least until the plea bargain, when he shifted to talking brightly about the firm’s postcriminal future.

  That Joseph had managed to postpone for two years a public admission of Drexel’s problems—a strategy that permitted Drexel to continue doing deals and earning huge fees—didn’t seem to bother Shad, who accepted Joseph’s explanation that he had seen no hard evidence of wrongdoing until the end of 1988, more than two years after Ivan Boesky first leveled his allegations. When Joseph finally admitted Drexel’s guilt, after making so many public denials and mailing out thousands of letters indicating the firm had done nothing wrong, Shad only admired Joseph’s composure and tenacity.

  And Shad was restless that wintry season in the Netherlands. His wife, Pat, had died in the fall, ending a terrible ordeal for both of them. Shad found in those melancholy months that he missed the hectic pace of the SEC. Although he had worked at staying busy as ambassador, it had been a slow period for diplomacy in the low countries. “I miss the stress,” he often said. Never a man to appreciate form over substance, Shad slipped in and out of the nightly cocktail parties in The Hague, refining his ability to shake the right hands and make a clean getaway in minutes. So little of the job, it seemed, involved the sort of tangible accomplishments Shad liked to record on his mental scorecard. He described his frustration this way to several visitors:

  When I was on Wall Street, I could get $100 million financings done with a few telephone calls. At the SEC, it took months or years to get things done but there was progress. Here in Europe the issues are global and there are no decisions at all. You can’t get things done the same way.

  By the time Irwin Schneiderman telephoned him in January 1989, it was clear to Shad that the ascendant Bush administration would have no place for him in government, or at least no station of cabinet or equivalent rank. The previous March, during a ride from the Old Executive Office Building beside the White House to Andrews Air Force Base, Shad had talked with then Vice President George Bush about resigning as ambassador and coming to work in his presidential camp
aign. Although they discussed the possibility of Shad becoming a spokesman on ethics, Bush already had his fund-raising under control and apparently didn’t feel a need to add Shad to the team—he never called to follow up.

  After Bush won the presidency, it seemed to Shad and those friends who talked with him about it that if Bush were elected, only a cabinet post—at Commerce or Treasury or perhaps as the president’s chief trade representative—would be appropriate for someone of his stature and experience. Anything else might seem an embarrassing slight, a step down. Bush and his advisers, though, kept saying that they wanted to find new blood, new approaches for their administration. In the field of economic and financial regulation, they seemed distrustful of the more radical adherents to Chicago School free market theory. And in Shad’s case, there was the not insignificant matter of the 1987 stock market crash. Still, from The Hague, Shad made some overtures about returning to Washington to join the Bush team. After the election, Bush’s chief campaign strategist, James Baker, called Shad and said, “I hope you’ll stay with the new administration.” But the call from the White House for the right job never came.

  Instead, that January of 1989, Irwin Schneiderman telephoned from Wall Street—in his dual role as friend of Shad and counsel to Drexel—to urge Shad’s acceptance of a stunning proposition.

  “It would be very helpful to Fred and Drexel if you came,” Schneiderman said. Shad would be the new chairman of Drexel Burnham Lambert, Incorporated, technically superior to chief executive Joseph but absolved of day-to-day mangement responsibility.

  Initially, Shad was lukewarm, having had no intention of returning to Wall Street and the money business. He had been only too aware as salaries escalated on Wall Street during the 1980s of the financial sacrifice he had made as SEC chairman. But when he left E. F. Hutton to become chairman of the SEC in 1981, Shad had self-consciously entered the third phase of his life. He had lived by his Mormon grandmother’s credo; at sixty-five, this was the time for serving, which he had always thought meant government duty, teaching, or charitable work, something other than pursuing wealth. Schneiderman suggested to Shad that if he were encouraged to take the Drexel chairmanship by SEC and Justice Department officials, and if he donated his salary to charity, it would not be purely a job situation. When nothing materialized in the Bush administration, Shad had thought briefly that charitable foundation work at a top institution would be appealing, but nothing suitable had come through in that field, either. Shad’s daughter, Leslie, urged that he consider slowing the pace of his life, that he perhaps learn how to take it easy. He did have offers to become an outside director of some large and prestigious corporations. But that didn’t seem enough to feed his need for stress. With Pat gone, Shad found the prospect of returning to Manhattan—to sit idly in his quiet Park Avenue apartment—utterly uninviting.