Drexel Burnham Lambert

According to Dan Stone, a former Drexel executive, the firm's aggressive culture led many Drexel employees to stray into unethical, and sometimes illegal, conduct. Milken himself viewed the securities laws, rules and regulations with some degree of contempt, feeling they hindered the free flow of trade. He was under nearly constant scrutiny from the Securities and Exchange Commission from 1979 onward, in part because he often condoned unethical and illegal behavior by his colleagues at Drexel's operation in Beverly Hills.[1] He personally called Joseph, however, who believed in following the rules to the letter, on several occasions with ethical questions.[3]

The firm was first rocked on May 12, 1986, when Dennis Levine, a managing director in Drexel's M&A department, was charged with insider trading. Levine had joined Drexel only a year earlier. Unknown to Drexel management, he had spent his entire Wall Street career trading on inside information. Levine pleaded guilty to four felonies, and implicated one of his recent partners, super-arbitrageur Ivan Boesky. Largely based on information Boesky promised to provide about his dealings with Milken, the SEC initiated an investigation of Drexel on November 17. Two days later, Rudy Giuliani, then the United States Attorney for the Southern District of New York, launched his own investigation. Ominously, Milken refused to cooperate with Drexel's own internal investigation, only speaking through his attorneys.[1] A year later, Martin Siegel, the co-head of M&A, pleaded guilty to sharing inside information with Boesky during his tenure at Kidder, Peabody.[10]

For two years, Drexel steadfastly denied any wrongdoing, claiming that the criminal and SEC investigations into Milken's activities were based almost entirely on the statements of Boesky, an admitted felon looking to reduce his sentence. This was not enough to keep the SEC from suing Drexel in September 1988 for insider trading, stock manipulation, defrauding its clients and stock parking (buying stocks for the benefit of another). All of the transactions involved Milken and his department. The most intriguing charge was that Boesky paid Drexel $5.3 million in 1986 for Milken's share of profits from illegal trading. Earlier in the year, Boesky characterized the payment as a consulting fee to Drexel. Around the same year, Giuliani began seriously considering indicting Drexel under the powerful Racketeer Influenced and Corrupt Organizations Act. Drexel was potentially liable under the doctrine of respondeat superior, which holds that companies are responsible for an employee's crimes.[1]

The threat of a RICO indictment unnerved many at Drexel. A RICO indictment would have required the firm to put up a performance bond of as much as $1 billion in lieu of having its assets frozen. This provision was put in the law because organized crime had a habit of absconding with the funds of indicted companies, and the writers of RICO wanted to make sure there was something to seize or forfeit in the event of a guilty verdict. Most Wall Street firms, then as now, relied heavily on loans. However, 96 percent of Drexel's capital was borrowed money, by far the most of any firm. This debt would have to take second place to any performance bond. Additionally, if the bond ever had to be paid, Drexel's stockholders would have been all but wiped out. Due to this, banks will not extend credit to a securities firm under a RICO indictment.[1]

By this time, several Drexel executives—including Joseph—concluded that Drexel could not survive a RICO indictment and would have to seek a settlement with Giuliani. Senior Drexel executives became particularly nervous after Princeton Newport Partners, a small investment partnership, was forced to close its doors in the summer of 1988. Princeton Newport had been indicted under RICO, and the prospect of having to post a huge performance bond forced its shutdown well before the trial. Indeed, the discovery of Milken's role in many of Princeton Newport's illicit doings led Joseph to conclude that Milken had indeed engaged in illegal activity. Joseph said years later that he'd been told that a RICO indictment would destroy Drexel within a month, if not sooner. As it turned out, even though Milken and Drexel signed a co-counsel agreement, Milken's legal team warned him that Drexel would almost certainly be forced to cooperate rather than risk being driven out of business by the pressures of the investigation.[1][10]

Nonetheless, negotiations for a possible plea agreement collapsed on December 19 when Giuliani made several demands that were far too draconian even for those who advocated a settlement. Giuliani demanded that Drexel waive its attorney–client privilege, and also wanted the right to arbitrarily decide that the firm had violated the terms of any plea agreement. He also demanded that Milken leave the firm if the government ever indicted him. Drexel's board unanimously rejected the terms. For a time, it looked like Drexel was going to fight.[1][10]

Only two days later, however, Drexel lawyers found out about a limited partnership set up by Milken's department, MacPherson Partners, they previously hadn't known about. This partnership had been involved in the issuing of bonds for Storer Broadcasting. Several equity warrants were sold to one client who sold them back to Milken's department. Milken then sold the warrants to MacPherson Partners. The limited partners included several of Milken's children, and more ominously, managers of money funds. This partnership raised the specter of self-dealing, and at worst, bribes to the money managers. At the very least, this was a serious breach of Drexel's internal regulations. Drexel immediately reported this partnership to Giuliani, and its revelation seriously hurt Milken's credibility with many at Drexel who believed in Milken's innocence—including Joseph and most of the board.[1][10]

With literally minutes to go before being indicted (according to at least one source, the grand jury was actually in the process of voting on the indictment), Drexel reached an agreement with the government in which it entered an Alford plea to six felonies—three counts of stock parking and three counts of stock manipulation.[1] It also agreed to pay a fine of $650 million—at the time, the largest fine ever levied under the Great Depression-era securities laws.

The government had dropped several of the demands that had initially angered Drexel, but continued to insist that Milken leave the firm if indicted—which he did shortly after his own indictment in March 1989.[6][10] Drexel's Alford plea allowed the firm to maintain its innocence while acknowledging that it was "not in a position to dispute the allegations" made by the government. Nonetheless, Drexel was now a convicted felon.

In April 1989, Drexel settled with the SEC, agreeing to stricter safeguards on its oversight procedures. Later that month, the firm eliminated 5,000 jobs by shuttering three departments—including the retail brokerage operation. In essence, Drexel was jettisoning the core of the old Burnham & Company.[1] The retail accounts were eventually sold to Smith Barney.[13]

Due to several deals that didn't work out, as well as an unexpected crash of the junk bond market, 1989 was a difficult year for Drexel even after it settled the criminal and SEC cases. Reports of an $86 million loss going into the fourth quarter resulted in the firm's commercial paper rating being cut in late November. This made it nearly impossible for Drexel to reborrow its outstanding commercial paper, and it had to be repaid. Rumors abounded that the banks could yank Drexel's lines of credit at any time. Unfortunately, Drexel had no corporate parent that could pump in cash in the event of such a crisis, unlike most American financial institutions. Groupe Bruxelles Lambert refused to even consider making an equity investment until Joseph improved the bottom line. The firm posted a $40 million loss for 1989—the first operating loss in its 54-year history.[1]

Drexel managed to survive into 1990 by transferring some of the excess capital from its regulated broker/dealer subsidiary into its holding company, Drexel Burnham Lambert Group—only to be ordered to stop by the SEC on February 9 out of concerns about the broker's solvency. This sent Joseph and other senior executives into a near-panic. After the SEC, the New York Stock Exchange, and the Federal Reserve Bank of New York cast doubts about a restructuring plan, Joseph concluded that Drexel could not stay independent. Unfortunately, concerns about possible liability to civil suits scared off an eleventh-hour attempt to find a prospective buyer.[1][10][7]

By February 12, it was obvious Drexel was headed for collapse. Its commercial paper rating was further reduced that day, and the holding company defaulted on $100 million in loans. Citibank led a group of banks that tried to put together a loan package for the reeling firm, but this came to nothing. With other firms shutting Drexel out of deals, Joseph's last resort was a bailout by the government. Unfortunately for Drexel, one of its first hostile deals came back to haunt it at this point. Unocal's investment bank at the time of Pickens' raid on it was the establishment firm of Dillon, Read—and its former chairman, Nicholas F. Brady, was now Secretary of the Treasury. Brady had never forgiven Drexel for its role in the Unocal deal, and would not even consider signing off on a bailout.[7][10]

Early on the morning of February 13, New York Fed president E. Gerald Corrigan and SEC chairman Richard Breeden called Joseph and told him that they, Brady and NYSE chairman John J. Phelan Jr. saw "no light at the end of the tunnel" for Drexel. They gave Joseph an ultimatum–unless Drexel filed for bankruptcy, the SEC would seize Drexel that morning before the markets opened. After Joseph told the board that Drexel had effectively been told to "go out of business," the board voted to file for bankruptcy. That night, Drexel officially filed for Chapter 11 bankruptcy protection.[10] Drexel was the first Wall Street firm since the Depression to be forced into bankruptcy.[6] The filing covered only the parent company, not the broker/dealer; executives and lawyers believed that confidence in Drexel had deteriorated so much that the firm was finished in its then-current form.[7]

Even before the firm's bankruptcy, Tubby Burnham spun off the firm's funds management arm as Burnham Financial Group, which currently operates as a diversified investment company. Burnham was reportedly still arranging deals until his death in 2002 at age 93.[13] The rest of Drexel emerged from bankruptcy in 1992 as New Street Capital, a small investment bank with only 20 employees (at its height, Drexel employed over 10,000 people) and strict limits on its activities.[6] In 1994, New Street merged with Green Capital, a merchant bank owned by Atlanta financier Holcombe Green.[14]

Richard A. Brenner, the brother of a president with controlling stakes stated in his memoir "My Life Seen Through Our Eyes" that other firms at Wall Street did not support Drexel or come to its aid when the company got into trouble because they were "smelling an opportunity to grab this business."[15]