Milken pointed out that whereas the
entrepreneurs using his junk-bonds owned 30% of their companies,
the managers (and Directors) of "Corporate America" owned
less than 1% of their company. This swing in the "delicate
balance" between entrepreneurial and managerial companies
was causing "some pain," as he put it. Although he conceded
it "was unfair to blame the manager if the owner had not
showed up for 30 years"; now, through his junk bonds,
they were showing up. As leader of the junk bond movement,
he had to rationalize what was happening in terms of "doing
He spoke of the conflict was between
value and size. Owners sought the former. They wanted to
see the value of their investment increase, even if it meant
reducing the size of the overall company by selling divisions
that they couldn't themselves manage efficiently to others.
The example, he gave was the new owners of Beatrice, who
sold its coca cola bottling plant back to Coke, and its
Playtex division back to its original founder, increased
the value of their investment by over a billion dollars
but reduced the size of the conglomerate. Managers, on the
other hand, tended to be concerned with the size of their
domain, which, in many cases, defined their standing in
the community. Milken argued this focus often led to inefficient,
citing in the case of Beatrice, that the previous management
had spent over 100 million dollars sponsoring auto races,
which they evidently personally enjoyed, and for an advertising
campaign to create a corporate image for Beatrice-- though
none of its products were sold under the Beatrice brand.
The idea that values
could be increased by reducing the size of corporations
provided an appealing logic for financing takeovers. If
the new owners could increase the cash flow by selling off
parts of the company, this increment could be committed
to repaying the bonds. Moreover, to make this takeover financing
less risky, Milken arranged the transaction so that the
bonds were only bought when, and if, the raider acquired
control of the company. In addition, in case the deal failed
to come to fruition-- as most did-- they buyers-in-waiting
received a handsome "commitment fee" from the raider. Institutions,
seeing a profit with a minimum apparent risk, rushed in
to provide this take over financing. (The American Lutheran
Church' pension, for example, received a $750,000 commitment
fee for agreeing to be a buyer-in-waiting of 10 millions
dollars of bonds, without putting up any money). These pledges
which Milken lined up allowed Drexel to provide raiders
with a letter stating it was "highly confident" the financing
could be arranged. For its part, Drexel received a cut of
the "commitment fees"-- which rarely involved anything more
than a promise -- which amounted to hundreds of millions
In terms of sheer power, Milken was
reached his zenith in the fall of 1986. Over 900 companies
had become issuers of junk bonds -- which was larger than
the number of companies issuing investment-grade bonds,
and the junk bond market was channeling up to four billion
dollars a month to companies excluded from the traditional
bond market. Because of Milken's money machine, corporations
signed on with Drexel (whether they needed the money-- or
out of feared, if they didn't, Drexel would supply the money
to their competitor). Drexel, which had been a minor brokerage
house 5 years earlier, now, in terms of profit, had become
America's leading investment bank. Drexel's pre-tax profits
were reportedly over $1.5 billion in 1986.
Suddenly, as Business Week warned on
its cover, no one was safe anymore. Felix Rohatyn, a senior
partner in Lazard Frere, warned "The takeover game as it
is practiced today is a really a little like the arms race.
You have to stop it before it gets out of control." Lane
Kirkland, the President of the AFL-CIO, called it "an outrage
and a bloody scandal." Senator William Proxmire, a Democrat
from Wisconsin, stated "The rising tide of hostile takeovers
threatens the foundation of the American business system."
Sir James Goldsmith, who has been both
a client and an opponent of Milken's, saw the conflict proceeding
from the threat to take power away from those who had held
it. "I don't know whether or not Mike Milken realized at
the time that he had found a way of financing an immense
revolution in America, but now he has witnessed the full
power of the establishment triangle: big business, big unions
and big government." He then added, " As I European, I witnessed
the same alliance trying to avoid change and neutralizing
those responsible for it."
"It is nothing short of war," declared
one of America's leading industrialists, who asked not to
be identified out of fear of being caught in the cross-fire.
Wall Street was
only one front in this war. It was fought also in court
rooms, board rooms and back rooms of state legislatures,
as well as on television and op pages, where accusations
were made that corporate managers were "corpocrats," and
raiders "assassins in three piece suits." It even was waged
even on the streets of Akron, Ohio, were Goodyear organized
workers, wearing rubber face masks, to march in protest
against Sir James Goldsmith.
At the center of the conflict is an
almost philosophic disputation about the purpose of the
large corporation in the scheme of American capitalism.
In one camp, the defenders of the present system of corporate
stewardship, argue that the corporation must be regarded
not just as a private profit-making but as a public institution.
As such, they must serves not only their legal owners--the
share-holders-- but broader interests, including their workers,
suppliers, the local community and the nation. They hold
that management, which represents these community interests
as well as shareholders, is best suited to run these institutions.
In the other camp, the raiders and their
allies, argue that corporation best serve others by serving
their legal owners-- the shareholders. In this view, they
benefit other constituencies--such as labor, suppliers and
communities-- not by being charitable institutions but by
making the most efficient use of their resources-- which
may mean selling or closing down unproductive divisions.
They hold that only managers who are accountable to owners
have the incentive to make such hard choices. Such accountability
comes down to owners having the ability to fire them-- which
may may mean taking over the corporation.
Behind these different rationales (which
belligerents may-- or may not-- sincerely believe), both
sides are after the same prize: control of the corporate
wealth of America. The means for waging this battle is money.
By opening up the
capital market, like some Aladdin's cave, to outsiders,
Milken has made himself central to this war. To end the
threat to take away their stewardship, and power, corporate
managers had to somehow close the cave. No unrated bonds,
no take overs.
Under siege, corporate managements turned
in increasing numbers to State and Federal government for
help. By November 1986, some 30 bills had been proposed
in Congress, while a dozen states passed or considered anti-take
over laws. With the Business Round Table, which represents
the Fortune 500, warning that junk bond take overs could
bring on a 1929-type depression, the Federal Reserve Bank
raised margin requirements on junk bond financing, State
Insurance Commissions mandated reduced investment in junk
bonds, and Congressmen called for new restrictions on their
Milken tried to explain these attacks
on his junk bond empire to money-managers with a baseball
metaphor. "Just imagine there was a baseball team, like
the N.Y. Yankees, that won all the time. It even came to
believe it had a divine right to win. Then a new team came
along whose pitchers knew how to throw curve balls and sliders
which its hitters couldn't hit. It began to lose. So its
manager decided, rather than teaching them how to hit these
pitches, to go to the Commission -- and have them banned."
Senators on the Banking Committee listened,
the Chairman, William Proxmire, opened a special hearing
on Wall Street by asking "How much do we really about the
corporate takeover game and the complex network of information
that circulates among investment bankers, takeover lawyers,
corporate raiders, arbitrageurs, stock brokers, junk bond
investors and public relations specialists?"
This question, which raised the specter of finding a vast
criminal conspiracy behind the battle for corporate control,
was directed to Rudolph Giuliani, a prosecutor who had made
his reputation proving criminal conspiracies against the
Mafia, and Gary Lynch, the Director of the SEC's enforcement
division. Senator Proxmire explained that in 1933, the same
Senate Banking Committee had "recruited" a young attorney
named Ferdinand Pecora to go after "white collar criminals"
on Wall Street. Pecora, as the Senate's chosen instrument,
went after the villain of that era: The House of Morgan--
who had turned the nation's capital markets into a private
The Chairman then came to his point: "Mr. Giuliani and Mr.
Lynch, you are the Ferdinand Pecoras of the 1980s; through
your vigilance, Wall Street is being rid of some of its
criminals whose greed has cut a sorry path through our American
system." His message--and charge-- was clear. The new Pecoras'
target would be Mike Milken, who ironically was responsible
for breaching the walls around J.P. Morgan's preserve.
Giuliani had already
cut his deal with Boesky. He also cut deals with the seven
other participants in the Boesky ring (who worked for such
firms as Lazard Frere, Shearson, Wachtell Lipton, Kidder
Peabody and Drexel)-- thus ending the case with 8 guilty
pleas. The New Pecora abruptly shifted his investigative
focus from the inside-trading scam to possible irregularities
in Mike Milken's operation.
Giuliani suggested the tough tactics
he planned to employ when he was asked what he believed
was the difference between culprits in organized crime and
those on Wall Street. He answered the latter "roll easier"--
meaning that Wall Street financiers, when threatened with
doing hard-time in prison, could be more easily induced
to implicate others to save themselves. To this end, he
arrested Timothy Tabor, who had worked in the Kidder Peabody
Arbitrage Department, too late in the afternoon for him
to arrange bail-- or even a lawyer. No indictment had been
obtained, nor was he ever advised he was being investigated.
He was then told he would have to spend the night in prison
if he did not cooperate with Giuliani's investigation by
making a taped phone call to his ex-boss. Giuliani candidly
explained "This isn't an invitation to a tea party-- people
are arrested in the hope they will tell you everything that
happened." (In this case , Tabor proved an exception to
Giuliani's prediction and, rather than "cooperating" spent
the night in jail. (Giuliani subsequently dropped these
charges when it came time for him to have a day in court).
Parking violations, as the name implies, involves a brokerage
house or bank keeping a client's stock in its own name in
disregard of its reporting requirements. Such "parking"
may allow the client to temporarily bypass his margin requirements,
keep secret his position in a company that otherwise he
would have to disclose, or stay within limits imposed by
other rules. It may also sometimes used by portfolio managers
who "window dress" their fund's holdings for public reporting
purposes. Such infractions of the myriad of reporting requirements
was not a rare occurrence. As one Wall Street executive
observed,"There is not a firm on Wall Street that can be
sure it has not, at one time or another, committed some
technical violation of these laws." Although clearly a breach
of the securities law, up until now no one ever went to
prison for such an infraction. The "new Pecoras" have,according
to their testimony, a very different idea about "parking
violations." They have over the past 7 months subpoenaed
numerous Drexel employees and clients, attempting to unravel
relations Milken may have had with clients that, in one
way or another violated reporting requirement.
Whatever the final disposition of Mike
Milken, the financial world will never be the same. With
his multi-billion dollar resources and secret alliances,
he has created the image of a viable and liquid market in
junk bonds. By any standard, this is a truly extraordinary
accomplishment which has changed the way that funds held
in trust are invested.