The Predators’ Ball (5 page)

Meanwhile, Lindner, Steinberg and Riklis would become among the most devoted stalwarts of the Milken empire.

Lindner and Steinberg—who is about twenty years younger than Lindner—had followed somewhat similar career paths. Both were outsiders, who had amassed their own fortunes, and who had
forever alienated the establishment with their onslaughts on major banks. And both acquired property- and casualty-insurance companies which would assume significant stock positions (in Steinberg's case, sometimes with hostile intent) in other major companies.

Lindner, a secretive, publicity-shy Cincinnati financier who did not finish high school, had built a milk-store business into a major supermarket chain and then had invaded the financial world—where his prize catch in 1966 was Cincinnati's Provident Bank, one of the pillars of the city. He had continued on his financial-service acquisition trail, acquiring a major property- and casualty-insurance company, Great American. By 1974, about the time he began buying bonds from Milken, his mammoth holding company, American Financial Corporation, had equity of $192 million and debt of $692 million: a debt-to-equity ratio of roughly 3.5 to one.

One Drexel employee maintains that officials at Drexel had turned Lindner down as a client about six months before Milken met him and began doing business with him, because they were worried about Lindner's reputation. He was known then to be the target of an SEC investigation, and he would be charged by the SEC with violating anti-fraud and anti-manipulation provisions of the federal securities laws in 1976 and in 1979. But Milken is said to have persuaded others at the firm to overcome their compunction, and by the midseventies Lindner became Drexel Burnham's biggest client, both in trading and in corporate finance. He would also become, of all Milken's clients, the one Milken would respect the most.

Steinberg had started a computer-leasing business, Leasco, when he was just a couple of years out of Wharton, in 1961. That very profitable company's stock had soared in the heady stock market days of the late sixties, making it possible for little Leasco to take over the conservative, 150-year-old Reliance Insurance Company, nearly ten times its size, by tendering to its shareholders a package of the highly valued Leasco paper.

Then, in a far more audacious move—one which rocked the corporate establishment, stirred currents of anti-Semitism, and foreshadowed the kinds of epic struggles that Milken would finance some fifteen years later—Steinberg in 1969 had targeted for conquest the $9 billion Chemical Bank. By the time he surrendered, those who had so effectively combined against him included not only the directors and management of Chemical, but most of the
banking business, Governor Nelson A. Rockefeller and the legislature of New York State, and members of the Federal Reserve Board and the Senate Banking and Currency Committee.

Riklis had never set his sights on a major bank, but he was every inch the renegade. Like Steinberg and Lindner, he had created his own fortune, relying on leverage, invention, keen business acumen and a disdain for the unwritten as well as some of the written rules. Like Lindner, Steinberg and Riklis by the midseventies signed consent decrees with the Securities and Exchange Commission—a standard securities-law-enforcement plea bargain—in which they neither admitted nor denied their guilt but agreed to desist from violations of securities laws in the future or face criminal-contempt charges.

An Israeli emigrant, Riklis had started out with a stake of just $25,000, buying and combining small companies in the 1950s. By the time he met Milken in about 1970, Riklis controlled a conglomerate, Rapid-American, which had sales of close to $2 billion. It included such companies as International Playtex, Schenley Industries, Lerner Shops and RKO–Stanley Warner Theatres. What Riklis had done was acquire one company and then use its assets to acquire the next, and that company's to acquire the next, in ever larger circles. He acquired these companies by issuing mainly bonds, or debt, in exchange for the company's stock. As Riklis liked to say, Rapid-American owed its success to “the effective nonuse of cash.”

The major difference between Riklis' debt-laden acquisitions and those of Milken's later acquirers was that Milken's chosen would issue the bonds for cash and then give the cash to the shareholders, while Riklis would issue the bonds directly to the shareholders. Both Riklis and his successors a generation later, however, would be using to their advantage the same debt-favoring provision of the U.S. tax laws: interest (on bonds) is deductible, but dividends (on stock) are not. Therefore, assuming roughly a 50 percent corporate-income-tax rate, a company that can pay shareholders a rate of return of 7 percent on dividends can just as easily pay 14 percent interest on subordinated debt, because it can deduct the interest.

“I started this thing,” Riklis would claim in an interview in 1986. “When Mike entered the market [in about 1970], I already had over a billion dollars of these bonds outstanding.”

Riklis' method of dealing with the day of reckoning on all this debt would also be used in later years by many of Milken's issuers.
Riklis has been the master of the exchange offer. In order to postpone the date of repayment of principal, he would offer a slightly more attractive bond—with a longer maturity—to his bondholders. And after another few years he would offer another. “You
have
to do the exchange,” Riklis declared. “Otherwise the bonds will come due!” On several occasions, he has reportedly commented that his bonds will never be repaid in his lifetime.

After years of encountering resistance from the SEC to his taking his company private, Riklis worked out the guidelines with the SEC's then head of enforcement, Stanley Sporkin, in 1980—and proceeded to take Rapid-American private. He was followed, in short order, by Lindner, who took American Financial private, and Steinberg, who did the same with Reliance. According to one former employee of Reliance, all three transactions were influenced by Milken. Since these three members of Milken's coterie sometimes owned each others' debt and/or equity, Drexel became the nexus for a lot of trading activity among them at this time. A 1982 SEC investigation explored, among other things, trading that had occurred in the securities of these and other companies from January 1980 through May 1982. The investigation was closed without any action being brought by the SEC.

Some of the earliest buyers of the high-yielding Rapid-American bonds Milken was hawking remember frequent meetings with Riklis, Milken and about a half-dozen buyers at the Pierre Hotel in the early seventies. At that time, Milken had only about twenty-five different issues to trade. There were fallen angels—including the airlines' busted convertibles (securities whose underlying equity is trading far below the bonds' conversion price) and “Chinese paper” like Riklis', which had been issued in the context of an acquisition.

They also remember when Riklis' companies got into trouble in the midseventies and his bonds went down to twenty and thirty cents on the dollar. Riklis had recently been divorced, his personal life was a nonstop party, and his attention had strayed from business.

At that time, Milken, Drexel, and Milken's customers are said to have owned about $100 million of Rapid-American's debt. Before Milken, debt holders had traditionally been a passive lot. But Milken made it his habit to accumulate with his fellows such enormous positions that he could demand attention from heads of companies. Sometimes it worked and sometimes it didn't; when Milken
in the midseventies went to lunch with Sanford Sigoloff, then head of Daylin, and announced how much of that company's debt he owned and what he thought Sigoloff ought to be doing with the balance sheet of the company, Sigoloff replied that the last time he had checked he was chief executive officer of the company, and that lunch was over. But Riklis was more desperate and more receptive. Milken gave him a business plan. As Riklis recalled:

“Mike said, ‘You're working for me. You own a lot of the equity in your companies, but I own your debt. And your equity is not worth the paper it's printed on unless your bonds are valuable. Riklis is working for Milken.'

“If you say that Mike rescued me, it would be wrong,” Riklis continued. “But if you say Mike chaperoned me, it would be right. He oversaw everything that I did. He had to—in order to know whether he should sell these bonds or not, and what was the bargain price. He had to be constantly monitoring what we were doing.”

Over the years, Riklis became a friend and a great fan of Milken, whom he considers “a creative genius.” “All my dealing with Drexel,” Riklis said, “is based on the fact that Mike exists in Drexel.”

Riklis claims that the word “junk” to describe these low-rated bonds originated in one of his and Milken's early phone conversations, in about 1970. “He looked at my bonds and he said, ‘Rik, these are junk!' And I said, ‘You are right! But they pay interest, and they sell at a discount.' Mike called them junk bonds, he created that name, unfortunately as a joke to start with. Today he would like to get rid of that joke, but sometimes it's very difficult.

“Today, Mike would kill to have everybody know it as a high-yield bond, but it's too late, so he might as well accept it,” Riklis concluded. “A pogrom is a pogrom.”

W
HILE
M
ILKEN
was forging the client relationships that would one day power his juggernaut, the man who would be his crucial partner and ally, Fred Joseph, arrived at Drexel Burnham. In later years, when the firm's profile became highly visible, Joseph would be Milken's face to the world. While Milken and his cadre would remain secluded from the press, Joseph would be supremely accessible—and so politic, so polished, so affable, so disarming, this silver-haired, soft-spoken Bostonian, that he would lend his mantle of legitimacy to the Milken operation.

And while Milken drove the money machine, Joseph would concentrate on building the institution—recruiting talent from rival firms with piles of money, watching for signs of restiveness within his team, carrying out the managerial responsibilities of the role he had assigned himself as, in his words, the “Dr. Feelgood” of Drexel.

Behind the scenes, Joseph would at times attempt to rein Milken in. When one of Milken's troops threatened a prospective client in order to get his business, Joseph would try to make amends. It was his job to bring the veneer of the civilized world to the brute force of the Milken crew. But however effectively the two men complemented each other, in at least one way they were more alike than different: both had a rapacious hunger for market share.

J
OSEPH, ARRIVING
at Drexel Burnham in 1974 via E. F. Hutton and Shearson, was a thirty-seven-year-old with a couple of false starts and an itch to do something grand in investment banking.
The son of Orthodox Jews, he had grown up in the blue-collar Roxbury neighborhood in Boston. He attended public school there and then went to Harvard on a partial scholarship. Majoring first in physics and then in English, Joseph decided on business school by default: he considered himself no physics genius and no poet, but he thought he was good enough at numbers and he knew he could sell.

After graduating from Harvard Business School in 1968, he applied for a job at E. F. Hutton, where he was interviewed by John Shad, who would later become the chairman of the SEC. Joseph recalled that after listening to Joseph explain his ambitions, Shad asked him three questions:

What kind of name was Joseph? Jewish.

What did his father do? He was a cabdriver.

What had he been best at, at college? Boxing. (He had won a collegiate championship three out of his four years.)

Joseph thought his answers were sure to lose him the job, but Shad read them to mean that he was highly motivated, and hired him. He made partner in four and a half years, which put him on an exceptionally fast track. But then Shad, who was his mentor, became embroiled in a power struggle to head the firm, and Robert Fomon seized the helm. Joseph had been Shad's campaign manager, and the bad blood between him and Fomon meant that there was no future for him at the firm. He left and went to Shearson, as a first vice-president in corporate finance.

After he had been at Shearson for a couple of years, Joseph became assistant to Alger (Duke) Chapman, the president of the firm, and was given the job of trying to salvage the firm's failing retail business which was losing money. Within a year it had become profitable.

After about eighteen months, Joseph was made Shearson's chief operating officer, its number-two position. By this time the firm was in desperate need of capital, and Joseph was one of the major negotiators of its merger with Hayden Stone. When that was finally completed, in September 1974, Joseph decided that he wanted to get out of his management role and go back to investment banking. But the head of corporate finance at Shearson Hayden Stone was a good friend of his. Rather than displace him, Joseph once again began looking for another job. He wanted a major-bracket firm. It had to be a major in trouble, though, because Joseph's résumé—bouncing
from one submajor in turmoil to another—wasn't made for the establishment powerhouses. Drexel Burnham fit the bill. It had just become a major, and Tubby Burnham and the firm's president, Mark Kaplan, were looking for someone to exploit that opportunity.

The merger of the old Burnham and Company with Drexel had taken place more than a year before Joseph joined as co-head of the newly constituted firm's corporate-finance department. Joseph found no trace of assimilation. The two firms, moreover, were such stereotypical opposites, each almost a caricature of its kind—the classy Drexel, genteel to the point of being effete, and the brash, bucket-shop Burnham and Company—that the place lent itself to parody.

One Drexel investment banker would later say, “The Drexel people were sitting at one end of the hall, waiting for Ford Motor Company to realize it had made a mistake and call us up and tell us that they'd really appreciate it if we would take them back. And you had the guys from Burnham and Company running around Seventh Avenue trying to underwrite every schmate factory they could find.”