For the first 30 years of his life, Ivan Boesky wasn't sure what he wanted to do. The son of a Russian immigrant who became a top Detroit restauranteur, Ivan graduated from the Detroit College of Law and bounced from one job to another until landing on Wall Street in 1966 as a stock analyst. His wife Seema was the daughter of real estate magnate Ben Silberstein, and the Silberstein fortune helped Boesky start his own arbitrage firm in 1975. By the mid-Eighties, "Ivan the Terrible" was worth an estimated $200 million. His book on the arcane art of arbitrage, Merger Mania, was published in 1985. A workaholic, he put in 20-hour days at a white marble office on Manhattan's Fifth Avenue that contained a 300-line telephone console. In the high stakes, fast-paced world of Wall Street, Boesky's specialty was trading stock in companies targeted for takeover, a legal enterprise as long as the trade was based on public knowledge of imminent acquisitions. But on November 14, 1986 the Securities and Exchange Commission (SEC) charged Boesky with illegal stock manipulation based on insider information. Sentenced to prison, barred from dealing in securities, and ordered to pay $100 million in penalties, Boesky cooperated with the SEC in an insider-trading probe that rocked Wall Street.
Corporate mergers and acquisitions soared in the 1980s. Nearly 3,000 mergers and buyouts worth more than $130 billion occurred in 1986 alone. Time and again the share price of stock in companies targeted for leverage buyout (LBO) or hostile takeover would rise before the deals were announced, indicating that insider trading was occurring. Using an arbitrage fund of capital provided by limited partners, Boesky would pay more than the current trading price for a company's shares with the expectation of selling them at a higher price when the acquisition was announced. For example, Boesky and others bought a large bloc of shares in Gulf+Western before rumors of a takeover bid drove up the price of that stock. Three days before Maxxam Group tendered an $800 million offer for Pacific Lumber, Boesky bought 10,000 shares of Pacific Lumber stock. When merger-and-acquisition specialist Dennis Levine, managing editor of Drexel Burnham Lambert, was charged with illegal trading in May 1985, the SEC learned that Boesky had cut a deal with Levine in which the former paid the latter a percentage of profits for insider tips.
In return for leniency, Boesky allowed the SEC to secretly tape his conversations with junk bond dealers and takeover artists. The SEC allowed the arbitrageur to reduce his partnership liabilities by selling stocks and securities before his crimes were made public. Outraged members of Congress and the business community complained about this "sweetheart arrangement," as Rep. Ron Wyden (D-Ore.) put it. In the sellout that followed news of the scandals, other arbitrageurs lost more than $1 billion as investors dumped deal stocks for more traditional blue chips, and corporate raiders backed off from takeover schemes. Some experts predicted that the widening scandal would prompt investors to act more conservatively and end the speculative boom that drove the bull market of the mid-Eighties.
According to critics, both small individual investors and companies targeted for hostile takeovers suffered as a consequence of the antics of Levine and Boesky, as well as corporate raiders like T. Boone Pickens and Sir James Goldsmith. For instance, Goldsmith and partners raided Goodyear Tire & Rubber and made a tidy $93 million profit when Goodyear had to hock its non-tire businesses to prevent the takeover, spending $2.6 billion to buy back the raiders' 11.5 percent stake in the company as well as another 36.5 percent owned by other shareholders. The chief complaint of economists and conservative business leaders was that these takeover ventures, tailored to reap short-term profits for high rollers, left many companies deeply in debt or dismembered.
Small individual investors usually lacked the time, skill and information necessary to compete with Wall Street insiders. Goodyear's shareholders complained that the company paid Goldsmith $52.50 a share in the buy-back while the market value of their shares was only $43. When T. Boone Pickens, Carl Icahn and other raiders bought up USX stock, that company's share price soared from $18 to $28.75 in anticipation of a takeover before dropping back to $19; late buyers following the raiders' lead lost money as a result. More and more individuals opted to put their investment dollars in mutual funds, and institutional trading on the New York Stock Exchange rose from 17 percent in 1975 to 52 percent in 1985. One benefit of this approach for the individual was the fact that brokerage firms could buy and sell at deep discounts. Where individuals might pay a commission of 75 cents to a dollar per share, institutions normally traded at 3 to 6 cents per share.
But there were potential risks for those who invested in mutual funds, since by 1986 those funds held one-fifth of all junk bonds issued. Corporate raiders often relied on junk bonds to fund takeover bids. Securities issued by firms with low credit ratings, junk bonds offered high yields because of the risk involved. Drexel Burnham Lambert dominated the $120 billion junk bond market. It kept the junk bond default rates low by persuading investors to accept an exchange offer that refinanced the debt of faltering companies built on junk bond capital. (In this way the default rate in 1986 was kept to 1.7 percent of the face value of outstanding junk bond issues instead of the 6.2 percent it would have been otherwise.) Experts feared that in hard times many companies financed in this way, and carrying interest rates as high as 20 percent as a result, would default. If that happened, tens of thousands of mutual fund shareholders would lose their investments. "The junk bond market . . . will go first," predicted investment manager James Rogers. "Then you'll see the bond market leading the stock market down."
Drexel's 40-year-old senior executive vice president, Michael Milkin, was the undisputed junk bond wizard. A Phi Beta Kappa graduate of Berkeley and the Wharton School of Business, Milkin's personal wealth was estimated to be around $1 billion. He made Drexel the foremost purveyor of junk bonds. Operating out of swank offices on Beverly Hills' Rodeo Drive, and handling as many as 500 phone calls a day at his X-shaped desk, Milkin became a principal target of the SEC's insider-trading probe thanks to Boesky's cooperation with the investigation. In September 1988 the SEC filed a 184-page complaint against Drexel. Manhattan's U.S. District Attorney Rudy Guliani hit Drexel and Milkin with racketeering charges under the 1970 RICO (Racketeer Influenced and Corrupt Organizations) statute. On December 21, Drexel pled guilty to six felony counts of mail, wire and securities fraud, paid a $650 million settlement fee, and fired Michael Milkin. The cases against Drexel and its young junk bond king revolved around charges that secret arrangements were made with Boesky and others to defraud Drexel's clients. Two months later, in Wall Street's biggest criminal prosecution ever, 98 indictments of fraud and racketeering were brought against Milkin. On April 14, 1990 Milkin was sentenced to ten years in jail and agreed to pay $600 million in fines.
Though the investigation had cost Drexel $175 million in legal fees and $1.5 billion in potential profits, the firm remained for a time the premier bond underwriter, and was a key participant in Kohlberg Kravis Robert's $25 billion LBO of RJR Nabisco. In 1988 junk bonds remained strong; high-yield bond funds realized 50 percent gains over three years. But without Milkin, potential borrowers and investors lost confidence in Drexel. In 1989, when Congress forced S&L thrifts to liquidate their high-yield bond holdings, and big bond issuers like Integrated Resources, Southmark and Lomas Financial defaulted, the junk bond market went into a tailspin. Drexel reported losses of $40 million for the year and carried $1 billion in unsold high-yield bonds. (An investment bank like Drexel sometimes bought a client's bonds with a "bridge loan," expecting to sell the bonds to investors for a profit, but Drexel's investor pool was quickly drying up.) Economist Daniel Fischel speculates that the temporary decline of the junk bond market led to a credit crunch that contributed to the 1990 recession.
Critics viewed the machinations of wheeler dealers like Boesky and Milkin as emblematic of the greed and excess they claim marked the 1980s. Defenders argued that "restructuring transactions" like LBOs and mergers created wealth for society as a whole and helped industries become more competitive in the new global economy. The Dow Jones industrial average tripled during the decade as shareholders logged more than half a trillion dollars in gains. Junk bonds made possible the growth of the cable and cellular industries. They provided capital for many Silicon Valley ventures and struggling new firms like MCI, which challenged AT&T's hegemony in the telecommunications industry.
On May 18, 1986 Ivan Boesky gave the commencement address at Milkin's alma mater, the University of California at Berkeley's business school. "I think greed is healthy," he told his enthusiastic audience. "You can be greedy and still feel good about yourself." A few months later Boesky was indicted on the charges that would land him in Southern California's Lompoc Federal Prison, also known as Club Fed West. Michael Milkin's ten-year sentence for fraud and illegal market manipulation was reduced to 24 months. He and other Drexel employees paid $1.3 billion into a pool to settle hundreds of lawsuits.
Sentenced to 10 years in prison, Milkin entered a minimum-security facility at Pleasanton, California in 1991. Two years later he was diagnosed with prostate cancer, and his prison sentence was reduced to time served. He was given 12 to 18 months to live. Milkin established Cap CURE, and raised $75 million to fund research into finding a cure for prostate cancer. In 1996 he and his brother Lowell founded Knowledge Universe, an educational services company which in a few years time was logging $1.5 billion in sales annually. In 1997 the Milkin Institute, an economics think tank, was created. The following year, Milkin's The Taste for Living Cookbook became a bestseller.
The Economist, 26 December 1987
Time, 1 December 1986, 8 December 1986
U.S. News & World Report, 1 December 1986, 8 December 1986, 22 December 1986, 19 September 1988, 26 September 1988, 31 October 1988
"My Master Is My Purse"
Connie Bruck, The Atlantic Monthly, Vol. 254, No. 6 (December 1984)
Payback: The Conspiracy to Destroy Michael Milkin and His Financial Revolution
Daniel Fischer (New York: HarperCollins, 1995)
Den of Thieves
James B. Stewart (New York: Simon & Schuster, 1991)
The Predator's Ball
Connie Bruck (New York: Penguin Books, 1989)