As Drexel Feels Heat, Prosecutors Face Their Own Obstacles in Probe

The rumors that Drexel Burnham Lambert finally is about to be charged in the insider trading scandal that brought down Ivan F. Boesky usually reach a crescendo on Fridays.

Since 1986, the investment banking firm has been under investigation by federal prosecutors and the Securities and Exchange Commission. Fridays are the best day for rumors, since it is expected that charges would be filed after stock and bond trading halts for the weekend, to minimize the impact on the financial markets. So it has become routine for Drexel’s spokesman and lawyers to field a barrage of press calls at the end of each week.

Lately, the rumors have intensified, and indeed it may not be many more Fridays before SEC civil charges are filed. Drexel confirmed in June that the SEC has approved, but not yet filed, a lawsuit against Drexel and several employees. That, in turn, has fueled speculation that criminal charges, too, may come as soon as September.

But federal prosecutors, wrestling with the complexities of the ground-breaking case, are struggling to obtain an indictment although one is widely considered to be inevitable. They are facing a host of major problems, not the least of which is their own star witness.

The investigations were sparked by information from Boesky, the Wall Street investor who paid a $100-million penalty in 1986 and is serving a three-year prison sentence in the country’s biggest insider trading scandal. Boesky’s cooperation with prosecutors led to swift guilty pleas last year from major targets, including Martin A. Siegel, a high-level executive at Kidder, Peabody & Co., who had just left to work for Drexel, and Boyd L. Jefferies, the former chairman of the Los Angeles-based brokerage firm, Jefferies Group. But Boesky has yet to testify publicly as a prosecution witness in a trial.

Meanwhile, Drexel steadfastly denies any wrongdoing and seems determined to fight in court, if necessary. That has triggered worries among government officials about how credible Boesky, a confessed major criminal who once publicly preached that greed is good, will be to a jury.

As a result, the federal criminal investigation has turned into an intensive effort to gain enough independent evidence that the case won’t stand or fall on Boesky’s testimony alone. Prosecutors are attempting to obtain documentary proof of illegal trades and independent testimony to buttress Boesky’s story. But it’s unclear how well they are succeeding.

Of the known pending investigations resulting from information from Boesky and the earlier guilty plea of investment banker Dennis Levine, the Drexel case is by far the most important. A major Wall Street investment firm, Drexel pioneered the use of high-yielding “junk bonds.” With these securities Drexel has helped raise mountains of cash swiftly for corporate raiders, making the firm a leading force behind this decade’s wave of takeover attempts and leveraged buyouts.

To some Drexel officials, the long-expected filing of charges would almost be preferable to the agonizing wait. “The problem with the investigation is that it’s taken too long,” said one Drexel senior official. He asserted, “To be under a cloud for two years is a sort of cruel and unusual punishment.”

Although Drexel is still doing extremely well financially--in the first half of this year it earned $161 million in fees just from underwriting bond issues--insiders say the investigation has taken its toll. For one thing, a senior official said, since the investigation began Drexel often has been forced to accept co-managers--other investment banking firms--when it underwrites new issues of junk bonds.

And while Drexel’s spokesman attempts to minimize the potential impact of the expected prosecution, insiders acknowledge that it inevitably will damage the firm. One reason is that Michael R. Milken, the creator and head of Drexel’s hugely profitable junk bonds operation in Beverly Hills and the man who has dealt directly with some of Drexel’s best customers, is a leading target of the investigation.

‘Parking’ Under Investigation

Lawyers associated with the case confirm that the investigation is looking into possible secret arrangements between Boesky and Drexel to profit from corporate takeovers.

A federal grand jury in Manhattan is said to be examining evidence that Boesky and Drexel officials agreed to illegally conceal the ownership of large blocks of stock in companies involved in takeover fights. The investigation of so-called stock “parking” is said to focus on such transactions as the 1985 takeover of Fischbach Corp. by investor Victor Posner and the 1986 merger of Lorimar Inc. and Telepictures Corp., which led to creation of Lorimar Telepictures.

Possible violations include misusing inside information, intentionally failing to comply with SEC disclosure rules, and deliberately failing to keep accurate books and records.

In addition, the grand jury is believed to be examining whether false explanations were given to investors and Boesky’s outside auditors about a $5.3-million payment in 1986 from Boesky to Drexel. Although Drexel denies it, the fee is suspected of being a payment to Drexel for parking stock for Boesky.

People involved with the case speculate that one reason the SEC has waited to file charges is to allow the U.S. Attorney’s office in New York more time to complete its investigation. Some SEC officials are said to have grown impatient with the pace of the criminal probe.

But grand jury witnesses are scheduled to testify through the end of August, according to lawyers in the case. And Drexel hasn’t yet produced all of the documents subpoenaed by prosecutors, who are unlikely to get an indictment before all of the records are turned over.

Sources say at least four Drexel employees have been granted immunity to testify before the grand jury. Several of Boesky’s former employees have appeared as well. Prosecutors also are known to have records of the $5.3-million payment, which Drexel described as a fee for consulting and investment advice.

Prosecutors are essentially looking for documents and independent testimony proving illegal trading by Drexel and collusion with Boesky, but some lawyers suggest that the documentary evidence known to be in prosecutors’ hands is ambiguous. And the search for corroboration may be handicapped by the fact that in his transactions with Drexel, Boesky usually spoke with no one but Milken.

Field Day Expected

Defense lawyers in the case understandably are anxious to portray the case against Drexel as nothing more than unsubstantiated allegations from Boesky. They say he is a man trying to justify a relatively light sentence by feeding more targets to prosecutors. They paint him as someone who in a trial will be inherently unbelievable.

“It’s tough to make a case when you’re using a self-confessed super-criminal to go after respectable businessmen,” asserted one lawyer representing a potential Drexel defendant.

Defense lawyers expect to have a field day cross-examining Boesky on the book he wrote on Wall Street arbitrage, published about a year before his downfall. In the dedication at the beginning of the book, Boesky wrote how his life was influenced by his father’s “emphasis on learning as the most important means to justice, mercy, and righteousness.”

Boesky wrote how the fortune he made by betting correctly on possible corporate takeovers really came from hard work and sound analysis. In fact, the killings he made on some of the deals resulted from leaked inside information. According to court records, Boesky paid for some of the illegal tips with satchels full of cash.

“You can disgust a jury pretty quickly just by examining him on his book,” said one of the main defense lawyers in the case.

The defense lawyers also say Boesky, although articulate and engaging in person, might elicit hostility as a witness. Prior statements, they say, might come back to haunt him. In a memorable speech before he was accused of wrongdoing, he once stated that, “Anyone who thinks that greed is a bad thing, I want to tell you, it’s not a bad thing.”

And one lawyer asserts that jurors may not react favorably to someone who turned on his own employees and associates, wearing a recording device and allowing prosecutors to tape his phone conversations before it was publicly known that he was cooperating with the government.

Defense lawyers also claim that Boesky’s recent request for a sentence reduction won’t help his credibility.

Although the defense lawyers may tend to exaggerate Boesky’s credibility problems, legal experts not involved in the case say the less prosecutors have to rely on his performance as a witness the better their chance of winning. Alan Bromberg, a professor of securities law at Southern Methodist University, said Boesky’s exceptional notoriety might work against him as a witness. “I think juries usually understand that somebody who has pleaded guilty is trying hard to justify a light sentence by cooperating with the government,” he said.

Potential jurors may be aware of the press coverage Boesky has received and the huge sentence he could have faced if he hadn’t cooperated. “At least the more sophisticated jurors might discount testimony because of that,” Bromberg said.

Constitutional Rights Involved

In interviews, federal prosecutors and SEC officials play down such concerns. Rudolph W. Giuliani, the U.S. Attorney in Manhattan, although not commenting specifically on the Drexel case, noted that it is routine for prosecutors to rely on confessed criminals as witnesses. “By and large the government makes its cases through the testimony of people who are involved in criminal schemes,” he said.

Giuliani acknowledged, however, that his office faces a difficult chore in bringing a major securities fraud case. In a criminal case, “all of the Constitutional rights come into play,” and the burden of proof is much higher. That, he says, is why a criminal investigation might take much longer than an SEC investigation. While prosecutors must prove their case beyond a reasonable doubt, the SEC need only win by the less rigid standard of “a preponderance of the evidence.”

Further, SEC cases are usually settled, and in the relatively rare instances when they end up in court, generally are resolved by judges. Criminal trials usually take place before juries.

One lawyer involved in the Drexel case notes that it involves extremely sophisticated transactions, as well as relatively arcane securities laws. Prosecutors who may have more background prosecuting drug cases than securities violations would have to master the complexities of the case themselves and then be able to lay it out clearly and persuasively for a jury of laymen, some of whom may never even have heard of junk bonds.

The SEC also has an advantage in the sense that, once it files a civil lawsuit, it can obtain additional evidence later through the legal process of discovery. Criminal prosecutors generally must have all of their evidence in hand before an indictment is returned.

Criminal charges are more serious than SEC charges because they could lead to prison terms for Drexel officials. The SEC can only exact financial penalties, although the sums conceivably could be quite large.

For his part, Giuliani bristles at suggestions that his investigation may be dragging on too long. “I can assure you that there’s no delay that’s unwarranted,” he says.