SEC Sues Drexel, Milken for Fraud : Accuses Brokerage and Junk Bond Architect of Illegal Stock Schemes
Drexel Burnham Lambert Inc., one of Wall Street’s leading brokerage houses, and Michael Milken, head of its “junk bond” department, were accused of insider trading, stock market manipulation and defrauding the firm’s clients in a massive lawsuit filed Wednesday by the Securities and Exchange Commission.
The 184-page suit, filed in U.S. District Court in Manhattan, caps the most far-reaching insider trading investigation ever undertaken by the SEC. It is an outgrowth of the agency’s earlier investigation of stock speculator Ivan F. Boesky, who is currently serving a prison sentence for insider trading and who now is cooperating with federal investigators.
The suit had been expected for months. But one surprise was that it also named Victor Posner, a longtime corporate raider and Drexel client, and his son, Steven N. Posner. It accuses them of participating in some of the alleged securities law violations.
Secret Transactions Alleged
The highly detailed legal complaint focused on an alleged arrangement between Drexel and Boesky, under which Boesky and his firms frequently acted as fronts for Drexel. The purpose allegedly was to conceal Drexel’s ownership of stock and to enable it to carry out stock transactions secretly.
According to the suit, Drexel employees, including Milken, also had secret personal investments in Boesky’s stock speculation firm, Seemala Corp. The lawsuit, which SEC officials said is not exhaustive, focuses on 16 series of transactions, most of which involved stocks in companies that at the time were in the midst of takeover battles or mergers. Many of the transactions involved companies engaged in the biggest corporate takeover fights going on at the time.
Many were companies with principal operations in Southern California, including Wickes Cos., Lorimar Inc., MGM/UA Entertainment Co., Viacom International and Occidental Petroleum Corp.
Boesky and Drexel later allegedly divided up profits and losses and then destroyed records to keep investigators from finding out about the transactions.
The suit accuses Drexel of a pattern of fraud and insider trading, under which the firm in 1984 through 1986 repeatedly hid its ownership of big blocks of securities, allegedly to profit from inside information, or to influence the size of fees it would receive from merger or takeover deals that it was handling for clients. As an investment banking firm handling mergers and acquisitions, the firm was required by law not to use information about pending transactions to make decisions on buying or selling stocks. But by using Boesky as a front, Drexel allegedly circumvented this restriction.
The suit also charges that at times Drexel arranged for stocks to be secretly bought or sold to influence their market price and apply pressure to clients who disagreed with Drexel advice on how to carry out takeovers or financings.
The suit asks for “disgorgement” of illegal profits and financial penalties equal to three times the amount of money illegally gained. The suit does not give a total figure, but an SEC lawyer said final penalties likely would total in the tens, if not hundreds, of millions of dollars. The suit also seeks injunctions against Drexel and the employees named in the suit. If Drexel is found liable, the case conceivably could lead to an injunction banning the employees or the entire firm from the securities business.
Milken Is Key Defendant
In addition to naming the firm itself, the suit, as expected, charges Milken, 42, as a key defendant. Milken invented the market for high-risk, high-yield securities known as junk bonds and heads Drexel’s high-yield bond department, based in Beverly Hills. Milken’s creative use of junk bonds to finance hostile takeover attempts made him a major force in the world of corporate takeovers, beginning in the early 1980s. The junk bond department has long been Drexel’s most profitable division, and the firm still dominates the market for such securities.
The suit also names Milken’s brother, Lowell J. Milken--a lawyer who for years has helped Michael run the junk bond department--and Drexel traders Cary J. Maultasch of New Jersey and Pamela R. Monzert of Santa Monica. Pennsylvania Engineering Corp., controlled by Victor Posner, was also listed as a defendant.
Drexel, Michael Milken and lawyers for the other defendants denied any wrongdoing and predicted that they would be vindicated in court. In general, they contended that most of the SEC’s charges were based on unsubstantiated allegations by Boesky.
Welcomes Hearing
In a statement, Michael Milken said: “For the past 22 months I have been the subject of a shadow trial of systematic leaks and innuendo based upon false accusations.” He added that “no one likes to be sued, but I welcome the opportunity to have at long last a full and open hearing of the allegations” in court.
Frederick H. Joseph, Drexel’s chief executive officer, said: “We disagree with the charges filed by the SEC and, in due course, we expect to be vindicated.”
The SEC’s investigation has been under way since early 1987, and Drexel confirmed last June that it expected the suit to be filed. Full details of the suit, however, were not disclosed until Wednesday.
There was no word Wednesday on the status of a parallel criminal investigation being carried out by the U.S. attorney’s office in Manhattan. A federal grand jury has been hearing evidence for months, and there has been unconfirmed speculation that an indictment will be filed in October. Bruce Baird, head of the U.S. attorney’s securities fraud unit in Manhattan, declined to comment on the investigation.
‘Sweeping Fraudulent Scheme’
“The complaint delineates a sweeping fraudulent scheme,” said Gary G. Lynch, director of enforcement for the SEC. He declined to characterize the case further or to discuss details.
It was not immediately clear what impact the lawsuit will have on Drexel’s business. Many Wall Street traders and analysts noted that the lawsuit has long been expected and Drexel’s clients have already taken it into account. Others, however, including one senior Drexel official, said Michael Milken is such a key figure at Drexel that any outcome of the lawsuit that required him to leave the firm inevitably will damage it.
Officials of several competing firms said some clients might reconsider their ties to Drexel now that the charges have been brought. And competitors will certainly try to exploit their new advantage, they said. “It certainly will have some impact,” one competitor said.
The filing of the SEC’s civil lawsuit raised the possibility of friction between the SEC and the Manhattan office of U.S. Atty. Rudolph W. Giuliani, which is conducting the criminal investigation. Securities lawyers have said that the filing of civil charges before the criminal investigation was completed would give defense attorneys an opportunity to subpoena government witnesses and take statements under oath. The lawyers said this might give defense attorneys advance knowledge of the government’s criminal case and help them build a defense.
May Request Court Order
Some lawyers speculated that Giuliani might request a court order stopping any proceedings under the SEC suit until after criminal charges are filed. But Giuliani’s office refused to comment Wednesday.
Martin Flumenbaum, one of the lawyers for Michael Milken, said he would oppose any move by Giuliani to stay the SEC case. He said “it would be grossly unfair” to stop the proceedings once public charges have been filed.
Several defense lawyers confirmed Wednesday that they would move swiftly--probably within days--to subpoena Boesky.
The allegations against the Posners relate to alleged stock “parking” carried out by Drexel--in which the firm illegally concealed the Posners’ ownership of certain stocks--and to allegedly fraudulent dealings in Pennsylvania Engineering’s acquisition of stock in Fischbach Corp.
Ownership Allegedly Hidden
Drexel and the Posners allegedly acquired shares in Fischbach in early 1984 but hid their ownership by using Boesky’s companies as a front. The SEC charged that the arrangement helped the Posners get around a contract in which they had agreed not to acquire more than 24.9% of Fischbach’s voting stock.
The insider trading charges against the Posners are the latest in a series of legal and business misfortunes, including a recent tax fraud conviction against Victor Posner.
John H. Sturc, an SEC deputy enforcement director, denied that the lawsuit relies exclusively on information obtained from Boesky. He said two of the main alleged insider trading transactions listed in the lawsuit had nothing to do with Boesky and were not based on information from him.
Lorimar Case Cited
In one, involving Lorimar Inc., the suit charges that in September, 1985, Lorimar and Telepictures Corp. sought advice from Michael Milken and disclosed to him in confidence that they were considering a merger. The suit charges that Drexel, based on that information, then illegally bought more than 159,000 shares of Lorimar stock and ended up making a $1.23-million profit.
Staff writer Paul Richter in New York contributed to this story.
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