Why Drexel’s Clients Are So Loyal : Spirits at Drexel, one of Wall Street’s largest firms, are being buoyed by the fact that the SEC charges so far have led to few if any defections among clients.

Drexel Burnham Lambert Inc. may be in serious legal trouble, but its plight isn’t bad enough to make the folks at Cablevision Systems Corp. think about dumping their investment bank.

“When we were a very young, small company, they raised money that nobody else could raise for us,” said William J. Bell, vice chairman of the medium-size cable television concern, for which Drexel has completed three financings. “They delivered for us, and they are and will continue to be our major investment bankers,” Bell said. “We stick by our friends.”

Drexel’s other clients seem to be doing likewise. Despite the massive lawsuit filed Sept. 7 by the Securities and Exchange Commission against Drexel, there are few if any signs of defections among the customers of one of Wall Street’s biggest firms. The SEC essentially threw the book at Drexel, filing a 184-page complaint that accused it of insider trading, defrauding clients, market manipulation, falsifying records, concealing ownership of stock and other violations.

The U.S. attorney’s office in Manhattan, conducting a parallel investigation, is expected to bring a criminal indictment next month against Drexel employees.

While no one knows whether loyalty may flag, or if customers will be scared off once criminal charges are filed, Drexel’s clients for the moment are taking the SEC lawsuit in stride. Some are going out of their way to express solidarity with the investment bank.

Steven S. Anreder, Drexel’s spokesman, said that since the SEC suit was filed, the firm has received hundreds of letters and telephone calls from chief executives at client companies, expressing support and promising continued business. He described client loyalty as “tremendous,” and asserted that there haven’t been any defections. A senior Drexel official said he was surprised by the “emotionalism” shown by clients in expressing support.

Independent industry experts say it may be too early to assess the impact of the SEC charges on Drexel’s client base. But so far, they say, they can’t point to any signs that clients are leaving.

The loyalty of the clients is perhaps a measure of Drexel’s reputation for completing highly sophisticated financings successfully and consistently. Some Wall Street executives also say it indicates a belief that Drexel and the chief of its “junk bond” department, Michael Milken, may overcome the charges. Interviews with industry experts and clients themselves elicited three main reasons for the apparent loyalty:

- Clients feel they owe Drexel a big debt of gratitude for helping them raise large sums of money, especially through the firm’s pioneering use of junk bonds. In some cases, Milken’s financial wizardry with high-risk, high-yield bonds transformed obscure investors into the owners of billion-dollar companies.

- The two-year investigation leading up to the charges was widely publicized, so that when the suit finally was filed it contained few surprises. Despite the severity of the charges, some clients dismiss the allegations as technical violations and note that proof seems to hinge on the word of a convicted criminal and federal prisoner, former stock speculator Ivan F. Boesky. Clients say they will treat Drexel as innocent unless the firm is proved guilty.

- Some suggest a darker reason for loyalty: a worry that Drexel, a noted financier of hostile takeovers, might eventually turn against them if they defect, especially if Drexel and Milken succeed in beating the charges. A few note that Drexel in the past has been accused of using hardball tactics to win clients or discourage them from leaving. Drexel, however, vehemently denies that it has ever threatened clients.

Drexel, Milken and the others named in the suit also deny all of the SEC charges.

Significantly, even the clients the SEC has accused Drexel of defrauding say that they don’t have any intention of switching investment bankers. For example, the SEC complaint accuses Drexel of three separate illegal schemes involving Wickes Cos., the big Santa Monica-based manufacturing and retailing conglomerate. One of the accusations alleges that Drexel cheated Wickes in 1986 by secretly manipulating the stock price of a Wickes takeover target.

‘Outstanding Job’

But Wickes’ management seems unperturbed by the accusations. Wickes is attempting to go private through a management-led leveraged buyout. Drexel not only is the investment banker for Wickes’ management, but if the deal goes through, Drexel and certain of its employees personally will own between 20% and 30% of the reorganized Wickes.

Sanford C. Sigoloff, Wickes’ chairman and chief executive, declined to be interviewed on the company’s relations with Drexel. But a Wickes spokesman, Michael Sitrick, said the company would be concerned only if the charges eventually are proved.

“Drexel has done an outstanding job for us in everything for which they’ve been hired,” he said, adding that Wickes doesn’t have any plans to change investment bankers. He also disputed a story in a recent book about Drexel, “The Predators’ Ball” by Connie Bruck, which claimed that Milken originally forced Sigoloff to hire Drexel by implying that Drexel was ready to back a hostile raid on Wickes if Sigoloff refused. “We are not aware of any pressure employed by Mike Milken then or at any other time,” Sitrick said. Drexel, too, denies the account.

Another possible explanation for the loyalty of firms mentioned in the SEC complaint is that, while some of the allegedly improper transactions by Drexel may have cost clients money, others directly benefited them. In another accusation involving Wickes, for example, Drexel allegedly saved Wickes money by artificially raising the market price of Wickes’ common stock in 1986. The move allegedly made it possible for Wickes to call in and redeem an issue of convertible preferred stock, saving the company costly dividend payments.

Underlying some client loyalty, too, is a widespread belief in some segments of the business world that the SEC and the U.S. attorney’s office in Manhattan have been on a witch hunt lately and that the charges, even if true, amount only to technical violations. “I don’t know of any firm that could stand up to 20-20 hindsight on every aspect of their business under all of this very technical regulation,” said a partner in one well-known New York investment firm.

Maxxam Sticks With Drexel

In an interview some weeks ago, before the charges were filed, one Drexel official who declined to be identified said clients not only were expressing support for the firm during the investigation but felt the government was being unfair. “In large measure they have been extraordinarily anti-SEC,” he claimed.

Such sentiment seems to have been a factor in Los Angeles-based Maxxam Group’s decision to stick with Drexel. Like Wickes, Maxxam also allegedly was the victim of fraud by Drexel, according to the SEC complaint.

The suit charges that Drexel defrauded Maxxam of several million dollars in 1985 following a dispute over Drexel’s fees in Maxxam’s then-pending takeover of Pacific Lumber Co. The SEC charges that Drexel arranged with Boesky to buy big blocks of Pacific Lumber stock to boost its market price. Drexel thus allegedly forced up the takeover’s cost to Maxxam and at the same time increased its fee, which was based on a percentage of the takeover price.

Maxxam is now part of MCO Holdings Inc., which is controlled by Maxxam’s former main shareholder, Houston investor Charles Hurwitz. Drexel today remains one of Maxxam’s two financial advisers, and Drexel is co-managing the financing for Maxxam’s $850-million acquisition of KaiserTech Ltd., the nation’s fourth-largest aluminum maker.

Hurwitz himself in 1971 signed a consent settlement without admitting SEC allegations of filing false and misleading information about an investment transaction. More recently, the New York Stock Exchange raised questions about a possible leak of insider information by Maxxam officials in advance of the Pacific Lumber acquisition, and a report by a House committee headed by Rep. John D. Dingell (D-Mich.) raised the possibility that Hurwitz evaded SEC rules by hiding his control of some Pacific Lumber stock.

Hurwitz seldom gives press interviews and couldn’t be reached for comment. But Don Winks, an outside spokesman for MCO and Maxxam, denied that Hurwitz or the companies had been involved in any wrongdoing and said he doubted that the charges against Drexel were true. Winks said the companies would stand by Drexel at least until any charges are proved. “If everybody had walked away from us after what the Dingell committee had alleged last October, where would we be?” he asked.

Far from retreating into the shadows while it fights the SEC charges, Drexel today is at the center of some of the biggest pending deals on Wall Street. After a lull in financing hostile takeovers during much of the investigation, Drexel lately has come roaring back. It is backing a group led by the Rales brothers in their fight to take over Interco Inc., a consumer products company based in St. Louis.

Drexel also is raising the financing for Shamrock Holdings’ attempt to gain control of Polaroid Corp. And, on the defensive side in a takeover attempt, Drexel is backing the leveraged buyout firm Kohlberg Kravis Roberts & Co. in its $2.36-billion effort to save textbook publisher Macmillan Inc. from a hostile raid by British publisher Robert Maxwell.

The highly visible deals are putting added pressure on Drexel: Success would reaffirm the firm’s strength, but a failure to raise promised financing would be a severe embarrassment just now. “Clearly, we’ve got to show that we can still do it,” a senior Drexel official said.

When the SEC charges were filed two weeks ago, Drexel activated a long-planned, highly coordinated public relations blitz to counter the negative publicity. Additional television commercials were run, some financings held in abeyance were put into effect and senior Drexel officials began calling a pre-selected list of clients to reassure them.

But clients, other investment bankers and business school professors say beyond the public relations effort stands Drexel’s proven record of completing successful deals and making a lot of people very rich.

A big part of Drexel’s client base is made up of relatively young, medium-size companies whose early growth was financed by junk bonds. Milken essentially invented the idea of helping small companies raise money by floating high-yield bonds.

Previously, when such companies needed capital to grow, their only source was banks and insurance companies, which often were stingy and attached numerous conditions to loans. But Milken and Drexel created an avid market for such bonds, enabling hundreds of young, entrepreneurial companies to raise big sums of working capital and grow quickly.

“He (Milken) helped them realize their visions,” said one former Drexel employee.

Robert Eccles, a member of the Harvard Business School faculty and co-author of a recent book on investment banking, said even though other Wall Street firms now compete with Drexel in the junk bond market, companies tend to value longstanding relationships and are apt to give their investment banker the benefit of the doubt. “Drexel just happened to develop relationships with a lot of companies that never had investment bankers before,” he said.

Milken and Drexel also retain a certain mystique for having enabled relatively small fish to devour very big companies. In 1985, for example, Drexel made it possible for Ronald O. Perelman, then the proprietor of a medium-size chain of supermarkets, to take over cosmetics giant Revlon, which then had more than $2.3 billion in assets.

Buyout Structure Key

The same year, it helped Nelson Peltz, a virtual unknown in the world of big business, raise over $500 million in financing to complete a hostile takeover of National Can. And it transformed Stephen Wynn into a big-time casino mogul when it raised the financing to build the Golden Nugget casino in Atlantic City.

While views vary on whether Milken has done anything improper, opinions are nearly unanimous that Milken and his staff are extremely reliable at putting together the financing for big leveraged buyouts. Wall Street executives say the structuring of leveraged buyouts--the different maturities of bonds and due dates of interest payments--is vital. They note that a few badly structured deals have led to disaster.

Revco D.S. Inc., the giant drugstore chain that went private in 1986 in a leveraged buyout handled by a Drexel rival, Salomon Bros., filed for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code two months ago because it couldn’t meet the payments on its junk bonds. A Salomon Bros. spokesman said the firm is obliged by Revco’s creditors’ committee not to comment on the transaction.

Big buyers of junk bonds also have been loyal to Drexel, in part because the firm has maintained a market for the bonds, readily buying them back when holders wanted to unload.

Securities industry analysts don’t rule out that there may be attrition among Drexel clients as the government cases progress. But they say such defections probably would be gradual. Clients probably wouldn’t abruptly announce that they were dropping Drexel but instead would simply increase the amount of business they gave to competing Wall Street firms. Loss of Milken, if he were banned from the securities industry or sent to jail, also might cause clients to leave the firm since many view him as the linchpin of Drexel’s operations.

But one key indicator of client confidence seems to be rebounding after falling off somewhat during the first year of the investigation. According to IDD Information Services, which keeps statistics on Wall Street firms, Drexel normally does most of its financings on its own but in 1987 had to take on co-managers--other investment banks--in many of its deals. Industry officials say this was because clients were nervous about whether Drexel would be able to raise the money on its own.

So far this year, however, Drexel is back to being sole manager in a much higher percentage of its deals. For the year to date, Drexel was the sole manager for 44 out of 54 underwritings. The 44 financings had a combined value of $6.89 billion, according to IDD.

Maintaining High Profile

At the moment, Drexel’s efforts to retain clients are aimed at showing that it can still carry off very big deals. Drexel and Milken are also hard at work polishing their public image. Drexel’s advertising has been intended to show how its junk bond financing has helped start-up companies and municipalities, and how, for example, one recent deal helped rank-and-file employees of a Seattle tugboat operator acquire a stake in their company.

Milken himself has taken a high profile in charitable activities through a family foundation and has been outspoken on issues such as alleviating Third World debt and improving health care and education.

At the same time, the firm has taken pains to overcome suggestions that at times it has dealt heavy-handedly with clients. Two years ago, Staley Continental, an Illinois-based food products company, sued Drexel, claiming that a Drexel official had threatened the company with a hostile leveraged buyout that would oust management unless Staley hired Drexel as its investment bank. The lawsuit was still pending earlier this year, even after Staley had been taken over by a British firm in a transaction that Drexel wasn’t involved with.

In an apparent move to get Staley to drop the embarrassing suit, Drexel in August agreed to purchase a Staley commodities trading unit. As part of the deal, Staley did drop the suit. Drexel officials assert that the firm bought the Staley unit for economic reasons unrelated to the suit.