FALLOUT FROM THE DREXEL CASE : Defection Undercut Best Defense Money Could Buy

To take on the government in its massive securities fraud case, Drexel Burnham Lambert Inc., its “junk bond” chief Michael Milken and other employees assembled one of the best legal teams money could buy.

But after the investment firm agreed Wednesday to settle the charges by paying $650 million and pleading guilty to six felony counts, some observers began to wonder whether what money could buy was enough.

“When the government can use the anti-racketeering law against you, and when your palace guard begins to turn state’s witness, you begin to see that’s the ballgame,” said John Coffee, a law professor at Columbia University. “The legal team can only do so much.”

Paul Grand, a defense attorney in the related securities case involving Princeton/Newport Partners, put it slightly differently: “Recently, it’s looked like one side was fighting with pistols and the other with tanks.”

Last summer, general assessments of each side’s strength were different.

The 25 lawyers representing Drexel and individual defendants included Arthur L. Liman, 58, a top defense attorney and former prosecutor, who last year was Peter Fleming counsel to the U.S. Senate committee that investigated the Iran-Contra affair. The team had Peter E. Fleming Jr., 59, another former prosecutor, who defended former Atty. Gen. John Mitchell, and Vincent Fuller, 57, who represented accused presidential assailant John Hinckley Jr.

The team is “the finest group of lawyers assembled in a long time,” said Howard Schiffman, a Washington lawyer who represents a potential witness in the case. “This is as good as it gets.”

Their counterparts in the federal prosecutors’ office were far less experienced.

Key players, in addition to U.S. Atty. Rudolph W. Giuliani, were John Carroll, 33, head of the prosecutor’s securities and commodities fraud office; Bruce Baird, 40, and Jess Fardella, 37. Carroll had only five years’ experience as a lawyer, most of which he spent working on narcotics cases in Giuliani’s office.

But the defense’s tactics met setbacks, one after one, all year. Last summer, when Drexel officials testified before Congress, Drexel Chief Executive Frederick H. Joseph seemed unsure of key points in securities law. “He looked bad, and the lawyers should have been able to prevent that,” said a New York defense lawyer familiar with the case.

Provoked a Judge

The defense failed in a controversial effort to force U.S. District Judge Milton Pollack to remove himself from hearing the Securities and Exchange case against the firm and some employees that was brought last September. The defense argued that Pollack, considered unfriendly to white-collar defendants, might be biased in favor of Drexel because the investment firm was involved in a buyout in Texas that stood to make money for his wife.

But while the defense lawyers provoked Pollack to angrily denounce them, a federal appeals court denied the defense motion by a 3-1 vote.

The defense was again set back when it failed to win access to the testimony of Ivan F. Boesky, the former stock speculator who is a key witness against Drexel. And it suffered a blow when it was unable to persuade Giuliani’s superiors in the Justice Department to bar the use of the potent anti-racketeering statute--the Racketeer Influenced and Corrupt Organizations Act, or RICO--against the firm.

But these setbacks seemed minor compared to other developments over which the defense team had little control.

The first setback came in August, when a federal district court rejected the efforts of Princeton/Newport to prevent the government from seizing assets of the firm while it was facing prosecution on RICO charges. The ruling meant that the government might be able to seize an enormous share of Drexel’s assets while the firm was prosecuted on RICO charges.

That, in turn, raised fears that banks and other business partners would cease doing business with Drexel, cutting off its financial lifelines and, conceivably, putting it out of business.

U.S. Enlists Senior Traders

“The government’s ability to use RICO was a threat that really obliterated all other legal considerations,” defense lawyer Grand said.

Then, in recent weeks, prosecutors began to succeed in efforts to enlist key Drexel employees in their cause.

Earlier this month, Drexel bond trader Terren S. Peizer joined senior equity trader Cary J. Maultasch, accountant Charles Thurnher and trader James Dahl as employees who had agreed to provide information to prosecutors in exchange for immunity.

The enlistment of the four meant that the government’s case no longer rested entirely on information provided by Boesky, who is serving a three-year prison term. And the defense had hoped to point out to a jury that the case was a matter of the word of Drexel employees versus that of a convicted felon.

“When the government’s case rested on Boesky, it looked easily defensible,” said Prof. Coffee. “But the phalanx of Drexel employees that had been so solid was suddenly breaking apart.”