How High Does Accountability Go? : Role of Drexel Chief a Growing Issue in Milken Inquiry

Newsday

During the 2 1/2 years of investigations into stock and bond trading involving Michael Milken, Drexel Burnham Lambert's "junk bond" chief, little has been said publicly about the conduct of Drexel's chief executive, Frederick H. Joseph.

But that may be about to change. Experts on securities law enforcement say they soon expect to see tough congressional scrutiny and public debate on how well Joseph and the brokerage supervised Milken's dealings and his money-minting junk bond department in Beverly Hills, 3,000 miles from Drexel's New York City headquarters.

The question at the core of the debate: In the wake of Drexel's December plea bargain calling for guilty pleas to six felonies allegedly committed by Milken, should Joseph and other top managers be sanctioned under failure-to-supervise provisions of federal securities law for letting the junk bond king run amok?

So far, indications are that Joseph--who has not been charged with anything--expects to survive the brokerage's ongoing settlement negotiations with the Securities and Exchange Commission with his job intact. But some observers question whether that would be the appropriate result.

Accountability Urged

Their concerns: While Joseph has not been directly implicated in wrongdoing, he had a close relationship with Milken and may have been the only person at Drexel capable of controlling an executive as highly placed as Milken.

Some think that Milken's rise was accompanied by possible red flags hinting at questionable dealings in the junk bond department. And others say government regulators must establish stringent management accountability to deter securities industry lawbreaking.

A case can be made that the alleged crimes were "high enough up in Drexel that Fred Joseph would be hard put to say he didn't know anything about it," noted New York University securities law professor Helen Scott in a recent interview. "He didn't have to know what every single broker and dealer were doing, but he did (legally) have to know what Milken was doing, because he was a key player."

Added Richard Phillips, a Washington securities lawyer, "A lot of people have raised that issue (privately), and it is a perfectly legitimate issue."

As part of its bargain to escape securities racketeering charges, Drexel will plead guilty to securities and mail fraud stemming from stock manipulations, hidden dealings and phony transactions involving the junk bond department from 1984 through early 1986. Drexel also has agreed to cough up $650 million and fire Milken to settle the case, but the deal is subject to the brokerage settling a civil suit filed by the SEC.

While negotiations with the SEC are ongoing, Drexel asserted in an announcement last month that Joseph will continue as chief executive. Drexel spokesman Steven Anreder said that neither Joseph nor other Drexel officials would discuss the supervision issue.

Internal Enforcement Key

Questions about the boss's role come up whenever there are serious allegations of wrongdoing in any company or public agency, noted the compliance director of another investment bank in a recent interview.

And as a matter of federal securities law, Joseph and all other securities firm managers face an unusually tough standard: Did they do enough to keep the wrongdoing from happening in the first place? The law says the SEC may censure, suspend or put out of business anyone who "has failed reasonably to supervise, with a view to preventing violations" of securities regulations and laws.

The supervision provision is in the law because Congress and industry leaders have stated that good internal enforcement is essential to protect investors, maintain public confidence in Wall Street and support capital formation for the economy.

SEC officials say they do not keep count of the number of proceedings they bring against brokers and dealers that include failure to supervise. However, James Treadway, general counsel of Paine Webber Inc. and a former SEC commissioner, said he senses that regulators are gradually starting to hold top officials to higher standards of responsibility than in recent years.

Rep. John Dingell (D-Mich.), for one, is expected to raise the question of Drexel's supervision during public hearings. Dingell, chairman of the House subcommittee that oversees the SEC, plans to hold hearings about a week after the SEC and Drexel agree on terms to settle the massive civil lawsuit the agency brought in September.

Joseph's public posture stands to make him a focal point of questions about supervision at Drexel. He has carried Drexel's banner through the controversy over the investigation and lobbied lawmakers during the uproar over junk bonds.

And he has invited a high standard for his performance in maintaining Drexel's image: "Public confidence and the integrity of our firm (are the) most important factors in every decision I make as chief executive officer of Drexel Burnham," he said in April when he appeared for a full day of grilling by a hostile congressional subcommittee.

In light of Drexel's plea deal, Joseph's apparent ability to shed personal responsibility for the brokerage's fiasco puzzles some securities law experts. "If what we've been hearing is true, the fact that Fred Joseph is being allowed to stay in office is surprising," said one securities expert. "If you talk about something happening on someone's watch, this is it."

Reliable Defense

Scott, the law professor, said, "I think (top managers) ought to be removed when something of this magnitude is discovered. . . . There is a criminal act going on, and it is perfectly respectable to say that the chief executive has to know what is going on or he has to lose his livelihood."

The law says a manager can escape blame for failure to supervise by maintaining procedures that would reasonably prevent wrongdoing. This defense has generally protected officials who have installed a compliance department and who have layers of managers between them and stockbrokers and traders, the most frequent targets of regulatory actions.

Drexel has a compliance department, complete with compliance manuals and computers programmed to spot improper trading by employees. And, on paper at least, there is a manager between Joseph and Milken--the head of fixed-income trading, Edwin Kantor.

Joseph, 51, has said that, in addition, Drexel Chairman Robert Linton reviewed trades by Milken's department. Linton, who is less well-known than Joseph, is expected to retire from the brokerage soon, though there has been no indication that he will leave because of the scandal.

Linton, 63, was chief executive of the brokerage until he turned over the post to Joseph in May, 1985. Joseph had been head of Drexel's corporate finance department since 1974 and had long been a member of the executive committee that runs the brokerage.

Martin Gold, a New York securities lawyer, believes that more facts about Joseph's conduct must come out before the public can judge his supervision. "When you're doing $1-billion deals like Drexel was out on the West Coast, it seems to me someone in management had an obligation to make sure those deals were being handled according to law," Gold said. "But it's ultimately possible that (an illegal) act could occur despite what you would consider to be adequate supervision."

Joseph, in a Dec. 19 talk with Drexel employees about the brokerage's settlement talks, said he had only recently learned that some employees had broken the law. The deeds violated Drexel policies, and there was no way the brokerage could have known about them, Joseph said. And at the core of the government's case is the assertion that Milken and former takeover speculator Ivan Boesky had a secret arrangement to violate securities laws.

Functions Typically Separate

A look at the public record, however, shows some possible red flags on Milken's dealings. For example:

- By 1984, Milken was widely recognized on Wall Street for both trading in junk bonds and putting together deals involving junk bond issuers--deals that could affect the price of the bonds Milken was trading. Wall Street typically separates these functions to avoid insider trading.

- In October, 1985, Green Tree Acceptance Inc., which had hired Drexel to help sell its stock to a wide distribution of investors, filed suit against Drexel, alleging that Milken had deliberately put a block of its shares into the hands of another client, corporate raider Saul Steinberg. Drexel officials denied at the time that they had played one client against another. Green Tree eventually settled the suit for undisclosed terms.

- Milken had a history of chafing under Drexel policies. For example, on several occasions he went ahead with deals against the orders of a Drexel review committee, according to the first major book on Milken, "The Predator's Ball," by Connie Bruck.

In answers to questions from a House investigations subcommittee in April, Joseph acknowledged that he had recognized investments by special employee partnerships potentially posed conflicts of interest between Drexel employees and clients several years before.

Members of Congress, who looked at evidence that the employee insider accounts had secretly profited at the expense of some mutual fund investors and insurance policy holders, declared that the partnerships did not meet "the smell test."

'Some Mitigating Things'

The partnerships, many of which Milken or his brother Lowell ran, sometimes gave Milken a vested interest in his bond trading and in underwritings and takeovers he was working on. Joseph insisted that the practice was legal but stopped it a few days later.

Securities lawyer Phillips cautioned against jumping to a harsh judgment of Joseph: "It may well be that Joseph did some mitigating things that showed a great deal of independence, given all of the circumstances."

But one former Drexel investment banker, who said he is inclined to believe that Joseph tried to keep Milken in line, said any mitigating factors may be outweighed in the coming discussion of Joseph's conduct by his two years of strident statements that Drexel was the innocent victim of felon Boesky and malicious government investigators.

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