Drexel Burnham Bankrupt : Junk Bond Pioneer Filing After $100-Million Defaults : Parent of Brokerage Firms Asks Protection

The parent of junk bond pioneer Drexel Burnham Lambert Inc. said today it would file for federal bankruptcy court protection, capping the downfall of the Wall Street firm that pioneered use of high-risk bonds in financing the takeover boom that swallowed many well-known firms.

Drexel Burnham Lambert Group Inc. said a staggering liquidity problem had resulted in defaults on about $100 million in loans and was threatening other defaults.

The decision to seek protection from creditors under Chapter 11 of federal bankruptcy law was expected to be approved by Drexel’s board of directors later today, said a Drexel official.

Drexel chief executive Frederick Joseph told employees on the firm’s internal communications system that the parent company and certain subsidiaries will file with U.S. Bankruptcy Court today.

Drexel said in a statement that it “intends to engage in an orderly liquidation of its positions” in government securities, although it would remain in the exclusive club of primary dealers for Treasury bonds.

Wall Street traders and other sources said Drexel was barely functioning today.

Few companies were reported to be trading with the firm, which rose to prominence through the risky “junk” bonds that have also marked its downfall.

Drexel was also said to be transferring accounts for which the firm holds securities to Smith Barney, Harris Upham & Co., which acquired Drexel’s retail brokerage business last year. The accounts were said to be employee or employee-related and include all types of securities, including stocks and bonds.

Drexel today also voluntarily withdrew from making markets in 228 stocks traded over the counter through the National Assn. of Securities Dealers.

The firm was able to maintain its duties as a specialist on the floor of the New York Stock Exchange when another firm, Speer, Leeds & Kellogg, agreed to clear Drexel trades and guarantee their financial obligations. Drexel owns the specialist firm Pforzheimer & Co.

Earlier, Drexel said in a statement that a Chapter 11 filing would exclude the broker-dealer subsidiary, Drexel Burnham Lambert Inc., and Drexel Burnham Government Securities Inc.

The Drexel statement sent the market in high-yielding junk bonds into turmoil.

“The market is going wild. It is all over the place,” one junk bond trader said.

“You want to talk about an end of an era?” said Joan Greenberg, a senior vice president for high-yield bonds at Dean Witter Reynolds Inc. “When you have a market as tentative as the high-yield market, the removal of any player has to have a negative effect.”

Junk bond prices fell two points to three points, or $20 to $30 per $1,000 of face value, following the news that Drexel’s board would meet to vote on the bankruptcy matter. Prices fell by a similar amount Monday, when Drexel said it was seeking a major investor or merger partner in an effort to raise additional capital.

Drexel blamed the bulk of its problems on the deteriorating market for high-risk, high-yield “junk” bonds that it helped to create in the 1980s under now-indicted executive Michael Milken.

Drexel’s announcement followed several days of marathon negotiations with the Securities and Exchange Commission, the Federal Reserve Board and the New York Stock Exchange over how to prevent a financial panic over its troubles.

The dire problems at the investment firm threaten confidence in the nation’s financial markets because of Drexel’s pre-eminence in the $200-billion junk bond market, which has been slumping since last fall when several companies failed to meet financing terms on their junk bond debt.

The firm was also hammered by its decision to plead guilty to six felonies and pay $650 million to the government to settle federal charges related to insider trading and other offenses. Drexel was forced to restructure as part of a civil settlement with the SEC and has since cut its work force to 5,300 from 10,700.

The firm last week began to shift cash to the strapped parent from its securities subsidiary, but the move alarmed officials at the Federal Reserve and the SEC, who feared it might weaken the subsidiary.

The SEC said in a statement today in Washington that it had moved to protect the assets of the brokerage firm by barring the subsidiary from transferring net capital to the parent without prior, specific approval.

“Inventory schedules and other detailed financial information submitted by Drexel Burnham Lambert indicate at this time the registered broker-dealer has positive net worth and remains in capital compliance,” the SEC said.

The Federal Reserve Bank of New York issued a statement saying it will “carefully monitor” Drexel’s decision to liquidate its position in government securities in consultation with the government, Drexel’s securities subsidiary and other market participants.

The bank said Drexel was still designated as a primary dealer in government securities.

Dealers in Treasury securities said there is concern that by selling off its large portfolio Drexel will add supply to the market and depress prices--pushing interest rates higher.

Drexel was a sleepy, second-rank Wall Street firm before financial whiz-kid Milken turned it into the pioneer and dominant player in the market.

Launched during the Depression by I. W. (Tubby) Burnham, the firm’s roots go back even further through a predecessor, Drexel Firestone, a prestigious, old-line investment house that Burnham acquired in 1973. Lambert was added through a 1976 acquisition.

Drexel Burnham had traditionally operated in the second tier of Wall Street houses. But its aggressive trading of commodities during the inflationary 1970s moved it closer to the top ranks and boosted its capital base.

As the commodities business cooled during the 1980s, Drexel sought to diversify.

Milken, known for working long hours and for his spellbinding speeches to clients, led Drexel’s march into the business of issuing high-risk bonds to finance new businesses. Companies having trouble raising funds through traditional channels were also sought as clients.

But it was the boom in corporate takeovers that provided the big boost to Drexel’s junk bond business. Drexel forged alliances with corporate raiders like Ivan Boesky, Carl Icahn and others.

But in November, 1986, Boesky agreed to pay $100 million to settle insider trading charges brought by the Securities and Exchange Commission. He also agreed to plead guilty to a criminal charge and cooperate in the government probe.