Drexel Begins Dismantling Once-Powerful Junk Empire

By SCOT J. PALTROW

Feb. 15, 1990 12 AM PT

TIMES STAFF WRITER

NEW YORK —

Wall Street scavengers descended on Drexel Burnham Lambert Inc. Wednesday after the investment bank’s parent company filed for bankruptcy protection.

Shortly before midnight New York time on Tuesday, lawyers for the parent, Drexel Burnham Lambert Group, filed a 22-page petition under Chapter 11 of the U.S. Bankruptcy Code, listing $3.698 billion in assets and $2.885 billion in liabilities. The initial filing listed only the 23 largest outside creditors, including the California Public Employees Retirement System, and gave few details of the firm’s financial situation.

After defaulting on a $100-million loan package Tuesday, Drexel said it will soon close down its operations, but no date has been set.

Many of the firm’s 5,300 employees began a search for jobs. Drexel spokesman Steven Anreder said the firm told employees Wednesday that they will be given severance pay, although the amount hasn’t been determined. Meanwhile, he said, employees on the trading floor and elsewhere at the firm had settled down to closing out the firm’s affairs. “I think the shock is over,” he said.

Executives from rival Wall Street firms flocked to Drexel to pick over its inventory of securities, hunting for bargains. Virtually all of the firm’s government securities holdings and much of its mortgage-backed bond portfolio were sold by the end of the trading day. There was speculation that the firm’s remaining massive holdings of junk bonds, valued at more than $1 billion, might be sold as a package to one or more buyers under a negotiated sale. Anreder said, however, that no decision has been made.

Junk bonds, the high-risk, high-yield securities that Drexel pioneered and made the cornerstone of its fantastically profitable business in the 1980s, were also the firm’s undoing. The firm couldn’t weather the severe downturn of the junk market that has been under way for months. A Chapter 11 filing normally allows a company to continue operating while it attempts to work out an arrangement with its creditors. But experts in bankruptcy law said that the law provides less protection to brokerage firms and that Drexel really had no option but to liquidate.

The fist tentative list of creditors contains many gaps and doesn’t name any insiders or former insiders who are owed considerable sums, such as the firm’s former junk bond chief, Michael Milken. The firm may ultimately contend that it owes Milken nothing.

After Milken was forced to resign from the firm last year following his indictment on 98 felony counts, Drexel refused to pay his salary and bonus for 1988 and 1989. Milken denies having violated any laws. The firm also never paid him for his large holdings of Drexel stock that he was required to turn in on leaving the firm. Some sources at Drexel say internal estimates show that the firm owes him no more than $100 million. But the Milken camp believes the figure to be around $200 million, sources said.

The bankruptcy filing also apparently means that Drexel will stop paying the huge legal bills run up by Milken and a dozen or more current and former employees. Under employment agreements, Drexel had been paying nearly all of the legal expenses that the employees incurred as a result of the government’s investigation into securities fraud, stock market manipulation and insider trading at the firm.

A spokesman for Milken refused to comment Wednesday on the cutoff of legal fees and other money owed to him. A lawyer for a Drexel employee who is a cooperating witness noted that most of the people for whom Drexel was paying legal fees have considerable personal wealth. “These guys can afford their own lawyers,” he said.

Another direct effect of the filing is that Drexel most likely will stop setting aside the money it was paying into a special fund to pay off claimants who have civil suits pending against the firm. Drexel was still scheduled to set aside $150 million for the fund, which the Securities and Exchange Commission required after the firm pleaded guilty to six counts of securities fraud last year.

Pamela Corri, a lawyer at the New York law firm of Weil, Gotshal & Manges, the firm representing Drexel in the bankruptcy proceedings, said a more detailed list of creditors, assets and liabilities probably won’t be filed for at least a month.

In the filing made late Tuesday, the largest single creditor listed was a Japanese life insurance company, Taiyo Mutual Life, which is owed $69.7 million under a private debt placement. The California Public Employees Retirement System is listed among the top six creditors. Drexel owes the state pension fund $25 million.

Basil Schwan, assistant executive officer of the pension fund, noted that the Drexel loan accounts for only a minuscule portion of the fund’s investments, which total about $57 billion. Schwan said the loan, a private debt placement, was made in 1986, when Drexel was “in a very strong growth posture” and had a high credit rating.

In an affidavit filed in Bankruptcy Court, Drexel Chief Executive Frederick H. Joseph said the parent firm was forced to file because “DBL Group currently faces a liquidity crisis and does not have the financial resources to weather this storm without court protection.” He said that, without the protection, the firm would soon be obligated to pay more than $3 billion in debt owed by the parent and its subsidiaries, payments that it couldn’t meet.

Joseph blamed the firm’s predicament on a general “downturn in the financial markets,” including the high-yield market. He noted that Drexel normally financed its day-to-day operations by selling commercial paper--short-term, unsecured IOUs. But as the junk bond market plummeted, and the market for commercial paper shrank, the firm could no longer raise the operating money it needed. He said the firm recently had to pay off $575 million in commercial paper debt, without being able to issue any new IOUs.

“The burden of meeting these obligations effectively wiped out DBL Group’s liquidity,” Joseph said.

Among the unanswered questions about the bankruptcy filing is why senior officials hadn’t anticipated the crisis sooner and acted more quickly to try to find a merger partner or investor to salvage Drexel. Both Joseph and Drexel’s chairman, John S. R. Shad, refused again Wednesday to be interviewed.

Anreder confirmed that Joseph had taken nearly all of last week off because of a bad cough. But he denied that top officials had been unaware of the gathering crisis. Anreder said senior executives had a “game plan” for dealing with the debt that was coming due. But he said the plan was wrecked at the end of last week when the SEC refused to let the parent company draw off more capital from the brokerage unit.

Officials at Salomon Bros., First Boston Corp. and other big Wall Street firms said they were waiting for more detailed information from Drexel before deciding to make a bid for the firm’s junk holdings.

Junk bond industry analysts said the possibility of selling off Drexel’s entire junk bond portfolio in one or more big blocks would have several advantages. A negotiated sale would prevent a large quantity of the securities from being dumped on the market, which would drive down already severely depressed prices. In addition, Drexel would be able to get rid of securities for which there is no current demand on the open market but which aren’t necessarily valueless.

In a related development, Groupe Bruxelles Lambert, a Belgian company that holds a 26% stake in Drexel, said it would write off its entire investment in the American firm.

The Drexel bankruptcy filing appeared to underscore that the federal government wouldn’t necessarily step in to prevent the collapse of a major Wall Street firm. Regulators from the Federal Reserve Board, the Treasury Department and the SEC have closely monitored the situation to make sure that there was no chain reaction that might have taken down other big firms. But few steps were taken to pressure commercial banks or other firms to bail out Drexel.

In an interview Wednesday, David S. Ruder, who recently stepped down as chairman of the SEC, said he didn’t believe that the federal government should be obliged to rescue a big securities firm unless its downfall threatened to take other big firms with it. But Ruder sharply criticized current federal law, which gives the SEC only very limited access to details of the financial affairs of securities firms’ parent holding companies.

Ruder said he had no knowledge of the Drexel financial crisis beyond what he has read in newspapers. But he said he believes that, if the SEC had received earlier warning of the holding company’s financial troubles, it might have been able to act sooner to head off the crisis, possibly by pressuring other firms to make an offer for Drexel. “I think it would have been much better if there had been some knowledge and early warning from Drexel to the commission.”

DREXEL’S TOP CREDITORS

Company: Amount owed ($ in millions)

Taiyo Mutual Life, Tokyo: $69.7

Home Capital Services, New York: 42.7

Banque Indosuez Paris, Paris: 30.5

Sumitomo Life Insurance, Tokyo: 25.0

Calif. Public Employees Retirement System, Sacramento: 25.0

First City Bancorp, Houston: 25.0

Bank of Ireland, New York: 20.0

Bank of China, New York: 20.0

Waltco (c/o Security Pac.), L.A.: 15.0

Centrust Savings Bank, Miami: 15.0