Fraud Is Possible in Drexel Bonuses
A Securities and Exchange Commission report released Thursday found substantial evidence of fraud in the payment of $262 million in year-end bonuses by Drexel Burnham Lambert just before the investment bank sought bankruptcy protection in 1990.
Drexel may have been insolvent when individual bonuses of as much as $16 million were paid, the SEC staff report said. In addition, the report said, the payments hastened the bankruptcy by aggravating Drexel’s severe cash shortage.
“Half of the most highly compensated employees at Drexel realized an increase in compensation over 1988 even as the firm was collapsing,” said the staff report, adding that a bankruptcy trustee probably could recover much of the money by making the argument that it was paid under fraudulent conditions.
While the SEC report said that the bonuses did not violate securities laws, the findings provide new ammunition for Drexel’s creditors, who have been seeking the return of the money, according to the SEC and lawyers familiar with the bankruptcy proceedings.
Drexel, a Wall Street titan in the 1980s and once home of convicted insider trader Michael Milken, filed for bankruptcy protection on Feb. 13, 1990, after it was unable to obtain enough cash to operate.
The filing capped a disastrous fall for Drexel. A year earlier, the firm pleaded guilty to six securities-related felonies and agreed to pay $650 million in penalties and fines. Drexel still owes the SEC $150 million of the penalties, so the agency is a creditor too.
Drexel is in the final stages of reorganizing as a dramatically smaller operation. The firm is expected to present creditors with a new operating plan next week. Part of that plan involves appointing a trustee who would try to recover part of the 1989 bonuses, according to a source at the company. A Drexel spokesman declined to comment.
Rep. John Dingell (D-Mich.), chairman of the House Energy and Commerce Committee, said the SEC report showed that Drexel put the bonuses ahead of the health of the firm as the end approached.
“Drexel’s behavior in its final days was at least consistent with its practice of enriching its own people at the expense of investors, creditors and customers,” said Dingell, who asked the SEC to do the report more than a year ago.
Word that Drexel had paid lavish 1989 bonuses leaked to the press a week after the bankruptcy filing. At the time, Drexel defended the bonuses, saying that they were necessary to keep key employees in an effort to salvage the firm after its guilty plea.
As part of the plea, Drexel fired Milken, whose junk bond operation in Beverly Hills had provided the bulk of the firm’s profits for more than a decade. Drexel executives said promises of big bonuses were necessary to keep Milken loyalists from leaving.
In an interview with the SEC staff, Drexel Chief Executive Frederick Joseph said he believed that Drexel had enough credit to continue operating the following year when he and others authorized paying the bonuses at the end of 1989. Joseph took his $2.5-million bonus in stock, which is now worthless.
The SEC said $208 million of the bonuses were in cash, the remainder in Drexel stock. The cash was paid at a time when banks were refusing to provide Drexel with new credit lines to keep operating.
The fattest bonus, $16.5 million in cash, was paid to Leon Black, the firm’s head of mergers and acquisitions at the time, according to the report. It brought Black’s salary to $20 million, making him Drexel’s highest-paid employee in 1989. Black is now advising a unit of Credit Lyonnais that is proposing to buy the junk bonds of Executive Life Insurance Co.
The other big bonuses were paid to employees of Milken’s former department, according to the report. John Kissick, who took over when Milken left, got $12 million. Junk bond trader Warren Trepp got $11 million. Another trader in the Beverly Hills office, who was not identified, got $7.7 million.
Peter Ackerman, a salesman in the Beverly Hills unit, was paid a $5-million bonus, a far cry from his $165 million the previous year. Another junk bond employee, James Dahl, received $5 million too. Lorraine Spurge, who left Drexel to join Milken’s new business in 1989, still received a $3.3-million bonus.
Bonuses are a key element in Wall Street compensation. Typically, an investment banker or trader receives a bonus far in excess of his base pay, depending on the firm’s profit. Drexel was best known for its $550-million bonus payment to Milken in 1986.
Recovering the bonus money will be up to the new trustee. The SEC predicted that a court action by the trustee stands a good chance of winning.
“It would help the pool for the creditors, no question about it,” said DeWitt Bowman, chief investment officer for the California Public Employees Retirement System, which is owed $25 million by Drexel.
