As RICO charges loomed, Drexel sought cover in settlement

The legal fencing match between the government and the Wall Street firm of Drexel Burnham Lambert Inc. came to a rapid end when the government pulled out a bazooka. The dispute was over whether Drexel, one of Wall Street's most profitable and renegade companies, repeatedly engaged in insider trading, wire and mail fraud, and other securities violations. The bazooka was the racketeering law, which is generally used to prosecute Mafia figures and not young professionals on Wall Street. The outcome was a tentative settlement - something that seemed highly unlikely six months ago, when Drexel still appeared defiant and confident it could prove its innocence.

On Wednesday Drexel agreed in principle to plead guilty to six felony counts and to pay $650 million in fines and restitution. That dwarfed the previous record penalty for securities violations, Ivan Boesky's $100 million.

The agreement in principle, which could unravel unless Drexel also reaches a settlement by Jan. 10 on civil charges filed in September by the Securities and Exchange Commission (SEC), is a big victory for the government and a big loss for some Drexel employees and clients. Under the terms of the agreement, Drexel will cooperate, by providing records and documents of transactions, in the government's continuing investigation.

That spells bad news for several Drexel employees - most notably, Michael Milken, who almost single-handedly made Drexel into a financial giant with a new way of raising money for clients - ``junk bond'' financing. There will also be a ``fallout'' for those associated with Mr. Milken. Drexel clients, other brokerage houses and investment banks, Wall Street arbitrageurs, and employees are also vulnerable, says Ira Lee Sorkin, a former SEC lawyer who is now a defense attorney. ``You don't do deals in a vacuum,'' he says.

As recently as Tuesday, Drexel was braced for indictments. But the government allowed ``significant modifications, and certain demands were removed'' in the terms of settlement, says Steven Anreder, a Drexel spokesman. According to another Drexel source, one of those modifications was that Drexel's lawyers do not have to turn over confidential papers. The courts may still require Drexel to do that, however.

Another concession is that Drexel may pick the six transactions in which it admits to have committed felonies. The most likely transactions to be picked, according to a source close to Drexel, are ``those in which Drexel will have minimal exposure in civil liability'' - that is, the smaller transactions in which future lawsuits by investors would be relatively limited. Drexel was meeting with the government about which transactions they wanted to include at time of writing.

When the Racketeer Influenced and Corrupt Organizations Act (RICO) was passed in 1970, ``no one thought about applying it to firms like Drexel,'' says Andy Weissman, a securities lawyer and RICO expert at the law firm Wilmer, Cutler & Pickering. Another securities lawyer adds that there is ``no question'' that ``RICO will be used outside of the context of organized crime in the future.''

To bring racketeering charges against an organization, prosecutors must allege a ``pattern'' of criminal acts; these may include securities violations, wire fraud, and mail fraud.

A RICO indictment throws a case into a new level of criminality. It puts a Mafia-type stain on a company's reputation. It allows the government to freeze certain company assets before trial. And it makes the company vulnerable to RICO cases from clients and shareholders, which allow for triple damages.

The Drexel case became public in November 1986, when Mr. Boesky, and arbitrageur, admitted to criminal charges related to insider trading. In return for a relatively light jail sentence, Boesky, who had worked closely with Drexel and particularly with Michael Milken, agreed to cooperate in the government's investigation of Drexel.

Why the government wanted to settle

Over the next two years, Drexel maintained its innocence. Questions began to arise about the strength of the case being built by Rudolph Giuliani, the Manhattan US attorney conducting the criminal probe of Drexel. With these questions came criticism that the US attorney had let Boesky off too lightly. That created pressure on the government to show that Drexel had committed criminal acts. It could prove that either through a settlement and a guilty plea from Drexel, or through conviction by a jury trial.

The goverment chose settlement. ``With a settlement, the government can immediately claim victory ... and say that Boesky's cooperation was well worth the bargain,'' says Lee Richards III, a former US attorney in Manhattan.

Moreover, a settlement would be safer for government prosecutors. ``You can have the best case in the world and lose because of a crazy jury verdict,'' says Paul Fischer, former associate director of enforcement at the SEC.

As recently as this fall, however, Drexel showed little inclination toward throwing in the towel. For one thing, the company wanted to stand by Milken. Second, Drexel figured it had already spent $175 million in direct expenses and sustained about $1.5 billion in lost business.

A change of heart for Drexel

But about two months ago, the idea of settlement ``began to crystallize,'' a source close to Drexel says. A ``major factor'' was the increasing chance that the firm and several employees would be charged with racketeering.

Charging Drexel with racketeering would let the government immediately freeze company assets.

``If the government thought the Beverly Hills office,'' where Milken operated the junk bond business, ``was a racketeering enterprise, then it could seize the profits generated by that office during the period that the enterprise was ongoing,'' a securities lawyer says. ``If you start to calculate that out, you hit [$650] million very quickly, and you don't end there,'' he says.

Moreover, criminal RICO indictments could lead to staggering civil awards to Drexel's clients and stockholders. ``If the government obtains convictions, private parties can just step in,'' since the government has already established the company's liability, says Robert Haft, a securities law professor at Georgetown University law school. Plaintiffs would only have to prove they suffered damages; and under RICO, they would receive triple that amount.

Until recently, Drexel thought that the government would not bring a RICO case, says a defense lawyer familiar with the investigation. Even if Giuliani wanted to, Drexel ``really thought they could get that knocked out at the Justice Department,'' the lawyer says.

Because of the severe stigma attached to RICO charges, top Justice Department officials have to give approval to a RICO case before a US attorney can go forward with it. Drexel lawyers met with Justice Department officials in November, but could not persuade them to drop the RICO charges.

Meanwhile, a RICO sideshow was taking center stage. In August, Giuliani's office charged five partners at a small securities firm called Princeton/Newport with a ``pattern'' of illegal activities - that is, racketeering. It was the first time a securities firm had been involved in a RICO indictment, and many Wall Streeters thought it was merely a preview of the Drexel case.

A sobering example

That preview was sobering. The government alleged that Princeton/Newport had received $446,653 in tax advantages. But it was able to freeze $14 million in assets. On Dec. 7, Princeton/Newport went out of business as its partners in the firm pulled out their money.

At that point, Drexel ``began to realize, based on the Princeton/Newport experience, just how much of a problem a RICO case could be,'' says the defense attorney.

So did Drexel's employees. For individuals, RICO holds the prospect of 20-year prison sentences and loss of their personal wealth.

In the Dec. 1 letter sent to Drexel employees, management noted that during the last two years, ``the employees of Drexel have stood together with our loyal clients and the results have been sensational.'' It concluded, ``Over the next weeks and months ... we will all need to pull together and to call upon our internal resources and the loyalty of our clients.''

Less than a week later, two key employees agreed to cooperate with government prosecutors, giving the government corroborating evidence to back up Boesky's testimony. Three weeks later, Drexel Burnham Lambert tentatively pleaded guilty to several felonies, and for now, at least, the fight is over.

Some events leading to Drexel settlement

August Executives at Princeton/Newport are indicted for racketeering, the first time a securities firm is involved with a RICO charge.

September Securities and Exchange Commission files a civil complaint against Drexel. Drexel lawyers move to disqualify Judge Milton Pollack, considered a prosecution judge, from overseeing the case.

October James Dahl, a Drexel trader, receives immunity from prosecution for cooperating with government's investigation. Drexel receives target letter from prosecutors, indicating Drexel may be charged with racketeering.

November Drexel lawyers try, and fail, to dissuade Justice Department officials in Washington from allowing Manhattan prosecutors to bring RICO charges. Panel of judges rejects Drexel's bid to remove Judge Pollack.

December Court rules that Drexel lawyers must turn over documents about Drexel's internal investigation. Cary Maultasch, a senior equity trader at Drexel, is said to have agreed to cooperate with government. Another trader, Terren Peizer, is said to have agreed to cooperate. Princeton/Newport liquidates in wake of RICO charges. Michael Milken, a chief target of government probe, agrees to resign to allow Drexel to plea-bargain with government. Drexel agrees in principle to six felony counts and to pay a record $650 million in penalties.