Wall Street Crime And Punishment: Michael Milken, The Dethroned Junk Bond King

Does crime pay?

Wall Street Crime and Punishment is a weekly series by Benzinga's Phil Hall chronicling the bankers, brokers and financial ne’er-do-wells whose ambition and greed take them in the wrong direction.

Few Wall Street felons have spent so much time, energy and money — especially money — to rehabilitate themselves in the public’s eye as Michael Milken. While the one-time Wall Street financier had already practiced philanthropy before his fall from grace, post-prison activities have been nothing short of tremendous, with hundreds of millions of dollars going into medical research, social research and the arts.

But while it would be cynical to doubt the sincerity of Milken’s generosity — plenty of other financial miscreants literally taken the money and ran — it would also be wrong to believe these acts are enough to fully erase his role in breaking the law while bringing chaos to the 1980s U.S. economy.

Gold In Junk: Michael Robert Milken was born July 4, 1946, in Encino, California. From a young age, he showed a knack for multi-tasking: he was the head cheerleader of his high school while also holding a job at a local diner.

He studied at the University of California, Berkeley and was already showing a talent for financial planning — he invested money for the members of his fraternity, keeping half of the profits and absorbing all of the losses from his market picks. He graduated in 1968 and then earned an MBA from the Wharton School of the University of Pennsylvania.

But for Milken, the most enlightening lessons came from “Corporate Bond Quality and Investor Experience,” a somewhat obscure 1958 book written by W. Braddock Hickman, the director of the Corporate Bond Research Project of the National Bureau of Economic Research who later became president of the Federal Reserve Bank of Cleveland. Hickman culled data from 1900 and 1943 that found portfolios with low-grade/high-risk bonds often outperformed higher-grade/higher-rated securities, albeit “if the list is large and held over a long period.”

Hickman explained that these securities were viewed as being below investment grade by the two major ratings agencies, Moody’s and Standard & Poor’s, because they either didn't have the backing of company assets comparable to investment-grade bonds or a comparable cash flow. But while they carried a higher risk of default or nonpayment, they also offered the opportunity of higher yields than the safer higher quality bonds.

Still, Hickman was viewing the potential of such financial vehicles from a mostly academic spectrum — for the first half of the 20th century, all new publicly issued bonds were investment grade and the riskier bonds were those that began as investment grade but were downgraded considerably as the issuer’s financial health frayed. Hickman considered these bonds to be “fallen angels” — the phrase “junk bond” was reportedly coined by Milken in the early 1980s, although he has denied its authorship.

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A Star Is Born: While at Wharton, Milken snagged a summer job in New York City at the investment bank Drexel Harriman Ripley. He joined the company, then renamed Drexel Firestone, after graduation and was appointed director of low-grade bond research.

Drexel merged with Burnham and Company in 1973 to become Drexel Burnham Lambert. Most of Drexel’s workforce were jettisoned when the companies’ combined, but Milken remained and was given the opportunity to start a high-yield bond trading department.

Milken quickly became a superstar within the company as his department generated $5 million a year with an astonishing 100% return on investment track record. Much of this was due to his acute workaholic regimen — arriving at work at 4:30 a.m. and staying there until 7:30 p.m., with the only interruption being a sandwich-and-soda lunch at 10 a.m. brought by one of three assistants on a tray. (He required three assistants because no single person could keep up with him.)

His value to Drexel was so great that the company allowed him to leave its New York City headquarters in 1978 and return to California, setting up his 20-person department at a new office in Beverly Hills. Drexel CEO Fred Joseph approved of the move by observing that Milken “understood credit better than anyone else in the country.”

Eating Up The 80s: From his West Coast platform, Milken began preaching the concept of junk bonds to money managers in need of healthier-than-normal returns. Recalling Hickman’s theory that these vehicles could pay off handsomely “if the list is large and held over a long period,” Milken cast a wide net and vacuumed up bonds from a multitude of companies with low credit standings — which wasn't particularly difficult, as the late 1970s brought about an era of stagflation to the U.S. economy.

The 1980s brought about Ronald Reagan’s presidency and its advocacy of government deregulation coupled with increased faith in the free market. The high-yield bonds that were touted academically by Hickman became the new path to quick riches via Milken, whose proselytizing on the golden possibilities of junk bonds spread far and fast. There was almost no junk bond market when Milken moved back to California, but within the decade of his West Coast return it had swollen to a $53 billion environment.

At first, the new age of junk bonds was used to finance strong-potential companies within the decade’s fast-growing industries including cable television and regional airlines. The junk bonds — or “high-yield securities” as Drexel literature insisted on calling them — carried an annual interest rate of 12% or higher, compared to 9.5% for investment-grade bonds and 8% for U.S. Treasury bonds. Today, many economists acknowledge that these products, when used correctly, played a beneficial role in the expansion of the U.S. economy.

But these bonds were also used to finance a new strategy called “greenmailing” that enabled entities to buy enough shares in a company to raise the threat of a hostile takeover, thus forcing the company to hurriedly repurchase its shares at a premium.

A new phrase, “corporate raider,” took root as the likes of T. Boone Pickens, Carl Icahn and Sir James Goldsmith used junk bond financing to either enact greenmailing threats or to actually seize control of a company. And no corporation was safe — even Walt Disney Co DIS had to fork over $30 million to save itself from a greenmailing hostile takeover bid. While there has been no definitive data on how much money was spent by companies fending off these corporate raiders, the total sum was easily into the billions.

The excesses went further when Milken began hosting an annual Beverly Hill gathering for junk bond traders called the Predators’ Ball. What began as a serious information-sharing conference evolved into a glitzy affair that could afford to bring in Frank Sinatra and Diana Ross for private entertainment. Milken would use these events to berate Wall Street executives who questioned the value of junk bond financing.

“We should all recognize from the moment we wake up in the morning, we don't like change,” he said at one of the events. “We don't like it when our children stop listening to Mary Poppins and all of a sudden have rock video blasting in the house. We don't like it when they change their hairdo or dress. People who run corporations don't like change either. One way to insulate yourself is to deny change is occurring."

For Milken, whose personal net worth ballooned to the point that he earned $550 million in 1987, the sky was seemingly the limit.

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From C-Suite To Cell Block: In May 1986, federal investigators arrested Dennis Levine, a managing director at Drexel, for insider trading. Levine began naming names of those who benefitted from his inside information — and among those cited was Ivan Boesky, who ran the arbitrage fund Ivan Boesky and Company.

In November 1986, Boesky found himself answering to investigators after Levine admitted his tips helped Boesky earn $50 million in his arbitrage trading. Eager to spare himself the full brunt of the law, Boesky began naming names of financial executives who ran roughshod over the rules governing Wall Street, and he went into particular detail on how Milken’s junk-bond-fueled leveraged buyouts were triumphs of insider trading and stock manipulation.

The Securities and Exchange Commission began to investigate Boesky’s claim that he paid $5.3 million to Drexel, which the firm identified in its filings as a “consultation fee.” The agency had kept Milken under surveillance since 1979 when some members of his Beverly Hills team strayed from ethical professional behavior.

Rudolph Giuliani, then the U.S. Attorney for the Southern District of New York, also launched an investigation into Drexel, focusing primarily on Milken. Drexel’s leadership, caught off-guard by these actions, started an internal investigation — but Milken refused to cooperate with this probe and would only communicate through his lawyers.

In September 1988, the SEC sued Drexel, accusing the company of insider trading, stock manipulation, defrauding clients and stock parking — with all of the transactions in the indictment tied to Milken and his Beverly Hills office. By December 1988, Giuliani began publicly dropping hints that the company could be indicted under the Racketeer Influenced and Corrupt Organizations (RICO) Act, which would make it liable for employee criminal behavior. But negotiations between Drexel and Giuliani stalled when the company balked at several of his demands, including the waiving of attorney-client privilege.

And then, Milken’s luck finally ran out — Drexel’s legal team studied MacPherson Partners, a limited partnership Milken created to enable his department’s members to transact their own investments. The legal team discovered irregularities tied to Drexel’s role as the junk bond issuing underwriter for Kohlberg Kravis Roberts’ leveraged buyout of Storer Broadcasting in 1985. A Drexel client that bought several Storer warrants sold them back to the Beverly Hills office, which then sold them to MacPherson — a major problem at multiple levels.

On Dec. 21, 1988, Drexel pleaded guilty to six counts of stock parking and stock manipulation. In March 1989, Milken was indicted by a federal grand jury on 98 counts of racketeering and fraud. Milken resigned from Drexel to start his own firm, but his entrepreneurship was short-lived — on April 24, 1990, he pleaded guilty to six counts of securities and tax violations and was sentenced to 10 years in prison, fined $200 million and banned for life from dealing in securities.

As Milken was on his way to prison, Drexel was on its way to oblivion — the company filed for bankruptcy in February 1990, a first for a Wall Street firm since the Great Depression.

Financing A New Reputation: Milken’s 10-year sentence was reduced in 1992 following his input in other government investigations into financial crimes. He was released from custody in March 1993.

Almost immediately upon regaining his freedom, Milken aimed a large portion of his wealth into philanthropic endeavors. While in prison, he founded the Milken Institute, a nonpartisan think tank focused on socioeconomic issues — the organization would take greater prominence in developing thought leadership studies once he returned to society as a free man.

Much of Milken’s philanthropic work has been focused on financing medical research, most notably for prostate cancer, which he had developed during his legal difficulties. Milken poured extraordinary sums into this effort over the years, to the point that he was the subject 2004 cover story in Fortune magazine titled "The Man Who Changed Medicine" and had a school at George Washington University named after him in 2014. Milken’s latest effort is the Milken Center for Advancing the American Dream, a 60,000-square-foot exhibition space in Washington scheduled to open on July 4, 2023.

He hasn't been completely absent from the private sector. In 2000, he was a founding investor in the online schooling company K12 Inc., now called Stride Inc. LRN. More recently, a recent Forbes article identified Milken as a "whale among SPAC investors, with exposure to a portfolio of 125 separate SPACs worth no less than $500 million as of March 30."

But his post-prison experience has not been without hiccups. In 1998, he paid the SEC $47 million to settle charges that he ignored the ban on participating in the securities industry by serving as a securities broker in facilitating a pair of mergers between publicly traded companies — the settlement did not require an acknowledgment of wrongdoing.

Milken’s relationship with Guggenheim Partners raised a red flag with the SEC in 2013, which questioned whether he acted in an advisory role with the asset management firm. Guggenheim paid $20 million in 2015 for failing to disclose a $50 million loan by a client to a senior executive — the client was not publicly identified, but media reports pegged Milken as being the lender.

In February 2020, President Donald Trump, reportedly at the insistence his personal lawyer Giuliani — who also prosecuted Milken — issued Milken a full pardon. When pressed by reporters on this action, the White House issued a statement that defined Milken as “one of America’s greatest financiers.”

Milken has refused to speak with journalists about his troubled financial career — a spokesperson once shooed away press inquiries by claiming, “He doesn’t have time for interviews; he’s too busy saving lives.”

Photo: Paul Kagame, Flickr Creative Commons.