A Heap of Woe for the Junkman

By Barbara Rudolph

The battle to control RJR Nabisco has pitted some of Wall Street's most powerful investment houses against one another, but the financial muscle behind the bidding is really the legacy of one man: Michael Milken. It is not just that Milken's firm, Drexel Burnham Lambert, is bankrolling the Kohlberg Kravis Roberts bid to the tune of $5 billion. Milken's role is much grander and far more controversial. The boyish moneyman with the tousled toupee and the obsessive work habits has almost single-handedly sparked the frenzy of takeovers and buyouts that has given the Roaring Eighties their name. And his tactics along the way may put him behind bars as a result.

It is Milken who created and has dominated the market for junk bonds, the high-octane financial fuel that powers many of today's most daring Wall Street deals. The volume of these bonds has zoomed from less than $1 billion in 1981 to more than $175 billion today. In the process, Milken, 42, has amassed a fortune of at least $500 million and a reputation as the most influential financier since J.P. Morgan.

The RJR Nabisco showdown may prove to be one of Milken's final moments of glory. He and Drexel are expected to be slapped any day now with criminal indictments accusing them of racketeering, mail fraud and other crimes. The charges would stem from two years of federal investigations that prompted the Securities and Exchange Commission to file a civil suit against Milken and Drexel in September, accusing them of 18 transactions including stock manipulation and other securities-law violations. Says a close associate of the embattled dealmaker: "Two years ago, Milken was on top of the world. Now it has crashed down upon him."

The expected criminal charges could heavily damage Drexel, the fifth largest U.S. investment firm and the fastest-growing powerhouse on Wall Street. Rudolph Giuliani, the U.S. Attorney for the Southern District of New York, is likely to follow the SEC in accusing Drexel and Milken of collaborating with convicted arbitrager Ivan Boesky to defraud the firm's clients, trade on insider information and conceal the true ownership of stocks -- all, presumably, in the pursuit of greater profits and power. Milken's lawyers, for their part, accuse the Government of a vindictive campaign based solely on self-serving testimony by Boesky. The potential racketeering charges against Drexel could hit the firm even harder than the civil suit, because federal law -- the Racketeering-Influe nced and Corrupt Organizations Act, or RICO -- would enable prosecutors to freeze a major portion of Drexel's assets.

The charges have triggered a vigorous debate over Milken's role in 1980s finance. Is he a megalomaniac who has built a tottering tower of corporate debt? Or is he a financial genius whose funding of unsung, mid-size industries greatly overshadows his role as a takeover player? He has many defenders among buyers and users of his junk bonds. Says MCI chairman William McGowan, whom Drexel helped raise $2.4 billion for building long-distance telephone lines: "When we first went to Milken, we were not even qualified for junk bonds, but he was able to help us. People went to him because the rest of the financial establishment was turning away companies like ours."

The son of an accountant, Milken grew up in California's San Fernando Valley, only about a dozen or so miles from his current headquarters. In high school, after he was benched as a member of the varsity basketball team, he became head cheerleader instead. Reflecting on those years during a recent interview with TIME, Milken mused, "When things look their worst, you always have the seed of great improvements." At Berkeley during the mid-'60s, Milken concentrated on math and business courses rather than on protest. It was there that he first considered the far-reaching idea upon which he built his empire. Milken came across a study showing that junk bonds, which at the time were often called fallen angels because they were the downgraded debt of ailing companies, actually represented a lucrative investment for those who bought them.

As a graduate business student at Pennsylvania's Wharton School, Milken made junk bonds a focus of his scholarship. Despite their reputation for high risk, he found that the securities showed a history of few defaults. Milken believed the securities' relatively high yields, typically 3% to 5% more than an investment-grade corporate bond, were more than enough compensation for that slightly increased risk.

Milken never put his big idea or his ambition aside. As a trader for the old-line Philadelphia firm of Drexel Firestone in the mid-'70s, he scorned colleagues who hewed to tradition and "spent from 11 o'clock to 2 o'clock at the racquet club." The dogged Milken soon discovered that junk bonds could provide much needed capital for medium-size companies that were unable, because of their size, to issue investment-grade debt. Other firms, notably Lehman Bros., had already tried minting bonds that were high yield from the outset. But Milken was the first to build a market for the bonds by finding hungry customers among institutional money managers, who must constantly search for higher returns on their investments.

Milken's junk bonds remained innocuous until the mid-'80s, when he began using the securities to raise mountains of money for hostile takeovers. In fact, the preferred opening salvo of corporate raiders became the dreaded letter from Drexel in which the firm stated it was "highly confident" of coming up with the necessary cash. In some cases, like T. Boone Pickens' failed bid in 1984 for Gulf Oil, Drexel charged a hefty fee for lining up money that it never had to deliver. But in many other raids, including Ronald Perelman's 1985 takeover of Revlon, Milken raised billions through his network of buyers. Before long, Milken's annual junk-bond conference became known as the Predator's Ball.

Milken's junk-bond department, which he moved from Manhattan to Beverly Hills not long after he formed it a decade ago, quickly became the engine of the Wall Street firm's furious growth. One reason is that junk bonds earn hefty fees: Drexel charges 3% to 4% of an offering's total value, compared with a fee of less than 1% for a higher-grade issue. Milken's web of buyers and sellers for the bonds has given him a virtual lock on the market, though the entry of such competitors as Morgan Stanley and First Boston has whittled Drexel's market share from a monopoly in the late 1970s to about 50% today. For his huge contribution to Drexel's bottom line, Milken has pocketed bonuses of as much as $200 million in a year and accumulated the largest individual stake in Drexel: a 6% share consisting of stocks and warrants worth $90 million.

Though Milken's title is only senior executive vice president, he has set Drexel's tone and direction during the past decade, according to many who deal with the firm. But his yen for control and lack of regard for convention, which served him so well in staking out his new financial realm, may have been what led him to allegedly illegal tactics. Says journalist Connie Bruck, author of the 1988 book on Drexel titled The Predator's Ball: "For years he's been a law unto himself. He has disdain for the way the world works. He figures he's waging a holy war."

Milken now spends nearly a third of his time working on his legal defense but otherwise maintains his characteristic workaholic schedule. After arriving at his office at 9560 Wilshire Boulevard by 4:30 a.m. each day in a chauffeur- driven Mercedes, Milken holds forth in a trading room the size of a basketball court. He has no private office, preferring to sit at one of three huge, X- shaped desks, where 30 bond traders and other workers shout into telephones and scramble to execute the orders that he barks out or scrawls on yellow legal pads. On the computer terminal next to his, a co-worker has posted a sign reading MENTAL ILLNESS IS ESSENTIAL TO SUCCESS.

The barrage of negative publicity during the past two years, starting when the Boesky case broke in 1986, has been tough on Milken's family. "The Michael Milken portrayed in the press is not the man I know and live with," said his wife Lori. Milken and Lori, who was his high school sweetheart, live quietly with their three children (Greg, 15, Lance, 12, Bari, 7) in Encino. Their five-bedroom house, which might sell for $3 million, was once occupied by Clark Gable and Carole Lombard. It is a suburban idyll trimmed by red and white Impatiens, finished inside with dark oak paneling and filled with photographs of the children.

Once extremely private, Milken has sought to improve his public image by appearing at charitable functions and bidding reporters to "call me Mike." Last year Milken and his wife donated $198.1 million to the family's three charitable foundations, more than a sixfold increase from the previous year. Less than $15 million of these funds was actually disbursed, going to some 200 organizations. The remainder was invested by the foundations. That is perfectly legal, but the California attorney general's office began this month to investigate the Milken foundations' activities for possible irregularities.

If Milken is indicted on the racketeering charges, his workdays may become devoted to legal defense. Drexel could ask him to resign or take a leave of absence, while the investment firm would pay a fine to settle its own charges. The company has set aside more than $500 million for legal costs, and could spare $1 billion without dipping into its bare minimum of capital. Under racketeering charges, the Government could freeze so much of Drexel's assets that the company would be paralyzed, but prosecutors may want to avoid a punishment that would cost innocent workers their jobs. Drexel is taking no chances: the firm already has 115 lawyers assigned to its case, compared with a total of about 35 at the SEC and the U.S. Attorney's office.

The investment firm may also be contemplating major changes in its executive suites. Drexel officials have approached former Senator and White House chief of staff Howard Baker with the idea that he become Drexel's chairman. According to one rumored scenario, Baker would take over after both Milken and Drexel chief executive Fred Joseph stepped aside.

Milken's legacy will take years to come fully into focus. "Behind every great fortune there is a great crime," Balzac once said. "Great fortunes are made by solving problems" is the way Milken has preferred to see it. The Government's view should be known in a few weeks. The true value of junk bonds will take longer to determine.

With reporting by Scott Brown/Los Angeles and Frederick Ungeheuer/New York