private investigator, Jules Kroll, was hired to do background checks on Drexel clients. And the Underwriting Assistance Committee (UAC) was formed (in response to Flight Transportation and a couple of other bad deals that occurred just prior to it). A group of about eight to ten senior corporate-finance people and executives, the UAC was to review and authorize every deal the firm underwrote.
Trottman, who described the aftermath of Flight Transportation as âthe worst period of my life,â suffered financially as well as emotionally. For by this time Fred Joseph had added the accountabilityfactor to his entrepreneurial system of compensation in corporate finance. âMore than most other firms, we understand that weâre a middleman in the marketplace,â Joseph claimed. âWe have clients on both sides. And because Mike is so powerful, we have really been serious about that ongoing responsibility to buyers. It is a long-term approach to your business, instead of just do the deal, get the fee and get out of there.
âIf you do a deal here that goes bad, weâre the only firm that keeps you accountable down the road. Youâve gotta fix it. If you donât try to fix it, Iâll kill you. If you try to fix it and do fix it, youâll almost recover the ding. If you try to fix it real hard and donât, youâll recover some.â
There was nothing Trottman could do to fix Flight Transportation. He received $50,000 as his bonus for 1982, while others in corporate finance received bonuses as high as $250,000-$300,000.
At least in Flight Transportation, Drexel was able to plead ignorance in the face of outright fraud. But in Drexelâs deal for American Communications Industries (ACI), the situation was different. There, the risks were apparent.
In February 1981, Drexel issued $20 million of bonds for ACI, a movie production and distribution company which had been formed in 1978. The prospectus admitted that the company might not have sufficient earnings to cover the interest on the debentures. This was a foreshadowing of the statements that would later become boilerplate in Drexelâs junk-bond prospectuses in its megadealsâbut in those deals, like the $1.9 billion issue done in 1984 for Metromedia Broadcasting Corporation, for example, there would be assets that could and would be sold. Here there were none.
There was considerable compensation to the investors for their risk. The investors got bonds with a 12 3 / 4 percent coupon (the coupon indicates how much interest is to be paid, usually semiannually) which were issued at a 70 percent discount. Warrants, included as sweeteners, were issued with the debentures in a unit.
These âunitâ deals, which Milken had started issuing in 1980, had a special advantage for him. Typically, bond buyers and equity buyers are different groups, and many of Drexelâs bond buyers therefore would not be interested in a companyâs warrants (exercisable into equity). Indeed, some high-yield mutual fundsâwhich by the early eighties were still a giant part of this marketâwere not allowed to own equity. And these warrants were detachable from thebonds. So Milken would strip off many of the warrants, sell the bonds separately andâaccording to sources both inside and outside of Drexelâsell them to favored clients at very favorable prices.
How risky a deal ACI was viewed as at Drexel may be deduced by noting not only what the investors got but also what Drexel got. Drexel claimed its lionâs share of the 3 percent underwriting discount, which was $600,000. It also received stock in ACI, which the company had the right to repurchase up to a certain date at a maximum price of $700,000. Furthermore, ACI entered into a âconsulting agreementâ with Drexel, for which the firm would be paid $4,000 a month until April 1983 (for a sum total of $100,000). Such side deals were generally not a part of
Trottman, who described the aftermath of Flight Transportation as âthe worst period of my life,â suffered financially as well as emotionally. For by this time Fred Joseph had added the accountabilityfactor to his entrepreneurial system of compensation in corporate finance. âMore than most other firms, we understand that weâre a middleman in the marketplace,â Joseph claimed. âWe have clients on both sides. And because Mike is so powerful, we have really been serious about that ongoing responsibility to buyers. It is a long-term approach to your business, instead of just do the deal, get the fee and get out of there.
âIf you do a deal here that goes bad, weâre the only firm that keeps you accountable down the road. Youâve gotta fix it. If you donât try to fix it, Iâll kill you. If you try to fix it and do fix it, youâll almost recover the ding. If you try to fix it real hard and donât, youâll recover some.â
There was nothing Trottman could do to fix Flight Transportation. He received $50,000 as his bonus for 1982, while others in corporate finance received bonuses as high as $250,000-$300,000.
At least in Flight Transportation, Drexel was able to plead ignorance in the face of outright fraud. But in Drexelâs deal for American Communications Industries (ACI), the situation was different. There, the risks were apparent.
In February 1981, Drexel issued $20 million of bonds for ACI, a movie production and distribution company which had been formed in 1978. The prospectus admitted that the company might not have sufficient earnings to cover the interest on the debentures. This was a foreshadowing of the statements that would later become boilerplate in Drexelâs junk-bond prospectuses in its megadealsâbut in those deals, like the $1.9 billion issue done in 1984 for Metromedia Broadcasting Corporation, for example, there would be assets that could and would be sold. Here there were none.
There was considerable compensation to the investors for their risk. The investors got bonds with a 12 3 / 4 percent coupon (the coupon indicates how much interest is to be paid, usually semiannually) which were issued at a 70 percent discount. Warrants, included as sweeteners, were issued with the debentures in a unit.
These âunitâ deals, which Milken had started issuing in 1980, had a special advantage for him. Typically, bond buyers and equity buyers are different groups, and many of Drexelâs bond buyers therefore would not be interested in a companyâs warrants (exercisable into equity). Indeed, some high-yield mutual fundsâwhich by the early eighties were still a giant part of this marketâwere not allowed to own equity. And these warrants were detachable from thebonds. So Milken would strip off many of the warrants, sell the bonds separately andâaccording to sources both inside and outside of Drexelâsell them to favored clients at very favorable prices.
How risky a deal ACI was viewed as at Drexel may be deduced by noting not only what the investors got but also what Drexel got. Drexel claimed its lionâs share of the 3 percent underwriting discount, which was $600,000. It also received stock in ACI, which the company had the right to repurchase up to a certain date at a maximum price of $700,000. Furthermore, ACI entered into a âconsulting agreementâ with Drexel, for which the firm would be paid $4,000 a month until April 1983 (for a sum total of $100,000). Such side deals were generally not a part of
Similar Books
