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Ivan Boesky - Michael Milken, The Junk Bond King

bonds drexel company trading

For generations the American bond market has been dominated by two large bond rating agencies, Moody's and Standard & Poor's. The agencies rate a corporation's risk factors in order to help guide investors on Wall Street. Companies trying to attract investors are given a rating and are divided into two categories—either investment grade or below-investment grade bonds.

A "AAA" rating is risk-free and given to top, blue-chip corporations. Risk-free bonds usually yield very low interest rates to investors. BBB is the lowest credit rating considered to be a worthy investment grade. Below BBB are the speculative or high-yield bonds Wall Street called "fallen angels," because their companies had fallen on hard economic times. These bonds pay high interest and are sold at a discount because of their high risk factor. The fallen angel name stood until the 1970s when Michael Milken arrived on Wall Street.

Milken became known as the "Junk Bond King" because he made his fortune trading in the high-yield, low-grade bonds, which he nicknamed "junk bonds." In 1973 Milken started with two million dollars in capital at his company, Drexel Burnham Lambert, in New York City. He had found buyers for his own company's bonds by sharing his vision of the untapped market. Milken soon generated a 100-percent return of the money invested in his company.

The next year Milken received double the amount of capital from his growing roster of clients, since they had made handsome returns on their investment. While other Wall Street traders tried to copy Milken, few could match his success. Impressed with Milken's achievements, additional investors contacted him and he soon accounted for most of Drexel's profits. In 1978 Milken moved his branch of Drexel from New York to Beverly Hills, California.

In the late 1970s corporate raiders were buying struggling companies and selling off pieces of those businesses and their assets at a huge gain. Milken transformed the art of speculating on these corporate takeovers with his ability to raise large amounts of capital using high-yield junk bonds. He knew the market and could raise capital for investors on short notice, but his methods were not always legal. Milken himself received huge bonuses from his company. One year he earned a total of $550 million.

Milken's involvement with insider trading practices became a focus of the SEC investigation in 1986 when Ivan Boesky agreed to be a government informer as part of his plea bargain. In September 1988, the SEC filed charges against Drexel and Michael Milken. (AP/Wide World Photos)
Michael Milken under the 1970 RICO (Racketeer Influenced and Corrupt Organizations) statute. The SEC accused the defendants of trading on inside information as well as filing false disclosure forms with the SEC to disguise stock ownership.

Drexel and Milken were accused of manipulating stock prices, of keeping false records, and of defrauding their own clients. Drexel plead guilty to six felony counts of securities fraud on December 21 and paid a $650 million settlement fee. The company also agreed to assist in the indictment against Milken. Two months later, Milken was indicted on ninety-eight counts, including insider trading and racketeering.

In a plea bargain, Milken agreed to plead guilty to six charges of securities fraud and related charges while the government agreed to drop the more serious charges of insider trading and racketeering. On April 14, 1990, Milken was sentenced to ten years in prison and fined $600 million. He entered the minimum-security prison at Pleasanton, California, in 1991, but was released two years later when he was diagnosed with prostate cancer.

Michael Milken was seen as a financial visionary who could have influenced corporate restructuring in America without breaking the law. Instead, his manipulation of stocks and company buyouts resulted in a large number of bankruptcies, especially for small- and medium-sized companies. The corporate consolidations and layoffs resulting from the Drexel's high volume of takeovers left few defenders once the investigation caught up with the firm.

The resulting investigations and indictments also resulted in a loss of investor confidence in the nation's financial markets for years. Investors returned to traditional bluechip stocks and mutual funds until enough time had passed and confidence returned to the riskier junk bonds. Following the insider trading scandal, Congress increased criminal penalties for securities violations.

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