Despite guilty plea, Drexel faces legal hurdles. Additional lawsuits and investigations could flow from firm's decision to avoid criminal trial
The legal monkey finally got too heavy for Drexel Burnham Lambert Inc. In reaching an agreement in principle to plead guilty to six felony counts of mail, wire, and securities fraud, the big broker has also started the process to settle the Securities and Exchange Commission (SEC) charges of insider trading and civil lawsuits. Drexel also faces possible scrutiny from state and exchange regulators as well as searching questions from its clients.
Already 17 civil suits are on file as various investors stake their claims against Drexel. Most of the lawsuits are class actions alleging that investors sold their shares earlier than they normally would have if they had the same knowledge as Ivan Boesky, who now claims he bought them on the basis of inside information supplied by Drexel. Limited partners who invested $200 million in Mr. Boesky's business are also suing, since they believe Drexel misled them into investing with Boesky. They want their money back, plus interest.
It is unclear how the Drexel settlement will affect the class-action suits. A Drexel spokesman, Steve Anreder, says the firm has yet to negotiate with the United States attorney's office the exact transactions to which the felonies will apply. Some of the suits will actually be settled once the final plea is determined. Of the $650 million settlement with the government, $350 million will be earmarked for customers who may prove they sold their stock early. Whatever is not claimed by these investors will be returned to the government, along with a $300 million fine.
Lawyers suing Drexel believe the guilty plea on criminal charges will benefit them. ``It would seem that if Drexel is going to swallow the pill to make a deal, they would want to clean up all the cases - get them all behind them,'' says David Berger, a Philadelphia-based lawyer who is suing Drexel.
If Drexel continues to fight any unsettled civil suits, the guilty plea to criminal charges ``should make it easier to prove our case,'' adds George Reycraft, a New York lawyer who is also suing the broker on behalf of the Boesky limited-partner investors.
Still more suits could follow. The admission of guilt potentially ``exposes it to all sorts of civil lawsuits,'' says Ira Lee Sorkin, a former SEC attorney who is now with the law firm of Squadron, Ellenoff, Plesent & Lehrer.
Drexel's admission of wrongdoing may open the door to other investigations of Drexel. Lee Polson, general counsel to the North American Securities Administrators Association, says a felony conviction ``could be the basis for a state agency to take action if it is appropriate.'' In a worst-case scenario, state administrators could revoke a license to sell securities within their states.
In many states, for example, felons are barred from making private placements under regulation D of the Securities Act of 1933. Under Reg D, as it is known, securities firms can sell securities to institutional investors without registering the securities under federal law. It is widely used for securities that are not expected to be resold to the public.
It is also possible that Drexel could be investigated by the New York Stock Exchange (NYSE), which can try to find out whether its own rules have been broken. In a worst-case situation, the exchange can suspend or revoke a membership and levy a substantial fine. Eighteen months ago the NYSE received unlimited fining ability from the SEC.
If the exchange feels the SEC has already penalized a firm sufficiently, it might not do anything. Also, if the securities firm brings in new management, the exchange may not act. In this respect Drexel has been negotiating with Howard Baker, the former US senator and White House chief of staff, to become its chairman.
However, when E.F. Hutton & Co. pleaded guilty to 2,000 felony counts of check kiting, the NYSE also fined the company $400,000 and named two of Hutton's executives as violators of the exchange's regulations. One of those executives, George Ball, is now the chairman of Prudential-Bache Securities.
After Kidder Peabody & Co. admitted it had improperly supervised two of its employees convicted of insider trading, the NYSE also fined Kidder $300,000 and fined two of its officers $25,000 for failing properly to oversee the operations.
The SEC can also take some specific actions against Drexel. It can take away its broker-dealer license - an extreme act. The SEC could also limit Drexel's ability to sell mutual funds to its clients. At the end of 1987, Drexel had 17 mutual funds with assets in excess of $3.2 billion. The SEC can also restrict Drexel's future stock and bond offerings and decide who can do business with the firm. ``It can do a lot more internally than the US attorney can,'' Mr. Sorkin says. The SEC can also agree to limit its restrictions to some fines and resignations.
There is little question that Drexel's admission of guilt will have a huge impact on the firm and its 10,500 employees. When Hutton pleaded guilty, former Hutton executive Peter Muratore remembers, ``Everyone had a feeling of being let down by the firm.''
Aside from the critical comments made in the press about Hutton, the company also found its investment banking activities handcuffed. The SEC prevented Hutton from issuing new mutual funds, but allowed it to run its old funds. State regulators had discussions with Hutton over its broker-dealer status.
Probably the biggest impact was on Hutton's clients. ``Clients wanted to do business with a strong reputable firm,'' Mr. Muratore says. The end result was that Hutton had trouble attracting new institutional and retail customers and had to merge with Shearson Lehman Brothers.
The same result may not happen at Drexel. ``The problem at Hutton was lousy management. Pleading guilty contributed to the internal problems at the time,'' says Perrin Long, a securities industry analyst at Lipper Analytical, Inc.
This seems to be the message Drexel's chief executive, Frederick Joseph, is giving. In taped messages explaining why Drexel agreed to the settlement, he said it allows management to ``refocus the firm without the burden of years of litigation.''
Six of the largest insider-trading settlements
Ivan Boesky, $100 million
Kidder, Peabody & Co., $25.3 million
Dennis Levine, $11.6 million
Martin Siegel, $9 million
Darius Keaton and eight foreign investors, $7.8 million
Robert Wilkis, $3.3 million