Milken and his enemies.

Michael Milken has become the symbol of Eighties Greed. Looking at his accusers in the prosecutor's office and the press, one might equally ponder the uses of Power and Envy.

WHEN SHE was nominated to be a federal trial judge in 1988, Kimba Wood could not have imagined that she would so soon be asked to sort out the most publicized criminal prosecution ever on Wall Street. What Judge Wood faces in October is a burden traditionally rare in American criminal law. Instead of asking only the usual questions about the level of wrong committed by the defendant, if she closely analyzes the record, she will ultimately have to ask a very different question: What could possibly have led prosecutors to such abuses of their awesome power? Judge Wood must decide whether sentencing will be judgment day for Michael Milken alone or also for his enemies. Enemy #1: The Zealous Prosecutor

FEW MAY realize that U.S. Attorney Rudolph Giuliani and his colleagues traded down when they cut a deal with Ivan Boesky in exchange for the supposedly bigger fish of Mr. Milken. Mr. Boesky admitted to being a thief. He traded suitcases of cash for inside information stolen by investment bankers from their clients, information he used as an arbitrageur to profit from small price changes in takeover stocks. There is an enormous moral and legal divide between the corruption of markets admitted by Mr. Boesky and the comparatively trivial offenses admitted by Mr. Milken. Yet Mr. Boesky was sentenced to three years in jail and fined $100 million, whereas prosecutors want at least five years for Mr. Milken. They would be happier with the maximum 28 years. This failure of proportionality is par for the course in the curious prosecution of Michael Milken.

Mr. Milken's settlement with federal prosecutors in April 1990 was the end point of his March 1989 indictment on 98 counts alleging serious crimes permeating the junk-bond market, including insider trading and violations of the Racketeer Influenced and Corrupt Organizations law. With the rubber hose of RICO, the prosecutors persuaded Mr. Milken to settle: he faced 520 years in prison and fines of $11 billion. He eventually pleaded guilty to six counts, none of them involving insider trading or racketeering.

What happened to move Mr. Milken from indictment to settlement despite claims of innocence is critically important to assessing both his character and his plea. Mr. Milken deserves a new wrinkle on the presumption of innocence-the presumption of RICO.

Rudolph Giuliani, who ran for mayor of New York City as a crimebuster, will be remembered instead as the federal prosecutor who made RICO famous. The law, passed as part of an organized-crime bill in 1970, had the sole purpose of strengthening the hand of prosecutors trying to lock up mobsters. One of the original proposals was a simple provision making it a crime to be a member of the Mafia. The Supreme Court frowns on so-called status crimes, however, so Congress instead tried to write RICO to cover the mob without mentioning it by name. It wound up writing the definition so broadly that almost any activity can become racketeering." All it takes is two "predicate acts" within ten years as part of a "pattern" involving a criminal enterprise." In other words, RICO violations are the American equivalent of the Soviet crime of hooliganism.

The Justice Department understood the risks of RICO well enough to send U. S. attorneys a separate set of guidelines for using it. Mr. Giuliani apparently never got his copy. The guidelines tell prosecutors not to bring "'imaginative' prosecutions under RICO which are far afield from the congressional purpose of the RICO statute," defined as "the infiltration of organized crime into the nation's economy." Prosecutors are also prohibited from using RICO to coerce a plea bargain or persuade a witness to testify. These safeguards are necessary because of the pre-trial powers RICO gives prosecutors, including the ability to get a court order freezing the assets of a target before trial.

The dry run for the Milken trial was the case Mr. Giuliani brought against the comparatively small securities firm of Princeton/Newport. The racketeering counts arose from end-of-year tax trades that prosecutors claimed were shams. No such case had ever been tried under RICO or under any other criminal statute, and there remains a good case that the trades were perfectly legal, but Princeton/Newport was apparently only a means to a greater end. A defense lawyer told a reporter that a prosecutor had told him: "We have no real interest in Princeton/Newport" except as a way to "get Drexel Burnham Lambert and others. We have bigger fish to fry and we will roll over you to get where we want to go."

Prosecutors deny the quote, but roll they did. They demanded pre-trial seizures of $23.8 million from the firm. Investors such as the Harvard endowment decided they couldn't risk having their investments seized, so they pulled out, forcing Princeton/Newport into liquidation before trial.

Perhaps even more horrifying, prosecutors used this case to show that they could win convictions without proving any substantive offense. They told jurors to ignore the technical tax arguments-the only alleged crime in the case and instead convict the defendants because, "Doesn't it sound sleazy? If it sounds sleazy, it's because it is sleazy."

If this prosecutorial style sounds sleazy, the Justice Department agreed. It issued two rare amendments to the RICO guidelines, one telling prosecutors never again to bring a tax case masquerading as a RICO case, the other prohibiting the use of RICO to squeeze a legitimate business into liquidation before trial.

This came too late to save the Princeton/Newport defendants from liquidation, and it came too late as well for Mr. Milken and Drexel. Faced with the possibility of a RICO indictment, the Drexel board decided to cop a plea, although a peculiar kind of plea: guilty to charges "which the company is not in a position to dispute"i.e., because RICO threatened to put the firm out of business. Drexel agreed to pay a fine of $650 million and fire Mr. Milken. It also agreed to two unprecedented demands, that it withhold income Mr. Milken had already earned, and that no Drexel employee or client would so much as speak with Mr. Milken. By the time prosecutors admitted that expropriating money owed Mr. Milken was unconstitutional, his absence from the firm and a massive regulatory attack on junk bonds had forced Drexel into liquidation.

What was Mr. Milken accused of doing that warranted all of this effort? The fact that he had made enormous amounts of money raised suspicions. Prosecutors such as Mr. Giuliani, whose experience was trying Mafia families and big drug dealers, can perhaps be forgiven for wondering if even the most brilliant of finance-theory nerds could earn such sums legally. They seem to have believed Mr. Boesky when he said that Mr. Milken was an even bigger insider trader than he was. Nonetheless, they could apparently not find even one solid count of insider trading, although Mr. Milken probably had more valuable inside information at his disposal than anyone else in history. What kind of criminal was this, who didn't trade on the information he had?

There is good circumstantial evidence that the prosecutors in these cases (including some functionaries of the Securities and Exchange Commission) do not understand financial markets. According to a defense lawyer, for instance, a highranking official at the Justice Department asserted during plea negotiations that hostile takeovers were by definition illegal. Or take Mr. Giuliani's involvement with former investment banker Martin Siegel.

Mr. Siegel admitted to taking from Mr. Boesky suitcases containing some $700,000 in cash in exchange for Mr. Siegel's information about his clients' takeovers. In the course of copping a plea Mr. Siegel gave the prosecutors information that led to the Case of the Giuliani 3: the investment bankers-Robert Freeman, Richard Wigton, and Timothy Tabor-whom Mr. Giuliani had arrested and handcuffed at their desks. They were accused of massive insider trading, but it was all a big mistake. Mr. Giuliani had to drop the case; he promised a new indictment in "record time," but eventually released Messrs. Wigton and Tabor from legal limbo, their careers shattered. All he got was a small consolation prize in the form of a bizarre guilty plea on a separate count from Mr. Freeman, based on Mr. Siegel's having once told him, Your Bunny has a good nose."

An unknown Richard Wigton is one thing. Mr. Milken was quite another. Maybe in their heart of hearts the prosecutors eventually realized their grand conspiracy theory that junk bonds had been built on some criminal scheme was a mirage. Maybe not. Either way, they couldn't let Mr. Milken off entirely. They had the RICO cudgel and they used it. They had also indicted his brother Lowell as a co-racketeer and used him as a hostage. They sent an FBI agent to speak with his 92-year-old grandfather. They indicted for perjury and won a conviction of Lisa Jones, a 26-year-old low-level assistant at Drexel; the clear lesson was that anyone who failed to cooperate would get nailed.

So what did Mr. Milken admit? He did not admit to any of the 98 original counts. None of the offenses to which he did admit were obvious crimes-the sorts of activities where suitcases of cash would be a natural tool of the

trade. Most of them involved "aiding and abetting" someone else's failure to disclose. These were all offenses that until recently would have been dealt with through civil, not criminal, procedures, and probably only by a stern letter from the SEC.

The most serious plea concerns what appears to be an accommodation involving Finsbury Fund Ltd. Again, the crime was failure to disclose. Here's what happened. Drexel salesmen sold the fund to investors overseas in exchange for a 1 per cent commission. To pay the commission, David Solomon of Finsbury agreed with Mr. Milken and with Drexel that he would pay a fraction more for securities Drexel sold his fund (though still within the bidding price range). The legal problem was that Finsbury failed to disclose this arrangement to its shareholders. Mr. Milken's crime was in failing to note this arrangement in the confirmation slips he mailed to Mr. Solomon.

The payments would have been legal if disclosed, but there is nothing to excuse Mr. Milken's participation in this scheme, which is the only evidence in his plea that any of his actions may have cost anyone anything though Mr. Milken could argue at his sentencing that shareholders actually lost nothing. After all, they would have had to pay the commission one way or another. But that's not the way it looked to SEC Chairman Richard Breeden. "If someone walked into a hotel where Finsbury shareholders were staying, pulled out a machine gun, and robbed them, everyone would regard that as a serious event," Mr. Breeden said. "I regard this as equally serious."

It may be helpful to review the jail sentences for other Wall Street defendants. The clear trend has been toward greater skepticism in the Wall Street cases brought during the Giuliani era. Judge Morris Lasker gave Mr. Boesky three years. Judge Robert Ward gave Mr. Siegel two months. Judge Robert Carter refused to order any punishment for any of the Princeton/Newport defendants on any RICO count. Judge Pierre Leval gave Mr. Freeman, who pleaded guilty to mail fraud, four months and refused to consider allegations that prosecutors were not willing to try in a courtroom. Judge Lasker gave Boyd Jefferies, who pleaded to several technical offenses after being implicated by Mr. Boesky, a five-year suspended sentence teaching golf to disadvantaged youth in Aspen.

Yet Mr. Milken's prosecutors hope for a sentence of many years; a sentence based partly on charges they never had the confidence to try and that Mr. Milken never admitted. This may have more to do with who Mr. Milken is and what he represents than with any crimes he may have committed. Only Mr. Milken's role as the leading influence on the financial markets in the 1980s explains the lengths to which prosecutors have gone to bring him down.

Enemy #2: Foes in the Market

IT IS a telling irony that Mr. Milken, although wildly successful, remained anonymous until he became involved in the hostile-takeover battles. Ironic because less than 10 per cent of the junk bonds went to finance these takeovers. Ironic also because the corporate managers at targeted companies and Mr. Milken's former competitors on Wall Street must already miss the heady days of the 1980s when stock prices and volume only went up. If we are about to enter a recession, it will be in large part owing to regulatory overreaction to criticism of the laissez-faire forces symbolized by Michael Milken.

Mr. Milken built his career on a simple observation. When he was a student at Wharton he realized that people commonly make the mistake of assuming that what happened in the past is necessarily a good indicator of the future; if this were true, railroad stocks would still make up the bulk of Big Board listings. From this insight, Mr. Milken came up with the hypothesis that the credit-rating agencies, on which investment bankers had long relied to assess the credit-worthiness of firms, might systematically err in favor of firms with long histories and high reported earnings. He would in time conclude that what really counted was future cash flow and the quality of a firm's management team. When he became head of the high-yield-bond department at the then sleepy Drexel firm, he trained a team to go out and find good investments. Suddenly entrepreneurs were no longer at the mercy of a few large investment banks or insurance funds.

Junk is in the eye of the beholder. Only some eight hundred companies in the United States now enjoy what is called "investment grade" ratings. This leaves junk bonds for 99.9 per cent of all U.S. companies and 95 per cent of companies with revenues of $35 million or more. The politicians may not realize it, but there are many states that have only junk-bond-grade firms incorporated in them. No minority-owned firm qualifies for anything other than junk financing. Mr. Milken helped raise funds for more than one thousand smaller firms, many of which have become household names, such as MCI Communications, Kinder-Care, and the Turner Broadcasting System.

The danger came with the beginning of the great takeover wars between corporate titans and their often upstart challengers. Again, Mr. Milken was often found hand in hand with the upstarts. The debate over whether takeovers were on the whole good or bad should have been settled when hundreds of billions of dollars flowed directly into the pockets of shareholders-pension plans and mom-and-pop investors, as well as the big players.

However, by providing funds to people like T. Boone Pickens, Ronald Perelman, and Carl Icahn for takeovers, Mr. Milken made a set of enemies even more powerful than the old-style investment bankers. Now he had to contend with entrenched managers at big corporations who saw him as a threat to their comfy status quo. No one will probably ever know how big a role these executives played in directing regulatory and prosecutorial attention toward Mr. Milken.

There are many measures of the change in the markets that Mr. Milken above any other helped to provoke. Between 1970 and 1989, the total number of private-sector jobs went from 59 million to more than 91 million. During that time, the Fortune 500 companies-most of them, of course, of investment grade-accounted for a loss of more than two million jobs. Yet because of small and medium-sized firms, net job increase was still more than 32 million. Contrary to accepted wisdom, incidentally, this was not accomplished through an orgy of dangerous debt. Many firms did take on more debt, but this was not the general trend. According to Federal Reserve data, in 1970 the equity value of corporations (excluding financial institutions) exceeded debt by $300 billion. By the recession of 1974, debt exceeded equity by $20 billion. At the end of 1989, equity again exceeded debt, this time by $1.2 trillion. Of course the one bankable prediction that can be made about financial markets is that they will never recognize too much of a good thing. By the late 1980s, voices were heard saying that many firms had gone beyond the point where it made sense to take on more debt. It has gone largely unnoticed that one of these voices was that of Mr. Milken. He maintained that the early, highly leveraged deals he and others had designed were sound-they could be financed out of cash flow and asset sales during a growth period-but warned that times and circumstances change.

As early as 1987, his High Yield Newsletter declared, "The byword is equitize." In 1989, Mr. Milken gave a speech warning that.. although the market had changed, many bankers wanted to copy financial structures for deals "that came out of the Xerox machine in 1985." He added, "The market is saying, Give us more equity. Turn your debt into equity. Hopefully more people will listen." Many didn't. It's worth noting that Mr. Milken explicitly warned against some of the infamous busted junk-bond deals of the past few years, such as the disastrous Campeau takeover of Federated Department Stores.

The latest attack on Mr. Milken has been a bizarre attempt by some congressmen and thrift regulators to make him a scapegoat for the savings-and-loan crisis. There are a few problems with this attempt. For one thing, Congress's own General Accounting Office found that junk bonds were the second best investment by thrifts, after credit cards. For another, losses to thrifts from just a few crazy real-estate deals dwarf the potential losses from their entire holdings of junk bonds. The total thrift portfolio is more than 1 trillion, of which about $10 billion is in junk bonds. Even if all these bonds became worthless overnight, this would be a drop in the thrift-crisis bucket.

None of this, of course, stopped Congress from making the thrift crisis worse by poisoning the junk-bond market. Congress passed a killer law requiring that the thrifts divest all their junk-bond holdings over five years. This had two unintended consequences. The first was that about 7 per cent of the junk bonds held by S&Ls were artificially forced into the supply looking for buyers. All junk-bond prices promptly fell.

The other effect was that once thrifts were required to sell their junk bonds, accounting rules required them to "mark to market," meaning the thrifts had immediately to reduce to the level of the falling market the value at which they carried bonds on their books. (However, thrifts have not been permitted to mark the bonds back up as the junk-bond market has improved.) The few thrifts that had invested heavily in junk bonds got hit with the third whammy: new regulatory capital-requirement rules meant that the marked-to-market revaluation put some thrifts into technical default.

If the 1980s were marked by growth and a booming stock market, it looks as if at least the beginning of the 1990s will be remembered as the return of the "credit crunch." Credit has become tight even for established firms. Property values are falling nationwide. Who will be the next Michael Milken, with a way out of this creeping malaise? And will this economic savior risk offering innovative financial solutions, or will he be deterred by the possibility of a criminal prosecution?

MICHAEL MILKEN's lawyers knew that his case would have to be fought at many levels when part of the indictment was an emphasis on his income. Notre Dame law professor Robert Blakey, who drafted the RICO law and has become its chief apologist, was a typical spokesman for the expected reaction. "Nobody else made that much in the history of the country except for Al Capone," he said. No doubt, $550 million in the single year of 1987 does raise questions. However, no voices were heard complaining that chain-store owner Sam Walton earned $4 billion the same year, while the publishing brothers Si and David Newhouse earned $2.4 billion each, and Trammell Crow, Rupert Murdoch, and Ray Hunt each added more than $1 billion to his net worth.

One difference of course was that Mr. Milken's $550 million was income earned from his own activities, while the others benefited chiefly from appreciated assets. But the real cause for the outrage against Mr. Milken obviously was that he upset so many interests in the process. The reactions of established Wall Street figures and big-business executives were understandable, though not laudable.

What was less understandable was the general reaction of the press. Somehow, during the 1980s, prosecutorial journalists, working hand in glove with government prosecutors, came to the fore, creating an atmosphere where presumption of innocence fell by the wayside.

One example is the extraordinary number of press accounts during 1989 about the superseding" indictment of Mr. Milken that never came. This was supposed to add new and more credible charges to the ones in the original indictment. By one count, there were some two dozen newspaper articles promising a new indictment any day: "within the next several months," before Labor Day," "by October l," "weeks, not months," "in November," "before year end." Each of these articles presented Mr. Milken's lawyers with phantom charges that they had no way of defending against. Part of the problem may have been Mr. Milken's initial reticence about speaking up for himself in the press. Edward Jay Epstein described Mr. Milken's surprisingly middle-class lifestyle in a 1987 article in the Los Angeles Times. "I have one house, one wife, one cat, and one car," Mr. Milken told Mr. Epstein in a rare interview. Mr. Milken is married to his high-school sweetheart and lives in a comfortable but hardly lavish house in the same Los Angeles neighborhood where he grew up, reports say.

Yet, after the plea bargain, the Houston Chronicle wrote: "The legality and productivity of his actions aside, the values that Milken embraced were corrupt." The Miami Herald warned, "If the government accepts a mere five years as part of Milken's plea bargain, then it will be blessing the rape, the theft, and the greed." To Hobart Rowen, Mr. Milken was "the living symbol of financial greed that dominated the 1980s." Why not capital punishment?

The largely negative press coverage was not without its gallows humor. Ben Stein is a former Nixon speechwriter turned novelist and Hollywood's favorite nasal-voiced character actor, with regular appearances as the obnoxious teacher on TVs The Wonder Years. He also has probably written more articles critical of Mr. Milken, beginning in 1985, than any other writer. Yet in November 1988, it later became known, Mr. Stein sent Mr. Milken a letter asking for a job.

The letter offers Mr. Stein's no doubt considerable services as "in-house vetter of deals from a fairness-to stockholders standpoint" and as a "teacher of ethics to your young and bright colleagues." Mr. Milken apparently never responded to the offer. After the plea agreement, Mr. Stein made what remains the most fantastic accusation yet made against Mr. Milken. In arguing for the disclosure of grand-jury evidence (which would be a crime), Mr. Stein wrote in the New York Times that "If organized crime was linked in a big way to Drexel and Mr. Milken, this is well worth knowing." Can Mr. Stein possibly believe that the RICO charges constitute a link between Mr. Milken and organized crime?

Mr. Milken's offended social critics might be cheered by a calculation of what happened to the $1.1 billion the government disclosed that he earned during the four years 1984 through 1987. No tax shelter exists for this kind of income, so at the higher rates then in effect he probably paid about $500 million in federal and state taxes. His staff reported last year that during this period the family trusts he created more than a decade ago gave away some $300 million to schools and other charities. Then there was the $600 million he paid the government to settle the case. This means he paid $1.4 billion out of his $1.1-billion income, for a net of negative $300 million. No doubt he retains substantial earnings from before and after this period, but he may not be quite as wealthy as some assume. Over time, the prosecution of Mr. Milken will be seen as ranking with other ugly incidents of outrage against anyone who symbolizes forces that undermine the status quo and discomfort the comfortable. Significantly, Mr. Milken had arranged nearly $1 billion of financing for Reginald Lewis's bid in 1987 for TLC Beatrice International, which remains by far the largest black-owned firm. This is what the Milken revolution brought: a new efficiency to markets that left no one untouched. Getting capital to entrepreneurs made for a booming growth market, but threatened the old ways. The same truth is even more pressing with the takeover market, which leaves no room for management error.

For now, however, Judge Wood will be under extraordinary pressure to justify the exertions by Mr. Milken's enemies to make him pay for his successes. But if she is looking for judicial precedent to do justice in this case, she might begin her sentencing hearing with these words from Justice Louis Brandeis: "It is immaterial that the intrusion was in aid of law enforcement. Experience should teach us to be most on guard to protect liberty when the government's purposes are beneficent. Men born to freedom are naturally alert to invasions of their liberty by evil-minded rulers. The greatest dangers to liberty lurk in insidious encroachments by men of zeal, well-meaning but without understanding."