Drexel Burnham Lambert Incorporated

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Drexel Burnham Lambert Incorporated

60 Broad Street
New York, New York 10004
U.S.A.
(212) 480–6000

Private Company
Incorporated: 1976
Employees: 10,000
Assets: $35.9 billion

Since its incorporation in 1976, Drexel Burnham Lambert, once a little-known, second-tier underwriter, has become perhaps the most widely publicized investment bank in U.S. corporate history. Drexel pioneered the “junk bond” craze of the 1980s and played a leading role in many of the decade’s best known corporate takeover bids. At its peak in the early 1980s, Drexel had a firm grip on more than 70% of the junk bond market. The company’s innovative and aggressive financing strategies made the firm virtually an overnight success, and Drexel became one of Wall Street’s most respected, and at times most resented, investment banking houses. But in 1986, the firm became the center of an investigation by the Securities and Exchange Commission involving insider trading and other illegal trading practices. Drexel Burnham Lambert’s role in the scandal took its toll on the company. In the late 1980s, its business declined as quickly as it had been built, and in February, 1990 Drexel declared bankruptcy and liquidated its business. It was the end of an era.

Drexel Burnham Lambert’s roots can be traced back to 1838, when Francis Martin Drexel went into the banking business. His son Anthony took over Drexel and ran it until the 1890s. During the late 19th and early 20th century, Drexel was the Philadelphia arm of J.P. Morgan and Company, of New York. The company conducted both commercial and investment banking until 1933, when the Glass-Steagall Act precluded commercial banks from underwriting and dealing in securities. Drexel and Company, like Morgan, followed the commercial banking route.

But in 1940 former Drexel partners Edward Hopkinson Jr. and Thomas S. Gates Jr., together with a number of their associates, founded an investment bank. The commercial bank was completely absorbed into the Morgan organization and they acquired the rights to the Drexel name. The new Drexel began with an initial capital investment of $1 million. The firm, although profitable, grew very slowly during its first 15 years, never quite making it to investment banking’s first tier. In those days Wall Street played by a strict set of unwritten rules which insured the continued dominance of only a few investment banks. One such practice was “bracketing,” which refers to the order of listing participants in the advertisement for an underwriting. The “special bracket firms,” such as Morgan Stanley, First Boston, and Merrill Lynch, were listed first, then the “major bracket firms,” then “submajors,” then “regional firms.” This hierarchy clearly indicated to issuers and buyers who the most powerful investment banks were. Drexel held close ties to many of the nation’s biggest securities issuers, but it ranked one notch below the special firm bracket and was not one of the dominant forces on Wall Street.

In 1965, Drexel merged with Harriman, Ripley and Company to form Drexel Firestone Inc. That arrangement, however, lasted only two years. With its capital dwindling, Drexel Firestone Inc. merged with the very successful, though relatively unknown, Burnham and Company.

Burnham and Company had been built by I.W. “Tubby” Burnham, who founded the company in 1935. Burnham began with $100,000 in capital, $96,000 of which Tubby had borrowed from his grandfather and the founder of I.W. Harper, a Kentucky distillery. Burnham and Company, though very successful, was still a submajor investment bank. By the late 1960s, Burnham could see that if he wanted to expand much further he would need to link up with the reputation of a major firm. The ailing Drexel Firestone provided the opportunity for such a combination. Drexel provided the “white-shoe” image and Burnham provided the capital.

Burnham’s investment bank had grown substantially over the years and by 1973, its capital was $44 million—80% of the new Drexel Burnham and Company. Tubby Burnham served as chairman of the new company. By focusing on underwriting securities issues of small- and medium-sized companies, Drexel Burnham prospered.

In 1976, Drexel Burnham and Company merged with Lambert Brussels Witter, which was controlled by the Belgian Bank Brussels Lambert. The Lamberts were one of Europe’s oldest banking families. Baron Leon Lambert served as a director of the new Drexel Burnham Lambert, Inc. while Tubby Burnham continued as chairman. Burnham’s protégé, Robert E. Linton, was president and CEO.

From the start, Drexel Burnham Lambert concentrated on the leftovers of Wall Street’s bigger investment banks, going after smaller companies with less than perfect credit ratings. The company’s high-yield (junk) bond department, which would spearhead its climb to the top of the investment banking heap, had the unique talents of Michael Milken. While working on his MBA at Wharton, Milken had discovered that so-called junk bonds—bonds rated BB or lower by Standard and Poor’s—had an only slightly higher rate of default than blue chip issues, while their premiums were considerably higher. Milken found that through careful research and selection, a diversified bond portfolio made up of junk bonds would pay interest rates which more than made up for the higher risk. Milken looked at a number of factors which the rating services ignored and paid more attention to a company’s future than its past. It was a very successful formula.

In 1978, Milken moved the high-yield bond department to Beverly Hills, a clear indication of his influence inside Drexel as the king of junk bonds. Before 1977, the junk bond market consisted entirely of “fallen angels”—bonds issued by former blue chip companies which had run into financial difficulty and had fallen from grace. In the late 1970s, however, a number of lower credit companies began to issue their own bonds, rated BB or lower. Milken and Drexel Burnham, with their close ties to the institutional investors who liked junk bonds, controlled this rapidly expanding market. Milken’s confidence in his ability to distribute high-yield bonds made Drexel actively seek out low credit issuers. Drexel’s first issue was Texas International, followed by Michigan General. As low-credit companies found they could raise capital without having to offer equity shares, the junk bond craze took off. Drexel Burnham Lambert had created a market for first-issue junk bonds.

In the early 1980s Drexel Burnham Lambert continued to tighten its stranglehold on the junk bond market. Investors trusted Milken, who had gathered the most talented group of researchers and traders of any investment bank and paid them well enough to prevent defections. If a company Milken had recommended got into trouble, Milken was on the phone with them getting information and giving advice. Drexel Burnham Lambert was also always willing to make markets for the bonds it underwrote. This built special confidence in the firm, since investors knew they wouldn’t get stuck with a bad issue. This, combined with Milken’s genius for picking winners, made Drexel the hottest investment bank on Wall Street. Although nobody is perfect—Drexel watched the Flight Transportation Company default on a $25 million issue it had underwritten in 1982—Drexel’s record was the best of any investment bank.

In 1982, Tubby Burnham stepped down as chairman and was replaced by president and CEO Robert E. Linton. Linton was one of a handful of investment banking executives who had never attended college; he had joined Burnham and Company after his discharge from the Air Force following World War II. Frederick Joseph, formerly head of the company’s corporate finance department, took over as president.

Joseph had joined the old Drexel and Burnham in 1974 and had worked closely with Milken assembling an aggressive team in the corporate finance department. Cultivating Drexel’s image as an upstart, Joseph once remarked that his firm was loaded with “fat women and ugly men”—not the typical blue-eyed six-footers most people picture as the classic investment banker. Joseph was described as a diplomat in an aggressive business, and was seen as the man who could best coordinate Drexel’s West Coast and New York offices. In 1983, Drexel underwrote its first $1 billion junk bond issue, for MCI Communications. Drexel’s share of the junk bond market peaked at about 75% in 1983 and 1984. At that time, other major investment banks, including Merrill Lynch and Morgan Stanley, were lured into these not-quite-respectable but highly lucrative markets. Drexel maintained its overall superiority, but these companies gradually encroached on its market share.

In the early 1980s Drexel also became increasingly active in mergers and acquisitions, specializing in leveraged buyouts financed by junk bonds. A letter from Drexel saying that it was “highly confident” that financing could be arranged was the go-ahead for many hostile bids, and Drexel became associated with the decade’s most notorious corporate raiders. It arranged financing for T. Boone Pickens’ unsuccessful run at Gulf Oil in 1983; it helped Carl Icahn try to take over Phillips Petroleum; and it financed Saul Steinberg’s bid for Disney Studios. One of the largest leveraged buyouts it arranged was Ted Turner’s purchase of MGM/UA for a staggering $1.3 billion.

While junk bonds remained its greatest strength, Drexel had been expanding in other areas as well. In 1984, Drexel acquired the Denver firm Kirchner, Moore, and Company, expanding its expertise in municipal bond financing. Drexel also launched a major effort to enter the mortgage-backed securities markets in 1984. By the mid-1980s, Drexel Burnham Lambert ranked solidly among Wall Street’s top investment banks.

But at this time Drexel and the junk bond market it had created began to draw some criticism. Critics claimed that many companies were overleveraged, while the media dubbed junk bonds “toxic waste.” Although default rates were no higher than before, there was speculation that the collective risk was accumulating and that a major default would soon shake the market. In addition, Drexel Burnham Lambert seemed to be making too much money too fast. Competitors—and the federal government—were inclined to take a closer look at the company.

In May, 1986 the Securities and Exchange Commission charged a Drexel Burnham Lambert managing director, Dennis Levine, with insider trading. When Levine pleaded guilty, a wave of insider charges ensued, including those involving corporate raider Ivan Boesky. Slowly, one of the Wall Street scandals of the century unraveled. The SEC investigated Drexel Burnham Lambert for two years before bringing any charges against the firm, while U.S. Attorney Rudolph Guiliani targeted Michael Milken himself. The investigation itself may not have been directly responsible for Drexel’s estimated 79% drop in earnings in 1987, the same year the stock market crashed, but the cloud over Drexel certainly didn’t help business. In spite of the negative publicity, Drexel maintained a 49% market share of the junk bond market in 1987, down considerably from the early 1980s but still the biggest single slice of the pie, as junk bonds made up about one-fifth of all new bond issues.

In December, 1988, threatened with racketeering charges that would have allowed seizure of certain Drexel assets and effectively put the firm out of business, Drexel pleaded guilty to six felony charges of illegal trading and paid $650 million in fines. In addition, Drexel agreed to withhold Milken’s estimated $200 million compensation for 1988 and remove him from his position as head of the high-yield bond operation. Milken challenged the actions in court, but finally left Drexel in March, 1989, after he was formally charged with 98 counts of wrongdoing, including securities fraud, racketeering, and tax fraud. Milken pleaded not guilty; his defense was expected to center on the notion that a $175 billion market was obviously too big to be controlled by one man.

In April, 1989, Drexel announced it was going to sell its retail operation. Many Wall Street firms had been suffering since the October 1987 stock market crash undermined public confidence in the markets, and Drexel’s investigation by the federal government was a double blow to the investment bank’s business. In an effort to brighten its tarnished image, Drexel brought in former SEC chief John Shad as chairman in 1989. Shad vowed he would be an active chairman rather than a “window dressing,” but just how he planned to restore Drexel Burnham Lambert in the wake of one of the broadest securities scandal of the century was uncertain. And indeed Drexel, which had risen from semi-obscurity in the mid-1970s to achieve annual revenues of $4 billion in the mid-1980s, survived barely more than a month of the new decade. The junk bond market had collapsed, and Drexel declared bankruptcy on February 13, 1990.

Principal Subsidiaries

Drexel Burnham Lambert American Specialist; Drexel Burnham Lambert Capital Markets Espana S.A.; Drexel Burnham Lambert Commercial Paper Inc.; Drexel Burnham Lambert Finanx A.G.; Drexel Burnham Lambert (France) S.A.; Drexel Burnham Lambert Government Securities Inc.; Drexel Burnham Lambert International Bank N.V.; Drexel Burnham Lambert International Inc.; Drexel Burnham Lambert International Ltd.; Drexel Burnham Lambert Management Corp.; Drexel Burnham Lambert (Netherlands) B.V.; Drexel Burnham Lambert Options Inc.; Drexel Burnham Lambert Puerto Rico Inc.; Drexel Burnham Lambert Securities Ltd.; Drexel Burnham Lambert Trading Corp.; Drexel Burnham Lambert Trading Ltd.; Drexel Management Corp.; Harbor Trust Co.; Kirchner Moore and Co.; The Washington Forum, Inc.