Mitt Courts the Junk-Bond King

The last time Mitt Romney ran for president, MIT business school professor Howard Anderson described Bain Capital—the firm Romney founded—as “the model of how to leverage brain power to make money.”

“They are real first-rate engineers,” Anderson told The Boston Globe. “They will do anything they can to increase the value. The promise [to investors] is to make as much money as possible. You don’t say we’re going to make as much money as possible without going offshore and laying off people.”

Anderson is a true believer and one-time Bain investor. He was describing the fundamental rule by which equity firms play the game. Which helps explain Romney’s willingness to accept millions in investments from expatriate Salvadoran oligarchs who had plundered one of the poorest nations in the hemisphere.

There were other questionable money deals. When Bain went looking for $300 million in junk bonds to buy department stores in Texas in 1988, Romney turned to Drexel Burnham Lambert bond-department director Michael Milken, who was then widely known as the Junk Bond King.

It was also widely known that Milken was under investigation by the SEC.

During Romney’s race against Ted Kennedy in 1994, Romney told the Globe that he never met or dealt directly with Milken. Perhaps not. Yet Romney did read the newspapers, and Bain’s bond deal didn’t close until long after Milken’s transgressions were widely reported, even if it was before he was indicted on 98 counts of fraud. In closing his deal with Drexel, Romney overlooked allegations of insider trading, stock-market manipulation, defrauding clients, and illegally disguising the ownership of securities.

Romney further rationalized the Drexel transaction by claiming that Bain could have found the same deal with another bank. While he wasn’t in a court of law, Romney’s response fell short of an affirmative defense of the deal he had done with Drexel.

Romney wasn’t asked about it at the time (and the campaign hasn’t responded to my query), but it is hard to imagine that he did not meet with his former Harvard MBA classmate Leon Black.

As he departed from Drexel, Black, who was Milken’s closest associate at the firm, protested his $10 million bonus. The company agreed to $16.5 million—on top of his $20 million salary—months before it filed for bankruptcy. As he departed from Drexel, Black pleaded out of a jail sentence by paying a substantial but undisclosed fine for his criminal offenses there.

Big, bold deals that use finance theory to confound legal theory is what these guys—whom Tom Wolfe nailed as “the masters of the universe” in The Bonfire of the Vanities —were groomed to do. And this was the milieu in which Mitt Romney worked.

Bain’s $300 million bond deal with Drexel would later find its way into a federal courtroom, as Milken’s defense team tried to use Bain’s acquisition of two clothing retail outlets in Texas as a get-out-of-jail card for their client. Or at least a way out of the courtroom of a federal judge known for his lack of sympathy for white-collar criminals.

The 1988 department-store buyout in Texas had played out as many of Bain’s deals did. Bain partners won. Bain investors won. Shareholders in the business Bain acquired lost. Employees lost their jobs.

According to filings in a Texas bankruptcy court, Drexel’s junk bonds were used to purchase two small department-store chains–Bealls, incorporated as Bealls Brothers, and Palais Royal. Bain packaged the chains into a holding company, loaded them up with debt, and downsized from 700 to 591 stores. Bain’s holding company, Specialty Retailers Inc., ultimately closed more than 360 stores, with job losses in Texas and Oklahoma numbering in the thousands.

By 2000, the stores were in bankruptcy court. Shareholders in retail chains lost their money. Bain didn’t. (It rarely does.)

To be fair, both small clothing chains were overextended when Bain acquired them. And the big-box competitors were just beginning to penetrate the market. The two chains emerged from bankruptcy and are successfully operating today, although on a much smaller scale than they were they were as Bain properties. But for shareholders who lost everything, and for workers who lost their jobs, Bain was synonymous with pain.

In 1989, the Palais Royal transaction would find its way into a New York courtroom, where Michael Milken tried to use it to avoid standing as a defendant before Federal District Judge Milton Pollack.

The chair of Palais Royal’s corporate board was Moselle Erlich, the widow of Isadore Erlich, who founded the chain in 1921. After Isadore’s death, Moselle married Judge Pollack.

Drexel tried to steer its securities fraud case out of Pollack’s court, arguing that Judge Pollack had to recuse himself because his wife was in line to make $30 million on the Bain buyout financed by Drexel junk bonds.

The judge refused, yet Milken’s attorneys were so desperate to move the case off the docket of the best white-collar jurist in the country that they appealed Pollack’s decision to the U.S. Supreme Court.

They lost their appeal and their criminal case.

Judge Pollack added an additional financial penalty for Milken’s “cupidity” and refused to shake Milken’s hand as he left the courtroom.