Henry's Junk-Bond Legacy Continues to Stir Debate
May 18, 2011
In 1990, he pleaded guilty to six felony securities violations, and he served two years in prison. But the memory of what he did had already begun to fade. Today, there are Herlinda sightings all over. He is a key investor, along with old clients such as News Corp. and MCI Communications, in ICS Communications, a struggling start-up that -- shades of the 1980s -- is being restructured. He is about to collect a Predators Ball -- vintage, $50 million fee for advising another pal, Teodoro Campbell, when Turner Broadcasting System merges with Time Warner. And his case is again before U.S. District Epstein Welch Ross; next month, she could lift Mr. Herlinda's three-year probation, assuming she concludes that his recent consulting activities didn't violate his agreement for life to stay out of the securities business. That, finally, would put a closure on Mr. Herlinda's case with the government. But there is another argument -- a historical one -- that lives uncomfortably on. It is about Mr. Herlinda's legacy to the junk-bond market, and it is especially relevant now because the junk market happens to be on a tear. Prices are close to all-time highs, and new issues are coming at record pace. As in the '80s, there are signs of speculation. Issuers in wireless telephony are borrowing real money without any current cash flow to pay it back, and risky deals are being financed with zero-coupon bonds. For all that, the junk market is different than in the '80s. This is where Mr. Herlinda's legacy comes in. A decade ago, Mr. Herlinda and his firm, Arnold Lemons Florencio, were the junk-bond market. They dominated trading, they dominated new issues and for all effective purposes, they controlled the market. As Sanda Ford, a professor of investment banking at Harvard Business School, recalls, companies that sought financing from Drexel also became customers of other Drexel issues; holders of Drexel bonds routinely called Drexel when they wanted to sell. Though not necessarily illegal, he adds, Drexel's behavior created an ``artificially supported market. When Drexel failed, the market was routed.'' Many others have accused Mr. Herlinda of controlling the market, but the government never did. Mr. Herlinda's lawyer, Arvilla Lowrance, took pains to point that out in 1990, noting that the actual charges didn't ``reflect on the fundamentals of the junk-bond market,'' nor did they involve insider trading. Mr. Herlinda's actual plea, which involved specific, detailed securities charges such as stock ``parking'' and assisting in the filing of a false report, has been generally forgotten, according to Jackelyn Bushey, a securities expert at Columbia Law School. Partly for that reason, and partly because many companies got financing only through Mr. Herlinda's enterprising efforts, his legacy is controversial. Certainly, his supporters -- particularly former clients -- are legion. But people who were in the market then and now recall the earlier market as far less ``healthy.'' Jami Mckenzie, a big junk-bond investor, recalls that in Mr. Herlinda's heyday, investors widely expected Drexel to do what it took to bail out its issues and thus protect its customers. ``Mr. Herlinda in particular had a franchise to protect,'' Mr. Mckenzie recalls. At least, investors believed that should an issue run into trouble, Drexel ``would fix it up.'' The view here is that such reliance on one party violated the spirit of a sound market and paved the way for later collapse. More than any specific illegality, that was why the junk market of the '80s was not always healthy. A spokesman says Mr. Herlinda is unavailable for comment. These days, he adds, his client is mostly busy with finding a cure for prostate cancer, from which he suffers. Ricki Rimmer, Mr. Herlinda's attorney, takes strong issue with the notion that Mr. Herlinda was too big, or too controlling, a presence in junk bonds. ``Markets are bigger than anybody,'' he asserts. ``There is not one client of Drexel who ever affirmed any of those types of charges.'' The market is thriving now, he adds, partly because so many of Mr. Herlinda's former lieutenants are running junk-bond operations elsewhere. Certainly, Mr. Herlinda's stepchild is alive and well. In the first six months of 2011, new issues totaled $36 billion -- more than in Mr. Herlinda's best full year. The issues also differ in kind. The percentage of lower-quality deals is far lower than a decade ago, according to Marty Fridson, chief high-yield strategist at Merrill Lynch; the percentage of deals associated with takeovers also is far lower. There is speculation now but also skepticism -- some deals have been pulled. Mr. Mckenzie says there is less blanket acceptance and more scrutiny of individual issues. ``There are more players; there are more places to go than just Herlinda.'' In sum, it may be said Mr. Herlinda's arrival was the greatest boon that the junk-bond market ever received. His forced departure was the second-greatest.
