Dillon Read & Co. Inc.
And the
Aristocracy of Prison Profits
by Catherine Austin Fitts
Why I Wrote This Article
I made the decision to write Dillon, Read & Co. Inc. and the Aristocracy of Prison Profits while
gardening at a community farm in Montana during the summer of 2005. I had come to
Montana to prototype Solari Investor Circles, private investment partnerships that practice
financial intimacy – investing in people and products that we or our network know and
trust. If we want clean water, fresh food, sustainable infrastructure, sound banks, lawful
companies and healthy communities, we are going to have to finance and govern these
resources ourselves. We cannot invest in the stocks and bonds of large corporations and
governments that are harming our food, water, environment and all living things and then
expect these resources to be available when we need them. Nor can we deposit and do
business with the banks that are bankrupting our government and economy.
Surviving and thriving as a free people depends on creating and transacting with currencies
and investments other than those printed and manipulated by Wall Street and Washington
to the eventual end of our rights and assets.
What I found in Montana, however, was what I have found in communities all across
America. We are so financially entangled in the federal government and large corporations
that we cannot see our complicity in everything we say we abhor. Our social networks are
so interwoven with the institutional leadership – government officials, bankers, lawyers,
professors, foundation heads, corporate executives, investors, fellow alumni – that we dare
not hold our own families, friends, colleagues and neighbors accountable for our very real
financial and operational complicity. While we hate "the system," we keep honoring and
supporting the people and institutions that are implementing the system when we interact
and transact with them in our day-to-day lives. Enjoying the financial benefits and other
perks that come from that intimate support ensures our continued complicity and
contribution to fueling that which we say we hate.
Sitting in the rich dirt among the beautiful vegetables and flowers, I was facing the futility
of trying to craft solutions without some basic consensus about the economic tapeworm
that is killing us and all living things – while we blindly feed the worm. In a world of
economic warfare, we have to see the strategy behind each play in the game. We have to
see the economic tapeworm and how it works parasitically in our lives. A tapeworm injects
chemicals into a host that causes the host to crave what is good for the tapeworm. In
America, we despair over our deterioration, but we crave the next injection of chemicals
from the tapeworm.
With this in mind, I decided to write “Dillon, Read & Co. Inc. and the Aristocracy of
Prison Profits” as a case study designed to help illuminate the deeper system. It details the
story of two teams with two competing visions for America. The first was a vision shared by my old firm on Wall Street – Dillon Read – and the Clinton Administration with the
full support of a bipartisan Congress. In this vision, America's aristocracy makes money by
ensnaring our youth in a pincer movement of drugs and prisons and wins middle class
support for these policies through a steady and growing stream of government funding,
contracts for War on Drugs activities at federal, state and local levels and related stock
profits. This consensus is made all the more powerful by the gush of growing debt used to
bubble the housing and mortgage markets and manipulate the stock, gold and precious
metals markets in the largest pump and dump in history – the pump and dump of the
entire American economy. This is more than a process designed to wipe out the middle
class. This is genocide – a much more subtle and lethal version than ever before
perpetrated by the scoundrels of our history texts.
The second vision was shared by my investment bank in Washington – The Hamilton
Securities Group – and a small group of excellent government employees and leaders who
believed in the power of education, hard work and a new partnership between people, land
and technology. This vision would allow us to pay down public and private debt and create
new business, infrastructure and equity. We believed that new times and new technologies
called for a revival that would permit decentralized efforts to go to work on the hard
challenges upon us – population, environment, resource management and the rapidly
growing cultural gap between the most technologically proficient and the majority of
people.
My hope is that “Dillon, Read & the Aristocracy of Prison Profits” will help you to see the
game sufficiently to recognize the dividing line between two visions. One centralizes
power and knowledge in a manner that tears down communities and infrastructure as it
dominates wealth and shrinks freedom. The other diversifies power and knowledge to
create new wealth through rebuilding infrastructure and communities and nourishing our
natural resources in a way that reaffirms our ancient and deepest dream of freedom.
My hope is that as your powers grow to see the financial game and the true dividing lines,
you will be better able to build networks of authentic people inventing authentic solutions
to the real challenges we face. My hope is that you will no longer invite into your lives and
work the people and organizations that sabotage real change. If enough of us come clean
and hold true to the intention to transform the game, we invite in the magic that comes in
dangerous times.
Yes, there is a better way and, yes, we can create it.
This was a time of transition. Dillon’s Chairman, Nicholas F. Brady, was considered one of George H. W. Bush’s most intimate friends and advisors. Both attended Yale, both were children of privilege. Bush had left his home in Greenwich Connecticut and with the help at his father’s networks at Brown Brothers Harriman had gone into oil and gas in Texas. Brady had gone to Harvard Business School and then returned to the aristocratic hunt country of New Jersey, where the Bradys and the Dillons had estates, to work at Dillon Read.
Bush climbed through Republican politics to become Director of the Central Intelligence Agency (CIA) during the Ford Administration. After spending four years displaced by the Carter Administration, Bush was now Reagan’s Vice President with Executive Order authority for the National Security Council (NSC) and U.S. intelligence and enforcement agencies. Bush’s new authority was married with expanded powers to outsource sensitive work to private contractors. Such work could be funded through the non-transparent financial mechanisms available through the National Security Act of 1947, and the CIA Act of 1949.
This was a secret source of money for funding powerful new weaponry and surveillance technology and operations owned, operated or controlled by private corporations.[3] Carter’s massive layoffs at the CIA had created plenty of private contractor capacity looking for work.[4] An assassination attempt on President Reagan’s life two months after the inauguration meant that Vice President Bush and his team were called on to play an expanded role. Meantime, Nicholas Brady continued as an intimate friend and collaborator from his position as Chairman of Dillon Read.[5]
In April of 1981, Bechtel, working through the Bechtel private venture arm Sequoia, bought the controlling interest in Dillon Read from the Dillon family, led by C. Douglas Dillon, former U.S. Treasury Secretary[6] and son of the firm’s namesake, Clarence Dillon. This was a time when Bechtel was facing increased competition globally while experiencing a decline in the nuclear power business that they had pioneered.[7]
We found ourselves with new owners whose operations were an integral part of the military and intelligence communities and who had demonstrated a rapacious thirst for drinking from the federal money spigot.[8] George Schultz, former Secretary of the Treasury during the Nixon Administration, and now Bechtel executive, joined our board.
Unusual things started to happen that were very “un-Dillon-Ready-like.” First came a new bluntness. I will never forget the day that one of the partners brought around a very charming retired senior Steve Bechtel to tour the firm. Upon introduction, he peered up at me through thick glasses and said “Far out, a chick investment banker.” Then came strategic planning with SRI International, the think tank offshoot of Stanford University that had long standing relationships with the Bechtel family and Schultz. The head of the Energy Group that I worked for at the time was part of the planning group. His mood changed during this period and he later left the firm, retiring from the industry. Before going he warned me that I should do the same. He never said why… leaving a chill that I have felt many times since as ominous changes continue that have no name or a face.
The planning group recommended that we expand our business into merchant banking. This means managing money in venture investment by starting and growing new companies or taking controlling interests in existing companies, including “leveraged buyouts.”[9] Rather than serving companies who needed to raise money by issuing securities, or make markets in existing securities, we were going to start raising money so we could create, buy and trade companies. A company was no longer a customer. They were now a target. Wall Street was its own customer who would raise money to buy companies who would work for us. This required new people with new skills.
A Time Magazine story from December 1981, “The Rothschilds Are Roving” describes a decision by the French Rothschilds in response to the nationalization of Banque Rothschild by President Mitterrand to move significant operations and focus to the U.S. Time reports that they are changing the name of their aggressive venture capital firm, New Court Securities to Rothschild, Inc. and are taking over from the current CEO, John Birkelund.[12]
Birkelund was tall and energetic. He had piercing blue eyes, a driving and hard working ambition and intelligence. He seemed frustrated by the process of organizing and invigorating Dillon’s club-like culture. There was much about his willingness to try that endeared him to me – a point of view that was not reciprocated. Whatever the reason, I was not Birkelund’s cup of tea. I will never forget one of his early addresses to the banking group. He was full of energy and launched a section of his pep talk, “When you get up in the morning and look into the mirror to shave...” He suddenly froze, looking at me (one of few or possibly the only woman in the room) with fear that his reference to a masculine practice would offend. In the hopes of putting him at ease, I said with merriment, “Don’t worry, John, girls shave too.” The whole room burst out laughing and John turned red.
Birkelund had his hands full after arriving at Dillon Read. In 1982, Nick Brady left temporarily to serve in the U.S. Senate, appointed by Governor Tom Kean of New Jersey to serve out Harrison Williams term. George Schultz left Bechtel to serve as Secretary of State under Reagan. With Brady and Schultz in Washington D.C., the Bechtel relationship stalled. With Brady returning in 1983, Birkelund engineered the repurchase of the firm from Sequoia by the partners and the creation of meaningful venture and leveraged buyout efforts. In 1986, Brady and Birkelund lead the sale of Dillon Read to Travelers, the large Connecticut insurance company that later became part of Citigroup. The relationship with Travelers expanded our capital resources to participate in the venture capital and leveraged buyout businesses. In no small part thanks to Birkelund’s hard work and dictatorial cajoling, Dillon Read would not be left behind in the 1980s boom time.
One of my favorite Dillon Read officers was the son of a former Dillon chairman and, thus, remarkably wise about the ways of the firm. I sought him out after a Birkelund temper tantrum and said that Birkelund was not at all like a “Brady Man” and that I was surprised at Nick’s choice. My colleague looked at me with surprise and said something to the effect of “Brady did not choose Birkelund. Birkelund is a 'Rothschild Man'.” I then said something about Dillon being owned by the Dillon partners, so what did the Rothschild’s have to do with us? My colleague rolled his eyes and walked away as if I was an interloper out of my league among the moneyed classes – clueless as to who and what was really in charge at Dillon Read and in the world.
After all, even Time Magazine had declared that the Rothschild invasion of America was underway.[13]
“With Dillon’s assistance Reynolds expanded out of its tobacco base into a wide variety of industries – foodstuffs, marine transportation, petroleum, packaging, liquor, and soft drinks, among others. In the process the R. J. Reynolds Tobacco Co. of 1963, which had revenues of $117 million, became the R. J. Reynolds Industries of 1983, a $14 billion behemoth.”
Throughout the 1980s, RJR’s huge cash flow fueled the buying and selling of companies that generated significant fees for Dillon Read’s bank accounts and investor connections for our Rolodexes.
In 1984 and 1985, Dillon Read helped RJR merge with Nabisco Brands, making the combined RJR Nabisco one of the world's largest food processors and consumer products corporations. Nabisco’s Ross Johnson emerged as the President of the combined entity. Johnson preferred the bankers he had used at Nabisco – Lehman Brothers. Johnson was on the board of Shearson Lehman Hutton.
To help RJR Nabisco digest the Nabisco acquisition, Dillon and Lehman helped to sell off eleven of RJR Nabisco’s businesses. In the process, numerous Lehman Brothers partners joined Dillon Read. Among them was Steve Fenster, who had been an advisor to the leadership of Chase Manhattan Bank and was on the board of American Management Systems (AMS), a company that figures in our story in the 1990s.
After tours of duty in Dillon’s Corporate Finance and Energy Groups, I spent four years recapitalizing the New York City subway and bus systems on the way to becoming a managing director and member of the board of directors in 1986. I did not work on the RJR account. Odd bits of news would float back. They were always about the huge cash flows generated by the tobacco business and the necessity of finding ways to reinvest the gushing profits of this financial powerhouse.
One of the young associates working for me teamed up with another young associate who worked on the RJR account to buy a sailboat in Europe. The second associate arranged to have the sailboat shipped to the U.S. through Sea-Land, an RJR subsidiary that provided container-shipping services globally. I was told RJR tore up the shipping bill as a courtesy. What kind of cash flows did a company have that could just tear up the shipping bill for an entire boat as a courtesy to a junior Dillon Read associate?
I was to get a better sense of these cash flows many years later when I read the European Union’s explanation. The European Union has a pending lawsuit against RJR Nabisco on behalf of eleven sovereign nations of Europe who in combination have the formidable array of military and intelligence resources to collect and organize the evidence for such a lawsuit. The lawsuit alleges that RJR Nabisco was engaged in multiple long-lived criminal conspiracies.
1. For more than a decade, the DEFENDANTS (hereinafter also referred to as the “RJR DEFENDANTS” or “RJR”) have directed, managed, and controlled money-laundering operations that extended within and/or directly damaged the Plaintiffs. The RJR DEFENDANTS have engaged in and facilitated organized crime by laundering the proceeds of narcotics trafficking and other crimes. As financial institutions worldwide have largely shunned the banking business of organized crime, narcotics traffickers and others, eager to conceal their crimes and use the fruits of their crimes, have turned away from traditional banks and relied upon companies, in particular the DEFENDANTS herein, to launder the proceeds of unlawful activity.
2. The DEFENDANTS knowingly sell their products to organized crime, arrange for secret payments from organized crime, and launder such proceeds in the United States or offshore venues known for bank secrecy. DEFENDANTS have laundered the illegal proceeds of members of Italian, Russian, and Colombian organized crime through financial institutions in New York City, including The Bank of New York, Citibank N.A., and Chase Manhattan Bank. DEFENDANTS have even chosen to do business in Iraq, in violation of U.S. sanctions, in transactions that financed both the Iraqi regime and terrorist groups.
3. The RJR DEFENDANTS have, at the highest corporate level, determined that it will be a part of their operating business plan to sell cigarettes to and through criminal organizations and to accept criminal proceeds in payment for cigarettes by secret and surreptitious means, which under United States law constitutes money laundering. The officers and directors of the RJR DEFENDANTS facilitated this overarching money-laundering scheme by restructuring the corporate structure of the RJR DEFENDANTS, for example, by establishing subsidiaries in locations known for bank secrecy such as Switzerland to direct and implement their money-laundering schemes and to avoid detection by U.S. and European law enforcement.
This overarching scheme to establish a corporate structure and business plan to sell cigarettes to criminals and to launder criminal proceeds was implemented through many subsidiary schemes across THE EUROPEAN COMMUNITY. Examples of these subsidiary schemes are described in this Complaint and include: (a.) Laundering criminal proceeds received from the Alfred Bossert money-laundering organization; (b.) Money laundering for Italian organized crime; (c.) Money laundering for Russian organized crime through The Bank of New York; (d.) The Walt money-laundering conspiracy; (e.) Money laundering through cut outs in Ireland and Belgium; (f.) Laundering of the proceeds of narcotics sales throughout THE EUROPEAN COMMUNITY by way of cigarette sales to criminals in Spain; (g.) Laundering criminal proceeds in the United Kingdom; (h.) Laundering criminal proceeds through cigarette sales via Cyprus; and (i.) Illegal cigarette sales into Iraq.[13a]
The European Union goes on to explain the role of cigarettes in laundering illicit monies:
Chapter 1
Brady, Bush, Bechtel
and "the Boys"
[1]
I remember when John Birkelund first came to Dillon Read in 1981 to serve as President
and Chief Operating Officer.[2] Dillon was a small private investment bank on Wall Street
with a proud history and a shrinking market share as technology and globalization fueled
new growth. I had joined the firm three years before and, after a period in corporate
finance, had migrated to the Energy Group – helping to arrange financing for oil and gas
companies who were clients of Birkelund’s predecessor, Bud Treman. Bud was a member
of the old school – an ethical man increasingly frustrated with the corrupting influence of
hot money and easy debt. This was a time of transition. Dillon’s Chairman, Nicholas F. Brady, was considered one of George H. W. Bush’s most intimate friends and advisors. Both attended Yale, both were children of privilege. Bush had left his home in Greenwich Connecticut and with the help at his father’s networks at Brown Brothers Harriman had gone into oil and gas in Texas. Brady had gone to Harvard Business School and then returned to the aristocratic hunt country of New Jersey, where the Bradys and the Dillons had estates, to work at Dillon Read.
Bush climbed through Republican politics to become Director of the Central Intelligence Agency (CIA) during the Ford Administration. After spending four years displaced by the Carter Administration, Bush was now Reagan’s Vice President with Executive Order authority for the National Security Council (NSC) and U.S. intelligence and enforcement agencies. Bush’s new authority was married with expanded powers to outsource sensitive work to private contractors. Such work could be funded through the non-transparent financial mechanisms available through the National Security Act of 1947, and the CIA Act of 1949.
This was a secret source of money for funding powerful new weaponry and surveillance technology and operations owned, operated or controlled by private corporations.[3] Carter’s massive layoffs at the CIA had created plenty of private contractor capacity looking for work.[4] An assassination attempt on President Reagan’s life two months after the inauguration meant that Vice President Bush and his team were called on to play an expanded role. Meantime, Nicholas Brady continued as an intimate friend and collaborator from his position as Chairman of Dillon Read.[5]
In April of 1981, Bechtel, working through the Bechtel private venture arm Sequoia, bought the controlling interest in Dillon Read from the Dillon family, led by C. Douglas Dillon, former U.S. Treasury Secretary[6] and son of the firm’s namesake, Clarence Dillon. This was a time when Bechtel was facing increased competition globally while experiencing a decline in the nuclear power business that they had pioneered.[7]
We found ourselves with new owners whose operations were an integral part of the military and intelligence communities and who had demonstrated a rapacious thirst for drinking from the federal money spigot.[8] George Schultz, former Secretary of the Treasury during the Nixon Administration, and now Bechtel executive, joined our board.
Unusual things started to happen that were very “un-Dillon-Ready-like.” First came a new bluntness. I will never forget the day that one of the partners brought around a very charming retired senior Steve Bechtel to tour the firm. Upon introduction, he peered up at me through thick glasses and said “Far out, a chick investment banker.” Then came strategic planning with SRI International, the think tank offshoot of Stanford University that had long standing relationships with the Bechtel family and Schultz. The head of the Energy Group that I worked for at the time was part of the planning group. His mood changed during this period and he later left the firm, retiring from the industry. Before going he warned me that I should do the same. He never said why… leaving a chill that I have felt many times since as ominous changes continue that have no name or a face.
The planning group recommended that we expand our business into merchant banking. This means managing money in venture investment by starting and growing new companies or taking controlling interests in existing companies, including “leveraged buyouts.”[9] Rather than serving companies who needed to raise money by issuing securities, or make markets in existing securities, we were going to start raising money so we could create, buy and trade companies. A company was no longer a customer. They were now a target. Wall Street was its own customer who would raise money to buy companies who would work for us. This required new people with new skills.
Chapter 2
A Rothschild Man
John Birkelund arrived at Dillon Read in September 1981. Born in Glencoe, Illinois, he
had graduated from Princeton and then had joined the Navy where he served with the
Office of Naval Intelligence in Berlin. While in Europe he became friends with Edward
Stinnes, who recruited him after a short career with Booz Allen in Chicago to work in
New York for the Rothschild family, considered to be one of if not the wealthiest family
in the world.[10] He started at Amsterdam Overseas Corporation, which then moved its
venture capital business into New Court Securities with Birkelund as co-founder. New
Court was owned by the Rothschild banks in Paris and London, Pierson Heldring Pierson
in Amsterdam and the management. Their venture successes included Cray Research,
inventor of the high-powered computers by that name, and Federal Express, the courier
company based in Memphis, Tennessee.[11] A Time Magazine story from December 1981, “The Rothschilds Are Roving” describes a decision by the French Rothschilds in response to the nationalization of Banque Rothschild by President Mitterrand to move significant operations and focus to the U.S. Time reports that they are changing the name of their aggressive venture capital firm, New Court Securities to Rothschild, Inc. and are taking over from the current CEO, John Birkelund.[12]
Birkelund was tall and energetic. He had piercing blue eyes, a driving and hard working ambition and intelligence. He seemed frustrated by the process of organizing and invigorating Dillon’s club-like culture. There was much about his willingness to try that endeared him to me – a point of view that was not reciprocated. Whatever the reason, I was not Birkelund’s cup of tea. I will never forget one of his early addresses to the banking group. He was full of energy and launched a section of his pep talk, “When you get up in the morning and look into the mirror to shave...” He suddenly froze, looking at me (one of few or possibly the only woman in the room) with fear that his reference to a masculine practice would offend. In the hopes of putting him at ease, I said with merriment, “Don’t worry, John, girls shave too.” The whole room burst out laughing and John turned red.
Birkelund had his hands full after arriving at Dillon Read. In 1982, Nick Brady left temporarily to serve in the U.S. Senate, appointed by Governor Tom Kean of New Jersey to serve out Harrison Williams term. George Schultz left Bechtel to serve as Secretary of State under Reagan. With Brady and Schultz in Washington D.C., the Bechtel relationship stalled. With Brady returning in 1983, Birkelund engineered the repurchase of the firm from Sequoia by the partners and the creation of meaningful venture and leveraged buyout efforts. In 1986, Brady and Birkelund lead the sale of Dillon Read to Travelers, the large Connecticut insurance company that later became part of Citigroup. The relationship with Travelers expanded our capital resources to participate in the venture capital and leveraged buyout businesses. In no small part thanks to Birkelund’s hard work and dictatorial cajoling, Dillon Read would not be left behind in the 1980s boom time.
One of my favorite Dillon Read officers was the son of a former Dillon chairman and, thus, remarkably wise about the ways of the firm. I sought him out after a Birkelund temper tantrum and said that Birkelund was not at all like a “Brady Man” and that I was surprised at Nick’s choice. My colleague looked at me with surprise and said something to the effect of “Brady did not choose Birkelund. Birkelund is a 'Rothschild Man'.” I then said something about Dillon being owned by the Dillon partners, so what did the Rothschild’s have to do with us? My colleague rolled his eyes and walked away as if I was an interloper out of my league among the moneyed classes – clueless as to who and what was really in charge at Dillon Read and in the world.
After all, even Time Magazine had declared that the Rothschild invasion of America was underway.[13]
Chapter 3
RJR Nabisco
If you want to understand Dillon Read in the 1980s, you must understand R.J. Reynolds
(RJR), a tobacco company based in Winston-Salem, North Carolina. According to the
official Dillon history, The Life and Times of Dillon Read by Robert Sobel (Truman Talley
Books/Dutton, 1991) at pages 345-346, RJR had been Dillon client for many years: “With Dillon’s assistance Reynolds expanded out of its tobacco base into a wide variety of industries – foodstuffs, marine transportation, petroleum, packaging, liquor, and soft drinks, among others. In the process the R. J. Reynolds Tobacco Co. of 1963, which had revenues of $117 million, became the R. J. Reynolds Industries of 1983, a $14 billion behemoth.”
Throughout the 1980s, RJR’s huge cash flow fueled the buying and selling of companies that generated significant fees for Dillon Read’s bank accounts and investor connections for our Rolodexes.
In 1984 and 1985, Dillon Read helped RJR merge with Nabisco Brands, making the combined RJR Nabisco one of the world's largest food processors and consumer products corporations. Nabisco’s Ross Johnson emerged as the President of the combined entity. Johnson preferred the bankers he had used at Nabisco – Lehman Brothers. Johnson was on the board of Shearson Lehman Hutton.
To help RJR Nabisco digest the Nabisco acquisition, Dillon and Lehman helped to sell off eleven of RJR Nabisco’s businesses. In the process, numerous Lehman Brothers partners joined Dillon Read. Among them was Steve Fenster, who had been an advisor to the leadership of Chase Manhattan Bank and was on the board of American Management Systems (AMS), a company that figures in our story in the 1990s.
After tours of duty in Dillon’s Corporate Finance and Energy Groups, I spent four years recapitalizing the New York City subway and bus systems on the way to becoming a managing director and member of the board of directors in 1986. I did not work on the RJR account. Odd bits of news would float back. They were always about the huge cash flows generated by the tobacco business and the necessity of finding ways to reinvest the gushing profits of this financial powerhouse.
One of the young associates working for me teamed up with another young associate who worked on the RJR account to buy a sailboat in Europe. The second associate arranged to have the sailboat shipped to the U.S. through Sea-Land, an RJR subsidiary that provided container-shipping services globally. I was told RJR tore up the shipping bill as a courtesy. What kind of cash flows did a company have that could just tear up the shipping bill for an entire boat as a courtesy to a junior Dillon Read associate?
I was to get a better sense of these cash flows many years later when I read the European Union’s explanation. The European Union has a pending lawsuit against RJR Nabisco on behalf of eleven sovereign nations of Europe who in combination have the formidable array of military and intelligence resources to collect and organize the evidence for such a lawsuit. The lawsuit alleges that RJR Nabisco was engaged in multiple long-lived criminal conspiracies.
Excerpt From European Lawsuit
Against
RJR Nabisco
If you like spy novels, you will find that the European Union’s presentation of fact to be
far more fascinating than fiction. One of the complaints filed in the case describes a rich
RJR history of business with Latin American drug cartels, Italian and Russian mafia, and
Saddam Hussein’s family to name a few. The Introduction reads as follows: 1. For more than a decade, the DEFENDANTS (hereinafter also referred to as the “RJR DEFENDANTS” or “RJR”) have directed, managed, and controlled money-laundering operations that extended within and/or directly damaged the Plaintiffs. The RJR DEFENDANTS have engaged in and facilitated organized crime by laundering the proceeds of narcotics trafficking and other crimes. As financial institutions worldwide have largely shunned the banking business of organized crime, narcotics traffickers and others, eager to conceal their crimes and use the fruits of their crimes, have turned away from traditional banks and relied upon companies, in particular the DEFENDANTS herein, to launder the proceeds of unlawful activity.
2. The DEFENDANTS knowingly sell their products to organized crime, arrange for secret payments from organized crime, and launder such proceeds in the United States or offshore venues known for bank secrecy. DEFENDANTS have laundered the illegal proceeds of members of Italian, Russian, and Colombian organized crime through financial institutions in New York City, including The Bank of New York, Citibank N.A., and Chase Manhattan Bank. DEFENDANTS have even chosen to do business in Iraq, in violation of U.S. sanctions, in transactions that financed both the Iraqi regime and terrorist groups.
3. The RJR DEFENDANTS have, at the highest corporate level, determined that it will be a part of their operating business plan to sell cigarettes to and through criminal organizations and to accept criminal proceeds in payment for cigarettes by secret and surreptitious means, which under United States law constitutes money laundering. The officers and directors of the RJR DEFENDANTS facilitated this overarching money-laundering scheme by restructuring the corporate structure of the RJR DEFENDANTS, for example, by establishing subsidiaries in locations known for bank secrecy such as Switzerland to direct and implement their money-laundering schemes and to avoid detection by U.S. and European law enforcement.
This overarching scheme to establish a corporate structure and business plan to sell cigarettes to criminals and to launder criminal proceeds was implemented through many subsidiary schemes across THE EUROPEAN COMMUNITY. Examples of these subsidiary schemes are described in this Complaint and include: (a.) Laundering criminal proceeds received from the Alfred Bossert money-laundering organization; (b.) Money laundering for Italian organized crime; (c.) Money laundering for Russian organized crime through The Bank of New York; (d.) The Walt money-laundering conspiracy; (e.) Money laundering through cut outs in Ireland and Belgium; (f.) Laundering of the proceeds of narcotics sales throughout THE EUROPEAN COMMUNITY by way of cigarette sales to criminals in Spain; (g.) Laundering criminal proceeds in the United Kingdom; (h.) Laundering criminal proceeds through cigarette sales via Cyprus; and (i.) Illegal cigarette sales into Iraq.[13a]
The European Union goes on to explain the role of cigarettes in laundering illicit monies:
V. THE LINK BETWEEN RJR’S CIGARETTE SALES, MONEY
LAUNDERING, AND ORGANIZED CRIME
Money-Laundering Links Between Europe, The United States, Russia,
and Colombia
20. Cigarette sales, money laundering, and organized crime are linked and
interact on a global basis. According to Jimmy Gurule, Undersecretary for
Treasury Enforcement: “Money laundering takes place on a global scale
and the Black Market Peso Exchange System, though based in the
Western Hemisphere, affects business around the world. U.S. law
enforcement has detected BMPE-related transactions occurring
throughout the United States, Europe, and Asia.”
21. The primary source of cocaine within THE EUROPEAN
COMMUNITY is Colombia. Large volumes of cocaine are transported
from Colombia into THE EUROPEAN COMMUNITY and then sold
illegally within THE EUROPEAN COMMUNITY and the MEMBER
STATES. The proceeds of these illegal sales must be laundered in order
to be useable by narcotics traffickers. Throughout the 1990s and
continuing to the present day, a primary means by which these cocaine
proceeds are laundered is through the purchase and sale of cigarettes,
including those manufactured by the RJR DEFENDANTS. Cocaine sales
in THE EUROPEAN COMMUNITY are facilitated through money laundering operations in Colombia, Panama, Switzerland, and elsewhere
which utilize RJR cigarettes as the money-laundering vehicle.
22. In a similar way, the primary source of heroin within THE
EUROPEAN COMMUNITY is the Middle East and, in particular,
Afghanistan, with the majority of said heroin being sold by Russian
organized crime, Middle Eastern criminal organizations, and terrorist
groups based in the Middle East. Heroin sales in THE EUROPEAN
COMMUNITY and the MEMBER STATES are facilitated and expedited
by the purchase and sale of the DEFENDANTS’ cigarettes in money laundering operations that begin in THE EUROPEAN COMMUNITY
and the MEMBER STATES, Eastern Europe, and/or Russia, but which
ultimately result in the proceeds of those money-laundering activities
being deposited into the coffers of the RJR DEFENDANTS in the
United States.
Background on the Convergence of Narcotics Trafficking and
Money Laundering
23. This complaint is about Trade and Commerce or, more correctly,
illegal Trade and illegal Commerce, and how money laundering facilitates
the financing and movement of goods internationally. Merchants
engaging in global trade often turn to the more stable global currencies
for payments of goods and services purchased abroad. In many markets,
the United States dollar is the currency of choice and, in some cases, the
United States dollar is the only accepted form of payment. Merchants
seeking dollars usually obtain them in a variety of ways, including the following three methods. Traditional merchants go to a local financial
institution that can underwrite credit. Private financing is usually available
for those with collateral. A third and least desirable source of dollar
financing can be found in the “black markets” of the world. Black
Markets are the underground or parallel financial economies that exist in
every country. Criminals and their organizations control these
underground economies, which generally operate through “money
brokers.” These “money brokers” often fulfill a variety of roles not the
least of which is an important intermediate step in the laundering process,
one that we will refer to throughout this complaint as the “cut out.”
24. The criminal activity that provides the dollars for these black market
money laundering operations is often drug trafficking and related violent
crimes. South America is the world leader in the production of cocaine,
and the United States and the European Union are the world’s largest
cocaine markets. Likewise, Colombia and countries in the Middle East
produce heroin. Cocaine and heroin are smuggled to the United States
and Europe, and are sold for United States dollars as well as in local
European currencies (and now the Euro). Russian drug smugglers obtain
heroin from the Middle East and cocaine from South America, and sell
both drugs in large quantities in the United States and in Europe. Retail
street sales of cocaine and heroin have risen dramatically over the past
two decades throughout the United States and Europe. Consequently,
drug traffickers routinely accumulate vast amounts of illegally obtained
cash in the form of United States dollars in the United States and Euros
in Europe. The U.S. Customs Service estimates that illegal drug sales in
the United States alone generate an estimated fifty-seven billion dollars in
annual revenues, most of it in cash.
25. A drug trafficker must be able to access his profits, to pay expenses
for the ongoing operation, and to share in the profits; and he must be
able to do this in a manner that seemingly legitimizes the origins of his
wealth, so as to ward off oversight and investigation that could result in
his arrest and imprisonment and the seizure of his monies. The process
of achieving these goals is the money-laundering cycle.
26. The purpose of the money-laundering cycle is to establish total
anonymity for the participants, by passing the cash drug proceeds
through the financial markets in a way that conceals or disguises the
illegal nature, source, ownership, and/or control of the money.
Background on Black
Market Money Exchanges
27. Within Europe, the United States, South America, and elsewhere, a
community of illegal currency exchange brokers, known to law enforcement officials as “money brokers,” operates outside the
established banking system and facilitates the exchange of narcotics sale
proceeds for local cash or negotiable instruments. Many of these money
brokers have developed methods to bypass the banking systems and
thereby avoid the scrutiny of regulatory authorities. These money
exchanges have different names depending on where they are located, but
they all operate in a similar fashion.
28. A typical “money-broker” system works this way: In a sale of
Colombian cocaine in THE EUROPEAN COMMUNITY, the drug
cartel exports narcotics to the MEMBER STATES where they are sold
for Euros. In Colombia, the cartel contacts the money broker and
negotiates a contract, in which the money broker agrees to exchange
pesos he controls in Colombia for Euros that the cartel controls in
Europe. The money broker pays the cartel the agreed-upon sum in pesos.
The cartel contacts its cell (group) in the European Union and instructs
the cell to deliver the agreed-upon amount of Euros to the money
broker’s European agent. The money broker must now launder the Euros
he has accumulated in the European Union. He may also need to convert
the Euros into U.S. dollars because his customers may need U.S. dollars
to pay companies such as RJR for their products.
29. The money broker uses his European contacts to place the monies he
purchased from the cartel into the European banking system or into a
business willing to accept these proceeds (a process described in more
detail below). The money broker now has a pool of narcotics-derived
funds in Europe to sell to importers and others. In many instances, the
narcotics trafficker who sold the drugs in THE EUROPEAN
COMMUNITY is also the importer who purchased the cigarettes.
Importers buy these monies from the money brokers at a substantial
discount off the “official” exchange rates and use these monies to pay for
shipments of items (such as cigarettes), which the importers have ordered
from United States companies and/or their authorized European
representatives, or “cut outs.” The money broker uses his European
contacts to send the monies to whomever the importer has specified.
Often these customers utilize such monies to purchase the
DEFENDANTS’ cigarettes in bulk and, in many instances, the money
brokers have been directed to pay the RJR DEFENDANTS directly for
the cigarettes purchased. The money broker makes such payments using a
variety of methods, including his accounts in European financial
institutions. The purchased goods are shipped to their destinations. The
importer takes possession of his goods. The money broker uses the funds
derived from the importer to continue the laundering cycle.
30. In that fashion, the drug trafficker has converted his drug proceeds
(which he could not previously use because they were in Euros) to local
currency that he can use in his homeland as profit and to fund his operations; the European importer has obtained the necessary funds
from the black market money broker to purchase products that he might
not otherwise have been able to finance (due to lack of credit, collateral,
or U.S. dollars, and/or a desire for secrecy); the company selling
cigarettes to the importer has received payment on delivered product in
its currency of choice regardless of the source of the funds; and the
money broker has made a profit charging both the cartel and the
importer for his services. This cycle continues until the criminals involved
are arrested and a new cycle begins. Money laundering is a series of such
events, all connected and never stopping until at least one link in the
chain of events is broken.
31. Many narcotics traffickers who sell drugs in THE EUROPEAN
COMMUNITY now also purchase and import cigarettes. In particular, as
the trade in cigarettes becomes more profitable and carries lesser criminal
penalties compared to narcotics trafficking, the “business end” of selling
the cigarettes has become at least as attractive and important to the
criminal as the narcotics trafficking. Finally, it makes no difference
whatsoever to the money laundering system whether the goods are
imported and distributed legally or illegally.
Regardless of whether he sells his cigarettes legally or illegally, the narcotics trafficker has
achieved his goal in that he has been able to disguise the nature, location, true source,
ownership, and/or control of his narcotics proceeds. At the same time, the cigarette
manufacturer (in this case RJR) has achieved its goal because it has successfully sold its
product in a highly profitable way.[13b]
Particularly endearing, the European Union alludes to one of the most important secrets
of money laundering – that the attorney-client privilege of lawyers and law firms,
particularly the most prestigious Washington and Wall Street law firms, are a preferred
method for the communication of corporate crimes:
“RJR has been aware of organized crime’s involvement in the distribution of its
products since at least the 1970s. On January 4, 1978, the Tobacco Institute’s
Committee of Counsel met at the offices of Phillip Morris in New York City. The
Committee of Counsel was the high tribunal that set the tobacco industry’s legal,
political, and public relations strategy for more than three decades. The January 4,
1978 meeting was called to discuss, among other things, published reports concerning
organized crime’s involvement in the tobacco trade and the tobacco industry’s complicity
therein. The published reports detailed the role of organized crime in the tobacco trade
(including the Colombo crime family in New York) and the illegal trade at the
Canadian border and elsewhere. RJR’s general counsel, Max Crohn, attended and
participated in the meeting. All of the large cigarette manufacturers were present at the
meeting and represented by counsel, such as Phillip Morris (Arnold & Porter, Abe
Krash) [Author's note: Arnold & Porter is a firm that will come up several times
later in our story] and Brown & Williamson (Paul Weiss Rifkind Wharton &
Garrison, Martin London). The Committee of Counsel took no action to address,
investigate, or end the role of organized crime in the tobacco business. Instead, the
Committee agreed to formulate a joint plan of action to protect the industry from
scrutiny of the U.S. Congress.”[13c]
See a list of articles on the RJR Case and other tobacco company lawsuits in Footnotes,
this site.[13d]
You will find an update in the litigation section in the SEC annual report for 2004 for
RJR’s successor corporation, Reynolds American, as well as other updates on litigation
cases involving smuggling and slavery reparations.[14]
According to Dillon Read, the firm’s average return on equity for the years 1982-1989 was
29%. This is a strong performance, and compares to First Boston, Solomon, Shearson and
Morgan Stanley’s average returns of 26%, 15%, 18% and 31% respectively.[15] Given
what we now know from the European Union’s lawsuit and other legal actions against
RJR Nabisco and its executives, this begs the question of what Dillon’s profits would have
been if the firm had not made a small fortune reinvesting the proceeds of – if we are to
believe the European Union – cigarette sales to organized crime including the profits
generated by narcotics flowing into the communities of America through the Latin
American drug cartels.
To understand the flow of drug money into and through Wall Street and corporate stocks
like RJR Nabisco during the 1980s, it is useful to look more closely at the flow of drugs
from Latin America during the period – and the implied cash flows of narco dollars that
they suggest. Two documented situations involve Mena, Arkansas and South Central Los
Angeles, California.
Chapter 4
Narco Dollars in the
1980s — Mena, Arkansas
During the 1980s, a sometime government agent named Barry Seal led a smuggling
operation that delivered a significant amount of narcotics estimated to be as much as $5
billion from Latin America through an airport in Mena, Arkansas.[16] According to
investigative reporters and researchers knowledgeable about Mena, the operation had
protection from the highest levels of the National Security Council then under the
leadership of George H.W. Bush and staffed by Oliver North. According to investigative
reporter and author Daniel Hopsicker, when Seal was assassinated in February 1986, Vice
President George H.W. Bush’s personal phone number was found in his wallet. Through
Hopsicker's efforts, Barry Seal’s records also divulged a little known piece of smuggling
trivia – RJR executives in Central America had helped Seal smuggle contraband into the
U.S. in the 1970s.[17]
The arms and drug running operation in Mena continued after Seal's assassination. Eight
months later, Seal’s plane, the “Fat Lady,” was shot down in Nicaragua. The plane was
carrying arms for the Contras. The only survivor, Eugene Hasenfus admitted to the
illegal operation to arm the Contra forces staged out of the Mena airport. Hasenfuss’
capture inspired Oliver North and his secretary at the National Security Council to embark
on several days of shredding. The files that survived North’s shredding that were
eventually provided to Congress contain hundreds of references to drugs.
An independent counsel was appointed to investigate the concerns raised by Hasenfuss’
capture. As described in my article, "The Myth of the Rule of Law," the founders note
written by Chris Sanders, head of Sanders Research states:[18]
“The investigation resulted in no fewer than 14 individuals being indicted or convicted of
crimes. These included senior members of the National Security Council, the Secretary of
Defense, the head of covert operations of the CIA and others. After George Bush was
elected President in 1988, he pardoned six of these men. The independent counsel’s
investigation concluded that a systematic cover up had been orchestrated to protect the
President and the Vice President… During the course of the independent counsel’s
investigation, persistent rumors arose that the administration had sanctioned drug
trafficking as well as a source of operational funding. These charges were successfully
deflected with respect to the independent counsel’s investigation, but did not go away.
They were examined separately by a Congressional committee chaired by Senator John
Kerry, which established that the Contras had indeed been involved in drug trafficking and
that elements of the U.S. government had been aware of it.”
There is a standard line you hear when you try to talk to people in Washington, D.C. about
the flood of narcotics operations and money laundering in Arkansas during the 1980s.
“Oh, those allegations were entirely discredited,” they say. This is not so. Thanks to
numerous journalists and members of the enforcement community, the documentation on
Mena drug running and the related money laundering is quite serious and makes the case
that the government was engaged or complicit in significant narcotics trafficking. This
includes the various relationships to employees of the National Security Council, the
Department of Justice and the CIA under Vice President Bush’s leadership and to then
Governor of Arkansas, Bill Clinton and a state agency, the Arkansas Development and
Finance Agency (ADFA). ADFA was a local distributor of U.S. Department of Housing
and Urban Development (HUD) subsidy and finance programs and an active issuer of
municipal housing bonds. One of its law firms included Hillary Clinton and several
members of Bill Clinton’s administration as partners, including Deputy White House
Counsel Vince Foster and Associate Attorney General Webster Hubbell.
Those convicted and pardoned by President Bush included former Bechtel General
Counsel, Harvard trained lawyer Cap Weinberger who as Secretary of Defense had
presided over one of the most crime-ridden government contracting operations in U.S.
history.[19] Forbes editor James Norman left Forbes in 1995 as a result of Forbes refusal
to publish his story “Fostergate”, about the death of Vince Foster and it’s relationship to
the sophisticated software, PROMIS, allegedly used to launder money, including funds for
the arms and drugs transactions working through Arkansas. Norman’s story allegedly
implicated Weinberger in taking kickbacks through a Swiss account from Seal’s smuggling
operation. In other stories, the software was considered to be an adaptation of PROMIS
software stolen from a company named Inslaw and turned over to an Arkansas company
controlled by Jackson Stephens. An historical footnote to our story is that a later study of
the prison industry shows that Jackson Stephens’ investment bank, Stephens, Inc., was one
of the largest issuer of municipal bonds for prisons.
Some of the most compelling documentation on Seal’s Mena operation and related money
laundering was provided by William Duncan, the former Special Operations Coordinator
for the Southeast Region of the Criminal Investigation Division, Internal Revenue Service
at the U.S. Treasury. The U.S. Treasury fired Duncan in June of 1989 when he refused to
dilute or cover up the facts in Congressional testimony.[20] [21]Since it is illegal to lie to Congress, this is the equivalent of being fired for refusing to break the law, and in the
process, protecting a criminal enterprise.
The Secretary of the Treasury when Duncan was fired was Nicholas F. Brady, former
Chairman of Dillon Read. Brady left Dillon in September 1988 to join the Reagan
Administration in anticipation of Bush’s victory in the November elections. Duncan was
fired within months of two important events detailed later in the story:
(i.) the RJR Nabisco takeover made famous by the book, Barbarians at the Gate: The Fall
of RJR Nabisco by Brian Burrough and John Helyer (Harper & Row, 1990) as well as a
later movie by the same name, and
(ii.) Lou Gerstner, now chairman of the Carlyle Group, joining RJR Nabisco to make sure
that the aggressive management was in place to pay back billions of new debt issued in the
takeover.
As we will see later in our story, the inability to stop Duncan from documenting the
corruption at Mena and the U.S. Treasury, emphasized the importance of placing control
of the IRS and its rich databases and information systems which illuminated flows of
money in friendlier hands.
Narco Dollars in the 1980s
South Central, Los Angeles
Gary Webb’s "Dark Alliance" story documenting the explosion of cocaine coming from
Latin America into South Central Los Angeles during the 1980s was originally published
by the San Jose Mercury News in the summer of 1996 and then published in book form in
1998. The story and its supporting documentation were persuasive that the U.S.
government and their allies in the Contras were involved in narcotics trafficking targeted at
American children and communities.
All the usual suspects did their best to destroy Webb’s credibility and suppress his story.
This included the Washington Post, which had pulled Sally Denton and Rodger Morris’
story on Mena at the last minute in 1995 – leaving it to run later in the summer in
Penthouse Magazine. Luckily, Webb had arranged to have significant amounts of legal
documentation substantiating his story posted on the San Jose Mercury News website. By
the time that the News was pressured to take the story down, thousands of interested
people all over the world had downloaded overwhelming evidence. Thanks to the Internet,
the crack cocaine Humpty Dumpty could not be put back together again.
In response to citizen concern inspired by Webb's story, then Director of the CIA, John
Deutsch, agreed to attend a town hall meeting in South Central Los Angeles with local
Congressional representatives in November 1996. Confronted by allegations in support of
Webb's story, Deutsch promised that the CIA Inspector General would investigate the
“Dark Alliance” allegations.
This resulted in a two volume report published by the CIA in March and October of 1998
that included disclosure of one of the most important legal documents of the 1980s – a Memorandum of Understanding (MOU) between the Department of Justice (DOJ) and
the CIA dated February 11, 1982 in effect until August 1995.[22] At the time it was
created, William French Smith was the U.S. Attorney General and William Casey, former
Wall Street law partner and Chairman of the SEC was Director of the CIA. Casey, like
Douglas Dillon, had worked for Office of Strategic Services (OSS) founder Bill Donovan
and was a former head of the Export-Import Bank. Casey was also a friend of George
Schultz. Bechtel looked to the Export-Import Bank to provide the government guarantees
that financed billions of big construction contracts worldwide. Casey recruited Stanley
Sporkin, former head of SEC Enforcement, to serve as general counsel of the CIA. When
Schultz joined the Reagan Administration as Secretary of State, such linkages helped to
create some of the personal intimacy between money worlds and national security that
make events such as those that occurred during the Iran Contra period possible.
No history of the 1980s is complete without an understanding of the lawyers and legal
mechanisms used to legitimize drug dealing and money laundering under the protection of
National Security law. Through the MOU, the DOJ relieved the CIA of any legal
obligation to report information of drug trafficking and drug law violations with respect to
CIA agents, assets, non-staff employees and contractors.[23] Presumably, this included the
corporate contractors who, by executive order, were now allowed to handle sensitive
intelligence and national security outsourcing.
With the DOJ-CIA Memorandum of Understanding, in effect from 1982 until rescinded
in August 1995, a crack cocaine epidemic ravaged the poorer communities of America and
disenfranchised hundreds of thousands of poor people into prison who, now classified as
felons, were safely off of the voting roles. Meantime, the U.S. financial system gorged on
what had grown to an estimated $500 billion-$1 trillion a year of money laundering by the
end of the 1990s. Not surprisingly, the rich got richer as corporate power and the
concentration of investment capital skyrocketed on the rich margins of state sanctioned
criminal enterprise.
Yale Law School trained Stanley Sporkin was appointed by Reagan in 1985-86 to serve as a
judge in Federal District court, leaving the CIA with a legal license to team up with drug
dealing allies and contractors. From the bench many years later, he helped engineer the
destruction of my company Hamilton Securities while preaching to the District of
Columbia bar about good government and ethics. He retired from the bench in 2000 to
become a partner at Weil, Gotshal & Manges, Enron’s bankruptcy counsel.
Gary Webb died in 2004, another casualty of an intelligence, enforcement and media effort
that keeps global narcotics trafficking and the War on Drugs humming along by reducing
to poverty and making life miserable for those who tell the truth. At the heart of this
machinery are thousands of socially prestigious professionals like Sporkin who engineer
the system within a labyrinth of law firms, courts and government depositories and
contractors operating behind the closely guarded secrets of attorney client privilege and
National Security law and the rich cash flows of the U.S. federal credit.[24]
Chapter 5
Leveraged Buyouts
Leveraged buyouts were a phenomenon that got going in the 1980s. A leveraged buyout
(LBO) is a transaction in which a financial sponsor buys a company primarily with debt –
effectively buying the target company with the target's own cash and financial ability to
service the debt. As described in Barbarians at the Gate: The Fall of RJR Nabisco at pages
140-141: “In 1982 an investment group headed by William Simon, a former treasury secretary, took private a Cincinnati company, Gibson Greetings, for $80 million, using only a million dollars of its own money. When Simon took Gibson public 18 months later, it sold for $290 million. Simon’s $330,000 investment was suddenly worth $66 million in cash and securities… By 1985, just two years after Gibson Greetings, there were 18 separate LBOs valued at $1 billion or more. In the five years before Ross Johnson [RJR Nabisco Chairman and CEO] decided to pursue his buyout, LBO activity totaled $181.9 billion, compared to $11 billion in the six years before that.
“A number of factors combined to fan the frenzy. The Internal Revenue Code, by making interest but not dividends deductible from taxable income, in effect subsidized the trend. That got LBOs off the ground. What made them soar were junk bonds.
“Of the money raised for any LBO, about 60 percent, the secured debt, comes in the form of loans from commercial banks. Only about 10 percent comes from the buyer itself. For years, the remaining 30 percent – the meat in the sandwich – came from a handful of major insurance companies whose commitments sometimes took months to obtain. Then, in the mid-eighties, Drexel Burnham began using high-risk “junk” bonds to replace the insurance company funds. The firm’s bond czar, Michael Milken, had proven his ability to raise enormous amounts of these securities on a moment’s notice for hostile takeovers. Pumped into buyouts, Milken’s junk bonds became a high-octane fuel that transformed the LBO industry from a Volkswagen Beetle into a monstrous drag racer belching smoke and fire.
“Thanks to junk bonds, LBO buyers, once thought too slow to compete in a takeover battle, were able to mount split-second tender offers of their own for the first time.”
In a highly leveraged company, the equity owner does not really have control. It’s the bondholder or creditor who can put the company in default. With the dirty tricks available from covert "economic hit" teams combined with a creditor's ability to throw a company in default, who needs to be a visible owner? Unmentioned was the ease and elegance with which junk bonds made it possible to take over companies with narco dollars and other forms of hot money financed by powerful partners hidden behind mountains of debt.
There emerged a growing number of attractive business savvy investment firms vying to be the owners of record for a growing number of companies taken private in leveraged buyouts. This included Kohlberg Kravis Roberts & Co. (KKR), the LBO firm that took over RJR Nabisco in 1989 in one of the most visible takeovers of the decade, documented by Barbarians at the Gate. Dillon Read represented the RJR Nabisco board on the transaction. While the bidding war between KKR and the management group led by Ross Johnson teamed with Shearson Lehman escalated, I remember being dumbfounded as to why anyone thought that RJR Nabisco could service the proposed amounts of debt. In later years as I read reports that the debt was being serviced, I wondered what magic tricks KKR had that we mere mortals were missing. In reading Barbarians at the Gate, it turns out they managed to win despite not having the highest bid on all bidding rounds. One wonders the extent to which the bidding process was reengineered to ensure a KKR win and the media manipulated to make it look like the board had reasons to favor KKR over management other than the real reasons.
Years later, reading between the lines of the European Union lawsuit, it struck me that perhaps KKR had simply sheltered one of the worlds premier money laundering networks and, behind the veil of a private company, taken this network to a whole new level. In that same period, they recruited Lou Gerstner from American Express to run the more aggressive, more leveraged RJR. The lawsuits filed by the European Union against RJR allege that top management, including during the time Gerstner led the company as CEO, directed RJR’s illegal activities. When the European Union said “highest corporate level” and “officers and directors,” that meant Lou Gerstner – and through Gerstner and the board, the controlling shareholder, KKR.
Successful at RJR, Gerstner left to revitalize IBM and was then knighted by Queen Elizabeth. After retiring from IBM, Gerstner was chosen to chair the Carlyle Group in Washington in late 2002. The European Union’s lawsuit highlights Gerstner’s deeper qualifications to revitalize IBM, one of the most powerful military and intelligence contractors, and to lead an LBO firm like Carlyle that built its business on military and intelligence contractors and the intelligence to which such contractors are privy.[25]
Henry Kravis and George Roberts were two of the founders of KKR. Kravis’ father – successful in the Oklahoma oil and gas business – was reported to be a friend of the Bush family and had many close ties with Wall Street. Henry Kravis and his San Francisco cousin and partner, George Roberts were said to be generous supporters of the Bush campaign.
It was inconceivable to me that KKR could have won the RJR Nabisco bidding war despite lower bids without Vice President George H. W. Bush in the White House (having just won the election) and/or Nick Brady at Treasury exercising their invisible hand. Bush’s White House counsel, Harvard educated C. Boyden Gray (now partner at Wilmer Cutler) was heir to one of the many North Carolina RJR fortunes. When the bidding team led by Ross Johnson, then CEO of RJR Nabisco lost to KKR, I wondered, did Nick finally get Ross Johnson back for diluting Dillon Read’s RJR lead underwriting business after the merger with Nabisco in 1985?
When Nick Brady first got to Treasury, he was apparently slow to staff and organize his public affairs office. Before leaving Wall Street in April of 1989 to join the Bush Administration, I used to get calls from reporters looking for basic background, including his bio. One reporter asked me if I thought Brady was tough enough to survive in Washington’s treacherous waters. I responded that, “Yes, Brady did have a genteel manner. However, the world was littered with the bodies of the men and women who had underestimated Nick Brady.”
Chapter 6
A Parting of the Ways
There was an invisible spirit that crept through our lives on Wall Street in the 1980s. LBOs
were a part of it. I could never quite put my finger on what was wrong. It was as if there
was too much dirty money and, as it grew more and more powerful in invisible ways, the
way companies were financed, bought and sold grew progressively more out of control.
The common sense and humanity seemed to drain out, and as personal wealth of the
insiders grew, so did the lies. Part of what was happening within Dillon Read was the difference in styles between Nick Brady and John Birkelund. When Nick wanted me to do something, he would come and say something like: “Look, I need you to do this and stop doing that and I can’t tell you why. I just need you to be a good soldier and do it.” And his candor had a certain charm to it and so in the spirit of being a good soldier you would give up on some deal or idea you thought was going to be a moneymaker. For some reason, Birkelund did not feel comfortable taking this straightforward approach and so situations would get caught up in complex pretzels of office politics.
For example, when the Dillon Read partners sold the firm in 1986 to Travelers, three years after buying our stock back from Bechtel, Birkelund came to my office to ask me what I thought of the deal. I told Birkelund that it was a done deal and that my opinion as one of the newest partners was irrelevant. Birkelund insisted – he really wanted to know. I told him that I was disappointed that we were no longer owners and that I thought a large insurance company would not prove to be a good business fit. He exploded with rage and stomped out of the office. Minutes later, my husband Geoffrey – a successful Wall Street attorney – called to tell me that he had just had a call from Fritz Hobbs, one of the senior Dillon partners, saying that Birkelund told him that I had resigned from the firm and that he, Geoffrey, needed to exercise some control of his wife. I explained that I had not resigned. I then advised Geoffrey to call Fritz and persuade him that he had managed to get me under control, to assure him that I had not and had no intention of resigning and that he, Geoffrey, could be counted on to make sure that I supported the sale and the changes contemplated. Hence, my partners could look to my husband to manage me. I then spent several weeks collaborating with Geoffrey on the manipulation of me – which turned out to be a remarkably effective, though unorthodox, communication vehicle.
My back channel[26] was compromised several weeks later when Ken Schmidt, the head of Dillon’s municipal department who Birkelund had also assigned to “manage” me while I managed a large and profitable client and deal flow, broke down one night after several drinks and confessed that he and my other partners were using my husband to manipulate me. Perhaps he would not have felt as guilty if he realized where Geoffrey was accessing his strategies.
After the sale of Dillon to Travelers, we put together significant Travelers financial support for our LBO business. Birkelund called me to his office to ask me if I would take the lead on marketing our LBOs to bond buyers. This request caught me off guard, as I was confident that this was a role in which I would not be successful. I asked why he thought I was appropriate. He described my success at designing and marketing $4 billion of New York City transportation systems bonds. This was a deal that nine firms had said could not be done but that had gotten done quite successfully with Dillon Read’s leadership, making the first page of the New York Times and the financial press. I explained to John that I could sell deals that I had personally structured and which I believed to be sound credits because they were based on some fundamental wealth creating purpose that would ensure the bond buyers were paid back. However, a lot of the LBOs flowing through Wall Street were not based on sound financial engineering and involved companies that were of dubious value. I was terrific with Dillon’s investment clients when I believed in a credit. Unless I was personally confident in the investments long-term viability, I was not effective at selling it.
John thought I was being difficult and I was amazed that he could not understand that just as fish don’t fly, I did not have the ability to do a good job for the firm at this task. It was as if two parallel universes were trying to communicate and failed. One was looking to go with the flow of more and more government and corporate debt without thought for how future generations would pay back all this debt – what some of us called the debt bubble – because that was the way to win at the game of hot money profits. The other thought that money served a strategic purpose and that flipping people and companies like pancakes for quick profits was risky business.
Things came to a head when I arrived at the weekly banking meeting of the Dillon Read partners one morning in 1988 and listened to Steve Fenster, one of the partners who had joined us in 1987 from Lehman Brothers with an interim stint at Chase, make his presentation on why Dillon’s LBO group should take the second position behind First Boston in the Campeau hostile takeover of the Federated Department Stores.[27] During his presentation, Fenster, later a professor at the Harvard Business School, presented a “sources and uses of funds” statement. This is a statement that estimates where the money is coming from to buy the company and how it will be spent and in what amounts. Steve described a significant source of funds would come from “productivity improvements” – a portion of what was needed to fund the cost of hundreds of millions for golden parachutes for senior management and fees for lawyers and investment bankers.
The “productivity improvements” were the increased profits to be generated by middle management over many years – all without partaking of the hundreds of millions pork fest enjoyed up front by senior management and Wall Street. We would get rich and get out up front. The guys in the trenches would work like dogs for years for scraps if the deal were to work. I was stunned. I asked Steve why in the world middle management would stick around and spend years working to generate increased profits without adequate incentives. After all, these financials would be disclosed in SEC filings. The companies’ middle managers would read the proxy and could “walk with their feet.” This meant the company would fail.
If the company failed before we sold new bonds, the Travelers bridge line that we were using would lose millions. If it failed after we sold the bonds, our customers who bought the bonds would get left holding the bag. Fenster looked at me in disgust and said something to the effect of “we will be out in December,” meaning if the deal tanks it will be someone else’s problem. I responded “Steve, our bond buyers won’t be,” meaning that Dillon would be selling the securities to pension and mutual funds and other bond buyers who would then take what could be millions in losses. By this time, Brady had left for Washington and Birkelund was now in command of the firm. Birkelund was trying to build a fortune. Nick had one to protect. It struck me that the balance that the Brady Birkelund partnership had somehow managed to strike between playing to win in the hot money game and not putting Brady’s personal reputation at risk was gone. Dillon anticipated significant fees and Fenster and the partners around the table were hungry for the quick bucks of big year-end bonuses.
That was when I decided that we might be losing sight of the line between financial engineering and financial fraud. I left the boardroom and headed downstairs to make a call to Washington, D.C. There was nothing else to learn at Dillon Read. It was time to go – I was too much a member of the old school. Other firms had indicated an interest in recruiting me. However, I had promised Nick I would institutionalize my clients and not strip the business from the firm. The way to continue to do that was to join the incoming Bush Administration in Washington, D.C. The corruption was bad, a crash was coming and Washington would lead the clean up. Besides, the corruption was being engineered in part through Washington. I wanted to understand how the economy and markets really worked. It was long my dream to find ways that investors could profit from activities that increased human and environmental safety and wealth. I needed to understand how the federal government and credit worked.
When the Federated Department Stores declared bankruptcy on January 15, 1990 as a result of their takeover by Campeau using an unsound financial structure, Dillon Read, Travelers and Dillon’s bond buyers were left holding millions of badly discounted securities. By that time, I was Assistant Secretary of Housing-FHA Commissioner at HUD managing billions of defaulted mortgages and coordinating with the group at the Resolution Trust Corporation who were managing billions of defaulted savings and loan (S&L) mortgages. While Birkelund and Fenster were explaining the Campeau-Federated defaults to Travelers, I was learning why Oliver North allegedly referred to HUD as “the candy store of covert revenues.”[28] It took years of cleaning up the mortgage mess to understand that this homebuilding and mortgage fraud was an integral part of the National Security Council’s shenanigans during Iran-Contra and a U.S. federal debt that was growing at alarming rates.
Chapter 7
“HUD is a Sewer”
As Assistant Secretary for Housing-Federal Housing Commissioner, I was responsible for
the operations of the Federal Housing Administration (FHA), which was the largest
mortgage insurance fund in the world. FHA at that time had annual originations of $50-
100 billion of mortgage insurance and an outstanding portfolio of $320 billion of mortgage
insurance, mortgages and properties. Leading the FHA necessitated significant
understanding of how homes are built, how mortgages finance thousands of communities
throughout America and how investors finance the process by buying securities in pools
of mortgages. My responsibilities included the production and management of assisted
private housing; management of an organization of 7,000 employees in 80 offices
nationwide; and development of network information systems and tools. In addition, I
served as advisor to the Secretary of HUD on financial markets regulatory responsibilities,
including the RTC Oversight Board, Federal Housing Finance Board and Home Loan
Bank Board System, Fannie Mae and Freddie Mac.When I told Nick Brady in 1989 that I was going to work at HUD, he said, “You can’t go to HUD – HUD is a sewer.” While my experience as Assistant Secretary cleaning up significant mortgage fraud that lost the government billions during the 1980s confirmed that HUD’s financial reputation was deserved, leading the FHA provided invaluable insight into how government management of the economy one neighborhood at a time really harms communities. Hence, access to the “real deal” on real estate and the mortgage markets was an opportunity. If you want to see the real economy in a place, you absolutely want an accurate map of the financial flows in that system – starting with the land and real estate. My favorite description of HUD was to come many years later from staff to the Chairman of the Senate HUD appropriation subcommittee – Senator Kit Bond. When asked what was going on at HUD, the Congressional staffer said, “HUD is being run as a criminal enterprise.”[29]
Shortly after arriving at HUD in April 1989, I began to learn about the FHA Coinsurance program. Since 1984, HUD/FHA had allowed private mortgage bankers to issue federal credit to guarantee multi-family apartment projects. After issuing $9 billion in mortgage guarantees, HUD/FHA was to lose something approaching 50% of the value of the portfolio – a level of losses hard to explain with mortal logic. When my staff approached me with a proposal to bail out a mortgage company so they could continue to lose money for us, I asked why we should spend money to lose more money in a way that would harm communities. After a long silence during which 30 staff members intently studied their feet, one brave soul explained to me that the mortgage bank was owned and run by a major Republican donor. Shocked, I said. “I am a major Republican donor,” and pointing to my presidential cufflinks that were adorning my French cuffs, “I got a pair of cuff links. You get cuff links. You don’t get $400 million of federal credit to throw down the drain.” My staff looked at me like I was so naive and clueless that there was no point in trying to communicate with me – better to let me learn the hard way.
Within minutes, a screaming Jack Kemp, furious that I had not provided illegal subsidy to keep the mortgage banking company going (despite his orders to stop anything corrupt or illegal), called me on the carpet.[30] The problems were compounded by the opinion of HUD General Counsel Frank Keating, who had joined from DOJ, that we did not have to honor our contracts. Rather we could abrogate contracts and ignore the law. If those who had been harmed sued us, Frank said, by the time they won "we will be gone." Frank was to help write and pass new laws and administrative policies to use HUD as a source of War on Drugs activities and enforcement revenues. After many dirty tricks and much ranting and raving, HUD was to turn the defaulted coinsurance portfolio over to a private contractor named Ervin & Associates, a newly created company founded by John Ervin, a former employee of Harvard's HUD property management company, NHP.
In the process of cleaning up the coinsurance portfolio, I got a chance to learn more about some of the tax-exempt housing bond deals that involved FHA mortgage insurance. Examples of these deals were those done through one of the Connecticut state housing authorities by a Dillon Read banker, Jewelle Bickford, during the 1980s. Bickford had a lot of support from two of the largest future Dillon Read investors in Cornell Corrections – Ken Schmidt and Birkelund – which was hard for me to fathom. Bickford was one for shortcuts and what sounded to me like more than little white lies. Schmidt shared an intelligence background with Birkelund. He served with Air Force Intelligence early in his career as Birkelund had served in the Office of Naval Intelligence (ONI). When I later realized the role of the intelligence agencies in the HUD portfolio their comfort with HUD deals in Connecticut with high default rates seemed somehow more logical.
After Bickford’s housing bonds were embroiled in the coinsurance crash and burn, Jewelle somehow managed to get promoted up – landing at Birkelund’s old firm, Rothschild Inc. Which always made me wonder exactly whose bank accounts ended up with the $4 billion emptied out of the FHA mutual funds at HUD as a result of coinsurance, not to mention the billions more lost in the single family FHA programs. Over $2 billion was lost by FHA/HUD in the Texas region in fiscal 1989 alone. The Texas region had included Arkansas, where the state agency, ADFA was so bad they had been disqualified at one point according to the HUD Fort Worth regional leadership. It was this state agency that was alleged to have laundered the local profit share of the arms and drug trafficking channeled through Mena, Arkansas.[31]
For comparisons sake, $4 billion is about the amount of money that would buy you a controlling lead position in taking over one of the world’s premiere money laundering networks. When KKR raised the war chest in 1987 that gave them the wherewithal to bid and win RJR Nabisco, it amounted to $5.6 billion.
Money is like the Pillsbury Doughboy. When you squeeze down on one part, it pops up someplace else.
Wall Street Lessons:
Dillon Read’s James Forrestal
James Forrestal’s oil portrait always hung prominently in one of the private Dillon Read dining rooms for the eleven years that I worked at the firm. Forrestal, a highly regarded Dillon partner and President of the firm, had gone to Washington, D.C. in 1940 to lead the Navy during WWII and then played a critical role in creating the National Security Act of 1947. He then became Secretary of War (later termed Secretary of Defense) in September 1947 and served until March 28, 1949. Given the central banking-warfare investment model that rules our planet, it was appropriate that Dillon partners at various times lead both the Treasury Department and the Defense Department.
Shortly after resigning from government, Forrestal died falling out of a window of the Bethesda Naval Hospital outside of Washington, D.C. on May 22, 1949. There is some controversy around the official explanation of his death – ruled a suicide. Some insist he had a nervous breakdown. Some say that he was opposed to the creation of the state of Israel. Others say that he argued for transparency and accountability in government, and against the provisions instituted at this time to create a secret “black budget.”[32] He lost and was pretty upset about it – and the loss was a violent one. Since the professional killers who operate inside the Washington beltway have numerous techniques to get perfectly sane people to kill themselves, I am not sure it makes a big difference.
Approximately a month later, the CIA Act of 1949 was passed. The Act created the CIA and endowed it with the statutory authority that became one of the chief components of financing the “black” budget – the power to claw monies from other agencies for the benefit of secretly funding the intelligence communities and their corporate contractors. This was to turn out to be a devastating development for the forces of transparency, without which there can be no rule of law, free markets or democracy.
I studied Forrestal’s oil painting with his solemn stare during many a private lunch – each time reminded that government service was an important duty and honor in the Dillon tradition but it was a dangerous business. Congressional Committees had roughed up Clarence Dillon. Forestall had died. Douglas Dillon was Secretary of the Treasury when Kennedy was assassinated.
Because I wanted to understand how the world really worked, I listened carefully. Over years of private lunches and dinners and conversations I watched and listened to hundreds of lessons on how to be careful – the tricks of predator evasion in Wall Street and Washington. In the midst of many knowledgeable teachers, Forrestal’s leadership was a guiding light that was to serve me well in the years ahead.
Wall Street Lessons:
The Power of the People
Another thing I learned on Wall Street is the extent to which those who appear to have little material power can have significant power when they organize to do so. My rise to partnership at Dillon Read was fueled by a steady stream of intelligence from loyal secretaries, print shop personnel, drivers and staff whose generosity, street smarts and hard work was a constant reminder that the rise to Wall Street’s board rooms was not necessarily based on performance as opposed to privilege. One of the greatest challenges as an associate at Dillon Read was knowing where to invest our time when multiple partners were pressing us to give priorities to their projects. Hence, a heads up from someone’s secretary that they were trashing me in the year-end reviews was insider intelligence worth its weight in gold. Giving first priority to those who supported us in year-end reviews and compensation could be the difference between failure and success.
Right after I became a partner, I got a call from a personnel department director who was looking for a new secretary for me. The person who called said they were interviewing someone who has been with a Canadian Broadcasting office in New York for seventeen years. This was her first interview since they shut the office down. She was absolutely excellent and if we wanted to recruit her we needed to make her an offer right away. The personnel director said, “The only problem is that she is Jamaican (of African descent), but she is very light skinned.” I was stunned and said something to the effect of “Who cares?” The personnel person said, “If I sent a black person to be interviewed with most of the partners in this firm, I would be fired.” And so I hired Pat Phillips to work for me and was the beneficiary of her extraordinarily overqualified talent until her death twelve years later, by which time she was a Hamilton shareholder and Secretary of our board.
Many years later, after I had started my own investment bank in Washington, D.C., I got a call from a driver at one of the car services that we used to use when I was at Dillon. He said, “Are you doing a deal with Ken Schmidt?” I explained that, yes, I had proposed working together on a fairly large complex transaction. It would take a lot of work but if successful would be great business for both firms. The driver said, “He was in the car last night. He was bragging about how he was going to screw you. Here is what he is going to do.” This was the same Ken Schmidt who had confessed the Dillon partners conversations with my ex-husband. Ken was still blubbering indiscreetly about his bad deeds. And so the driver saved me from my mistake of attempting to partner with my old firm.
Chapter 8
Dillon’s Investment in Cornell
According to a later Harvard case study on Cornell’s facility,[34] David Cornell was pursuing the prison business while at Becon in partnership with Dillon Read – presumably the part of the firm that helps to create and sell the types of local government bonds that finance many prisons. When Becon decided not to pursue the prison business, Cornell decided to leave and start his own private prison company. With Bechtel out of the business, Cornell and Dillon then decided to use Brown & Root to construct the first prison. Brown & Root was a subsidiary of Halliburton, both based in Houston like Cornell Corrections.
According to Cornell’s filings with the SEC and other corporate reports, Dillon used funds from three of its venture funds, Concord, Concord II and Concord Japan to make these initial investments. Dillon Read’s April 1997 SEC filing described Concord and Concord II as limited partnerships organized under the laws of New York and Delaware.
To understand Dillon’s investments in Cornell it is essential to understand who governed Dillon Read, who at Dillon invested personally as well as who at Dillon along with outside directors helped to govern the Dillon venture funds that invested in Cornell. These are the people who are responsible for the investment decisions and who would have benefited in various forms.
As provided in Dillon’s Cornell SEC filings, Dillon, Read Holding Inc.,[35] Dillon, Read Inc.[36] and Dillon, Read & Co. Inc.[37] listed their officers and directors as including John P. Birkelund, David W. Niemiec, Franklin W. Hobbs, IV, Francois de Saint Phalle as well as senior leadership from Barings, the British bank that was now an investor in Dillon and ING, the Dutch financial conglomerate that acquired Barings when it failed in 1995.[38]
The presence of Barings in Dillon’s governance structure is noteworthy. Barings, the oldest merchant bank in England and said to be a financial leader in the 1800s China opium trade, collapsed in February 1995 as a result of a trading scandal in Asia and was taken over by ING. Barings became the lead outside investor in Dillon Read in late 1991, when they effectively financed Dillon’s management buying out Travelers. This was the same year that Dillon bankrolled Cornell Corrections. Barings’ difficulties in 1995 may have increased the pressure on Dillon to generate revenues, particularly before it was sold to Swiss Bank Corporation (now part of UBS) in the summer of 1997, changing its name to SBC Warburg Dillon Read.
In the April 1997 Dillon Cornell SEC filing, the Concord Japan venture fund invested in Cornell is described as a corporation organized under the laws of the Bahamas, whose principal office and business address was c/o Roy West Trust Corporation, (Bahamas) Limited, West Bay Street, Nassau, Bahamas. Hence, Concord and Concord II were “onshore” funds and Concord Japan was an “offshore” fund. The officers and directors of Concord Japan include representatives of some of the largest most prestigious Japanese corporations as well as Amerex SA, which listed its address as the Coutts Bank office in the Bahamas. Coutts is considered one of the most prestigious private banks in the world.[39]
In May 1991, Dillon invested additional funds from one of the Lexington Funds.[40] The Lexington Funds were created to invest money for Dillon officers and directors. Dillon then made additional investments with these various funds in September and November 1991. By the time of Cornell’s initial public offering of stock in October 1996, Dillon Read and the funds it managed and its officers and directors had accumulated approximately 44% of the outstanding common stock. This meant that they were the controlling shareholders.
Along the way, Dillon officers and directors had personally purchased significant shares of Cornell stock. Investors included Chairman John Birkelund, Vice Chairman Dave Niemiec who signed many of the documents on behalf of Dillon and Lexington, President and CEO Franklin “Fritz” W. Hobbs, IV as well as numerous other senior partners, including Ken Schmidt. Dillon officer Peter A. Liedel, who signed on behalf of Concord, had joined the board of Cornell. Cornell named one of its facilities after him – the Liedel Community Correctional Center, a pre-release facility in Houston.
Seven Largest Dillon Holders of Personal Positions in Cornell
SHAREHOLDER SHARES OPTIONS
INCLUDED AMOUNT
OF
FUNDSJOHN P. BIRKELUND 39,579 3,736 $96,990.16
JOHN H. F. HASKELL, JR. 36,730 3,505 $85,382.75
DAVID W. NIEMIEC 35,018 3,270 $76,989.51
FRANKLIN W. HOBBS, IV 30,455 2,803 $56,986.04
PETER FLANIGAN 28,178 2,687 $48,781.40
GEORGE A. WIEGERS 28,176 2,571 $44,988.85
KENNETH M. SCHMIDT 24,778 2,454 $35,622.38
Source: Cornell Corrections, Inc. April 1997 13-D Filing by Dillon Read. Note: For the full list of 32 Dillon officers with personal positions, click here. [41]
Total Estimated Dillon Investment in Cornell Corrections Stock [41.5]
SHAREHOLDER AMOUNT
OF FUNDS Concord (Est.) $630,000
Concord II $2,120,459.83
Concord Japan $338,734.26
Lexington III $70,000.65
Lexington IV $9,541.14
Dillon Read Officers and Directors $652,999.99
TOTAL (Est.) $3,821,736
Source: Cornell Corrections, Inc. October 1996 Prospectus and April 1997 13-D Filing by Dillon Read.
Dillon’s investments in Cornell represent an extraordinary firm-wide commitment to starting up one company. This was not a common occurrence, but as we will see, this was not the first time that Dillon Read had backed a Houston business involved in privatization in an extraordinary way. The decision for an officer and director to buy shares would have been an individual decision – whether they used their own funds or if the firm helped arrange credit or other funds for them to finance their purchases. Hence, this meant that a significant number of Dillon's leadership decided that investing was something they actively wanted to do and for which they chose to be financially and ethically liable. One can only wonder what the Dillon leadership had been led to believe about the future of the private prison business, let alone what it implied about the future of the country.
Chapter 9
Cornell Corrections
The U.S. Marshals Service is the oldest U.S. enforcement agency. Among other duties, the U.S. Marshals Service houses and transports prisoners prior to sentencing and provides protection for the federal court system. According to the Marshals Service’s website, they are also:
“Responsible for managing and disposing seized and forfeited properties acquired by criminals through illegal activities. Under the auspices of the Department of Justice Asset Forfeiture Program, the Marshals Service currently manages more than $964 million worth of property, and it promptly disposes of assets seized by all DOJ agencies. The goal of the program is to maximize the net return from seized property and then to use the property and proceeds for law enforcement purposes.”
An article by Jeff Gerth and Stephen Labaton in the New York Times in November 1995, “Prisons for Profit: A Special Report; Jail Business Shows Its Weaknesses” describes the problems that Cornell ran into with its Rhode Island facility. This facility had been financed with municipal bonds issued through the Rhode Island Port Authority in the summer of 1992 and underwritten by Dillon Read. The article states:
“Two years ago, the owners of the red cinder-block prison in this poor mill town threw a lavish party to celebrate the prison's opening and show off its computer monitoring system, its modern cells holding 300 beds and a newly hired cadre of guards. "But one important element was in short supply: Federal prisoners.
“It was more than an embarrassing detail. The new prison, the Donald W. Wyatt Detention Facility, is run by a private company and financed by investors. The Federal Government had agreed to pay the prison $83 a day for each prisoner it housed. Without a full complement of inmates, it could not hope to survive.
“So the prison's financial backers began a sweeping lobbying effort to divert inmates from other institutions. Rhode Island's political leaders pressed Vice President Al Gore while he was visiting the state as well as top officials at the Justice Department to send more prisoners. Facing angry bondholders and insolvency, the company, Cornell Corrections, also turned to a lawyer who was then brokering prisoners for privately run institutions in search of inmates.
“The lawyer, Richard Crane, has done legal work for private corrections companies and Government penal agencies. He put the Wyatt managers in touch with North Carolina officials. Soon afterward, 232 prisoners were moved to Rhode Island from North Carolina, and Mr. Crane was paid an undisclosed sum by Cornell Corrections.”
Cornell’s Donald C. Wyatt facility later became a case study at the Harvard Design School’s Center for Design Informatics. This was an indication of the wave of business and investment opportunities that prisons and enforcement presented to everyone from architects to construction companies to real estate and tax-exempt bond investors.[42] Harvard’s case study mentions that Cornell arranged for the facility to be constructed by Brown & Root of Houston, Texas, a subsidiary of Halliburton. (Brown & Root is now known as KBR and remains a subsidiary of Halliburton.) Brown & Root/KBR’s construction of prison facilities was to become more visible many years later after its construction of detention facilities at Guantanamo Bay, prisoner of war camps in Iraq and its winning of contracts to build detention centers for the Department of Homeland Security. A request to Cornell for information regarding companies used for prison construction subsequent to the Wyatt facility has been made, but no response has yet been received.
Dillon Read had long standing relationships with Brown & Root and the Houston banking and business leadership as a result of the firm's historical role in underwriting oil and gas companies, including pipelines. In 1947, Herman and George Brown, the founders and owners of Brown & Root, were part of a group of Texas businessmen banked by Dillon Read as investor and underwriter (in a manner very similar to Dillon's backing of Houston-based Cornell many years later) to form the Texas Eastern Transmission Co. to buy the "Big Inch" and "Little Big Inch" pipelines in a privatization by the U.S. government.
The Texas Eastern pipelines were critical to bringing natural gas from Texas and the Southwest to Eastern markets. For most Americans, Houston and New York seem far apart. However, the intimacy of their connection is better understood when you study the investment syndicates that controlled the railroad, canals, pipelines and other transportation systems that have connected these markets and helped to determine control of the local retail businesses for both goods and capital along the way. For example, Texas Eastern’s Big Inch pipeline went from east Texas to Linden, New Jersey, some 30 miles away from the Dillon and Brady estates in New Jersey and approximately 20 miles from the Dillon Read offices on Wall Street.
According to investigative journalist Dan Briody in The Halliburton Agenda: The Politics of Oil and Money, the Brown brothers netted $2.7 million in profits on their shares in their initial public offering right after the company was formed and won the bid to buy the pipelines from the government in the late 1940’s. That, however, was not the real payoff. According to Briody, Brown & Root subsequently worked on 88 different jobs for Texas Eastern, and generated revenues of $1.3 billion from Texas Eastern between 1947 and 1984. [42.1]
According to Robert Sobel in The Life and Times of Dillon Read, under August Belmont's personal leadership of the transaction, Dillon Read also made a profit on the Texas Eastern shares. "Nothing is known of Dillon Read's profits on the underwriting, but it was a sizeable owner of TETCO [Texas Eastern] common, acquired at 14 cents a share, which rose to $9.50." [42.2] While figures for Dillon Read revenues from underwriting and other investment banking services over the years comparable to Brown & Root's construction contracts are not available, my recollection was that Dillon continued to maintain a profitable relationship with Texas Eastern when I worked at the firm in the 1980s many decades later. Interestingly enough, Briody also describes in detail the McCarthyist efforts that were made to destroy Federal Power Commission chairman Leland Olds, an honest government official, because his ethical regulatory decisions threatened the richness of the Texas Eastern profits. The clear implication is that the pattern of generating financial windfalls from government privatizations combined with dirty tricks against honest government officials is nothing new. [42.3]
The closeness of the Brown & Root relationship with Dillon Read is also underscored by Briody’s description of the head of Brown & Root’s frustration with Lyndon Johnson's decision to serve as John Kennedy's running mate. He quotes August Belmont, by then a leader of Dillon Read, who was with Brown in Houston in his private hotel suite listening to the radio coverage of Johnson's announcement. According to Belmont, "Herman Brown.... jumped up from his seat and said, ‘Who told him he could do that?’ and ran out of the room." [42.4]
What Briody does not mention is allegations regarding Brown & Root's involvement in narcotics trafficking. Former LAPD narcotics investigator Mike Ruppert once described his break up with fiancé Teddy – an agent dealing narcotics and weapons for the CIA while working with Brown & Root, as follows:
“Arriving in New Orleans in early July, 1977 I found her living in an apartment across the river in Gretna. Equipped with scrambler phones, night vision devices and working from sealed communiqués delivered by naval and air force personnel from nearby Belle Chasse Naval Air Station, Teddy was involved in something truly ugly. She was arranging for large quantities of weapons to be loaded onto ships leaving for Iran. At the same time she was working with Mafia associates of New Orleans Mafia boss Carlos Marcello to coordinate the movement of service boats that were bringing large quantities of heroin into the city. The boats arrived at Marcello controlled docks, unmolested by even the New Orleans police she introduced me to, along with divers, military men, former Green Berets and CIA personnel.
“The service boats were retrieving the heroin from oil rigs in the Gulf of Mexico, oil rigs in international waters, oil rigs built and serviced by Brown and Root. The guns that Teddy monitored, apparently Vietnam era surplus AK 47s and M16s, were being loaded onto ships also owned or leased by Brown and Root. And more than once during the eight days I spent in New Orleans I met and ate at restaurants with Brown and Root employees who were boarding those ships and leaving for Iran within days. Once, while leaving a bar and apparently having asked the wrong question, I was shot at in an attempt to scare me off.”[43] Source: “Halliburton’s Brown and Root is One of the Major Components of the Bush/Cheney Drug Empire” by Michael Ruppert, From the Wilderness
Another important relationship for the Houston-based Cornell Corrections was the California Department of Corrections. Whether this reflected that California was home base for David Cornell’s former employer, Bechtel, is not clear. When Cornell Corrections got started, California had the largest prison population of any U.S. governmental entity. In part due to extraordinary growth in incarcerations of non-violent drug users as a result of the War on Drugs, the federal prison population managed by the Federal Bureau of Prisons at the Department of Justice has become the largest with 186,560 based on their September 8, 2005 weekly update.[44] California is close behind with 168,000 youths and adults incarcerated in California prisons and 116,000 subject to parole.
Cornell’s early years of business were not financially profitable. The private prison industry faced significant resistance and legal and operational challenges to privatizing federal, state and local prison capacity. Within the private prison industry, Cornell faced competition for new contracts and acquisitions from two larger, more experienced companies, CCA and Wackenhut. By 1995, compared to industry leaders, Florida-based Wackenhut and Tennessee based Corrections Corporation of America (CCA), Cornell Corrections appeared to be lagging in government contract growth. As of mid 1996, Cornell was carrying $8 million of cumulative losses on its balance sheet.
Cornell’s Chief Financial Officer, Treasurer and Secretary was Steven W. Logan, who had served as an experienced manager in Arthur Anderson’s Houston office. This was the same office of Arthur Anderson that had served as Enron’s auditor until the Enron bankruptcy brought about the indictment and conviction of Arthur Andersen.[45] Arthur Andersen was Cornell’s auditor, having first served as a consultant to create market studies which helped support the approvals for and financing of the building of the Rhode Island facility for the U.S. Marshals Service. Logan was later forced out of Cornell after an off balance sheet deal[46]engineered with the help of a former Dillon Read banker Joseph H. Torrence, like those done for Enron was called into question and significant stock value declines triggered litigation from shareholders.
Cornell’s Reported Revenues and Net Income for 1992-1996
1992 1993 1994 1995 1996 Revenues $2.5MM $3.2MM $15.7MM $20.6MM $32.3MM
Net Income (Loss) .9 (.9) (.6) (1.0) (2.4)
Beds in Operation - 282 1,155 1,135 2,899
(MM = In millions)
Source: Cornell Corrections, Inc., Selected Consolidated Financial Data, Form 10-K For Fiscal Year Ended 1996
Most venture capital investors prefer to exit their investment within 5 years. That means that Dillon Read would have likely wanted to establish or start their exit from Cornell by 1996. The stock market was hungry for Initial Pubic Offerings (IPOs) where a new company sells its stock to the public for the first time. Venture capitalists typically make their profit from financing a company and then selling their equity when a public market has been established for the company’s stock. However, by the end of 1995, Cornell’s story was not an exciting one. It was not a market leader, its growth was slow and it had no profits. If the calf was going to be taken to market, it would need fattening.
A Note on “Prison Pop”
The “pop” is a word I learned on Wall Street to describe the multiple of income at which a stock is valued by the stock market. So if a stock like Cornell Corrections trades at 15 times it's income, that means for every $1 million of net income it makes, it's stock goes up $15 million. The company may make $1 million, but its “pop” is $15 million. Folks make money in the stock market from the stock going up. On Wall Street, it's all about “pop.”
Prison stocks also are valued on a “per bed” basis – which is based on the number of beds provided and the profit per bed. “Per bed” is really a euphemism for people who are sentenced to be housed in their prison.
For example, in 1996, when Cornell went public, based on the financial information provided in the offering document provided to investors, its stock was valued at $24,241 per bed. This means that for every contract Cornell got to house one prisoner, at that time, their stock went up in value by an average of $24,261. According to prevailing business school philosophy, this is the stock market’s current present value of the future flow of profit flows generated through the management of each prisoner. This, for example, is why longer mandatory sentences are worth so much to private prison stocks. A prisoner in jail for twenty years has a twenty-year cash flow associated with his incarceration, as opposed to one with a shorter sentence or one eligible for an early parole.[47] This means that we have created a significant number of private interests – investment firms, banks, attorneys, auditors, architects, construction firms, real estate developers, bankers, academics, investors among them – who have a vested interest in increasing the prison population and keeping people behind bars as long as possible.
When you invest in stock, you make money if and when you sell the stock at a higher price than you paid for it. This would be true for the people who invested in Cornell stock, including Dillon Read and its venture funds. Cornell was run by a board of directors that represented the shareholders, particularly the controlling shareholders – in this case Dillon Read. The board is the group of people who decides what goes. Senior management officials, such as the founder and Chairman David Cornell, who run the company day to day, are also on the board. Most of the money they make comes from stock options that they get to encourage them to get the stock to go up for the investors. That means that what everyone who runs the company wants is for the stock to go up.
There are two ways to make the stock go up. First, you can increase net income by increasing capacity – the number of “beds” – or profitability – “profits per bed.” Second, you can increase the multiple at which the stock trades by increasing the markets’ expectations of how many beds or what your profit per bed will be and by being very accessible to the widest group of investors. So, for example, passing laws regarding mandatory sentencing or other rules that will increase the needs for prison capacity can increase the value of private prison company stock without those companies getting additional contracts or business. The passage of – or anticipation of – a law that will increase the demand for private prisons is a “stock play” in and of itself.
The winner in the global corporate game is the guy who has the most income running through the highest multiple stocks. He is the winning “pop player.” Like the guy who wins at monopoly because he buys up all the properties on the board, he can buy up the other companies. So the private prison company that wins is the one that gets the most contracts that guarantee it the most prisons and prisoners that generate the most income for the longest period with the smallest amount of risk.
The way that Cornell could become a winner quickly was to get lots of government contracts to house lots of prisoners and acquire other companies with government contracts to house lots of prisoners and do it quickly.[48] And that was exactly what happened.
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The Clinton Administration: 32s
Progressives for For-Profit Prisons
extensive footnotes 1-48 found here starting at page 94...https://www.dunwalke.com/resources/documents/DillonRead_1.112506as.pdf
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