THE DREXEL SETTLEMENT : Shad Brings Strong Belief in Ethics and in the Free Market

NEW YORK —  John S. R. Shad, who agreed Thursday to become chairman of Drexel Burnham Lambert’s holding company, is a former Securities and Exchange Commission chairman known for strong convictions on ethics and free-market economics.

During an SEC chairmanship that lasted between 1981 and 1987, the long-time E. F. Hutton investment banker presided over the agency’s most far-ranging investigation of Wall Street corruption. He was personally shocked at the lawbreaking, friends say, and in 1987 pledged $30 million--most of his fortune--to set up a business ethics program at Harvard University.

Yet Shad, 65, remains staunchly convinced of the investment world’s basic honesty, and told business school students in a speech earlier this year that while “Wall Street has long been a favorite target, Wall Street’s ethics compare favorably with other professions and occupations.”

Shad’s appointment came as Drexel agreed to settle SEC securities fraud charges under terms that will require much closer supervision of its activities.

In an interview, the recently retired ambassador to the Netherlands said he was taking the job because it was “a challenge,” and because he has been encouraged to do so by “many members of the business and financial community.”

In addition, he said, SEC Chairman David S. Ruder called him Wednesday to say he was pleased about the appointment. Shad noted that Rudolph W. Giuliani, who recently resigned as federal prosecutor for Manhattan, also urged him to take the job.

“The bulk of my future and present wealth is dedicated to charitable activities,” Shad said. The most important of those, he said, is the Harvard business ethics program.

Hasn’t Made Judgment

Shad declined comment on whether Drexel requires a change in its corporate culture. “These recent problems indicate they’ve got to have a much more effective legal and compliance effort,” Shad said. “They’re committed to that.”

“You have a few individuals who have been charged,” he added, “and until they’ve have their day in court you don’t know if there’s any truth to the allegations.”

Shad said the job of directing Drexel’s day-to-day operations will remain in the hands of Chief Executive Fred Joseph. But Shad said he will be involved in a broad range of issues, including not only securities compliance, but such matters as management succession, and long-term strategy.

He said he believes that Joseph will remain chief executive “for the long haul.”

The former SEC chairman said he will be paid by “conventional scale. I’m not doing this for the purpose of putting money in my own pocket.” He declined to disclose the terms of his salary agreement.

Shad will be chairman of the holding company’s oversight committee, as well as chairman of the parent firm. He will not, however, be chairman of Drexel Burnham Lambert Inc., the securities broker-dealer subsidiary.

A New York resident, Shad is a 1947 graduate of University of Southern California. He received an MBA from Harvard in 1949 and a law degree from New York University in 1959.

Backed Smaller Firms

During 32 years on Wall Street, the son of a Brigham City, Utah, launderer worked as stock analyst, broker and investment banker. He made his name in the corporate finance department of Hutton, where, in 1963, he gave Joseph his first Wall Street job.

Shad made his mark in corporate finance by taking risks on small- and medium-sized companies that were less worthy of credit that big blue chip companies. In that respect, his activities were like those that have brought Drexel to the first ranks of Wall Street investment houses.

Joseph and Shad were friends, and in 1970, Joseph supported Shad in his unsuccessful bid to become Hutton chairman. Later, Shad took the job of vice chairman.

Shad’s tenure as SEC chairman was the longest of any official to hold that post. In 1984, he spoke out publicly about his concern that American companies were dangerously burdening themselves with debt.

But despite that view, Shad resisted years of pressure to regulate tender offers and the use of high-yield “junk bonds” of the kind that Drexel brought to popularity.

Streamlined Rules

“He was one of the first to sound the alarm bell on debt, yet he had tremendous faith in the markets to function without government intervention,” said Gregg Jarrell, who was chief SEC economist under Shad.

Deregulation was the byword of Shad’s tenure. He presided over introduction of such reforms as the “shelf registration,” a streamlining reform that allows corporations to issue securities several times after receiving SEC approval only once.

He resisted efforts to increase the SEC’s budget over the years, which critics asserted kept the SEC from doing a thorough job of regulation. Some also found fault with Shad for failing to extend regulation of government securities markets after the failure of such firms as EMS Government Securities in 1985 lost millions of dollars for investors.

“That can be laid at his door,” said Richard S. Phillips, a Washington securities lawyer active in regulatory issues who has disagreed several times with Shad. “But it’s irrelevant to this job, where I think he will be as good a choice as anyone I know.”

KEY POINTS OF THE AGREEMENT As part of its settlement of civil charges filed by the Securities and Exchange Commission last September, Drexel Burnham Lambert will:

Pay $15 million in civil penalties, an amount already accounted for under the total of $650 million in penalties that Drexel has agreed to pay to settle criminal charges.

Appoint a new chairman of the firm, John S. R. Shad, former chairman of the SEC.

Appoint three new directors: Shad; Roderick Hills, chairman of Manchester Group Ltd. and former SEC chairman, and Ralph Saul, a former president of the American Stock Exchange and former chairman of Cigna Corp., now chairman of Peers & Co.

Appoint an oversight committee of outside directors to monitor internal functions of the firm.

Make other managerial changes, including the appointment of William Hughes Mulligan, a lawyer and former federal appeals judge, as ombudsman. Drexel will also name a new general counsel and a new senior trading official. And it will appoint a member of its executive committee who is acceptable to the SEC to live in the Los Angeles area and supervise the firm’s high-yield or “junk bond” operation in Beverly Hills.

Move to New York the equity and convertible securities trading functions associated with the Beverly Hills junk bond department.

Strengthen its legal and compliance departments, including placing at least three compliance officers in the junk bond department.

Establish a new Capital Markets Services Department as a way of tightening control on sensitive information that could be used in insider trading.

Agree to be placed on administrative probation for three years, meaning the SEC will give the firm’s operations special scrutiny during that period.

No longer employ Michael Milken and place any other indicted employee on a leave of absence. Drexel also agrees not to be involved with Milken in any business transactions in the future.

Appoint an independent consultant to review and make recommendations on improving Drexel’s policies and procedures. The consultant will complete a report within eight to 12 months and will monitor the firm to see that recommendations are being carried out. Drexel will also retain an outside accounting firm and a “special reviewer” to study the firm’s activities.

Require employees to sign an agreement acknowledging that they may be disciplined if they refuse to cooperate with government investigators.