TRHE DREXEL CASE : Toughest Quarry : Prosecution Faces a Tough Time in Getting Milken to Cooperate

Federal prosecutors face an uphill fight in the next phase of their massive Wall Street investigation--persuading Michael Milken to plead guilty and implicate some big-name clients of Drexel Burnham Lambert.

Sources close to the investigation said Friday that the U.S. Attorney’s Office in Manhattan and the Securities and Exchange Commission are both pursuing information concerning possible securities violations involving some Drexel clients.

The information has been developed by the government through interviews with key Drexel employees, who have begun to cooperate since receiving immunity from prosecution. The cooperation is a recent development, which has allowed the government to broaden its investigation.

Milken’s assistance in corroborating the information could be central to cementing cases against some of his clients, according to the sources. But the odds against securing the cooperation of the “junk bond” king appear to be high.

“There have been no conversations between his lawyers and prosecutors about settlement,” said one person close to Milken. “He is not interested. He says he is innocent. He believes he is innocent.”

Drexel, the New York securities firm Rudolph W. Giuliani

that employs Milken in its Beverly Hills office, maintained a similar posture for months in the face of the government inquiry. But the firm reversed its stance Wednesday and agreed in principle to plead guilty to six felonies and pay a record $650 million in penalties.

A Drexel official said the firm has opened negotiations with the SEC in Washington to settle the civil lawsuit brought against it in September. Central issues concern whether the firm will retain its various brokerage licenses despite admitting to felonies and what limitations the SEC might impose on its operations, such as requiring tighter supervision of the firm’s junk bond operations or restrictions on its mergers and acquisitions business.

Another touchy issue is whether the SEC will insist on pressing “failure to supervise” charges against top executives. A formal finding that the executives did not control employees adequately could carry penalties as strong as requiring the officials to leave the firm.

If Drexel fails to reach an agreement with the SEC, its deal is off with Rudolph W. Giuliani, the U.S. attorney in Manhattan. The company official said that, while important issues are unresolved, Giuliani has agreed to intercede with SEC officials to help reach a compromise.

Drexel had clear financial motivations for agreeing to plead guilty and avoid a trial. Prosecutors were certain to indict the firm on racketeering charges, which could have severely damaged the nation’s fifth-largest securities firm even before a trial. Offering Drexel the chance to avoid those charges was a strong bargaining chip for the government.

With Milken, defense attorneys say, the prosecutors have less bargaining power because they probably could not allow Milken to avoid jail or remain in the securities business.

“They can’t let him off with less than Boesky got,” said a former high-ranking prosecutor in Giuliani’s office now in private practice, referring to the three-year prison term, $100 million in penalties and lifetime ban on participating in the securities business meted out to stock speculator Ivan F. Boesky when he pleaded guilty to one felony count and implicated others, including Milken.

The attorney also questioned the value of what Milken could offer the government, saying: “Milken is going to be the high-water mark. Who could he implicate who would be bigger?”

A defense lawyer involved in the current case said the government is definitely pursuing information about Drexel clients and could agree to reduce expected fines against Milken in exchange for his cooperation. But he agreed that it is highly unlikely that the government would allow Milken to avoid prison altogether.

Nonetheless, prosecutors are expected to try to increase pressure on Milken to cooperate as his expected indictment approaches. It is not known whether the government has set a deadline for a decision by Milken, but one possible date would be around Jan. 10.

That is reportedly when Drexel must reach the settlement with the SEC that would finalize the firm’s plea bargain with the prosecutors. The reasoning is that, if Drexel fails to settle, the firm could be indicted along with Milken shortly after the deadline expires.

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Details of Drexel’s agreement with Giuliani’s office have not been disclosed yet, but a Milken associate said it requires the firm to cooperate extensively against both clients and its own employees.

A former prosecutor who works at a rival securities firm in New York, however, said there are questions about how much more cooperative Drexel could be. The firm has already provided thousands of documents to the government.

The key to its cooperation, the attorney speculated, would be requiring employees to testify. The firm’s leverage would be firing employees who refused to cooperate and refusing to pay for their lawyers.

Douglas Frantz reported from Los Angeles and Scot J. Paltrow from New York