(FORTUNE Magazine) – QUESTION NO. 1 on Wall Street these days is who's next. Which multimillion- dollar-a-year investment banker will be marched out of his office by U.S. marshals to face charges of trading on inside information? Question No. 2, up Broad Street and down Pine, is when will the feds finally unveil their charges -- if any -- against Drexel Burnham Lambert. Just about everyone in the securities business assumes that the government's biggest case will be against Drexel, the renegade investment banking firm that created the junk bond market and the junk bond takeover. Drexel Burnham has been involved, sometimes as a participant as well as a banker, in some of the most sensational and controversial takeover battles. It also has ties to all three of the crooks whose revelations have rocked the financial world and confirmed suspicions that the sharpies in lower Manhattan had somehow rigged the takeover game in their favor. Dennis Levine, the first to fall, had landed at Drexel as a merger specialist when he was nabbed for insider trading there and at previous employers. Ivan Boesky, the arbitrager who paid $100 million for his sins, raised $660 million through Drexel to invest in takeover plays and got some of his inside information from Levine. And Martin Siegel, the canary who fingered top executives at Kidder Peabody and Goldman Sachs, was co-head of Drexel's mergers and acquisitions department (though the crimes he has admitted all occurred while he worked for Kidder Peabody). The Securities and Exchange Commission may never bring charges against Drexel, but not for want of trying. Investigators have subpoenaed records of Drexel merger and takeover deals, and they keep on asking for more. If the commission does make a case, it quite likely will go beyond insider trading and could be the most significant in what already is the biggest financial scandal since the 1920s. The SEC may even use charges to write new rules about the ways investment bankers compete for business and what they can do to help clients in takeover fights. If so, the rough-and-tumble tactics that raised Drexel from a second-rate investment house to the pinnacle of power in less than a decade could bring it back down even faster. The SEC is curious about such things as $5.3 million that Boesky paid to Drexel a year ago. Drexel executives have said the payment was perfectly innocent: Boesky, hoping to graduate from arbitrager to raider, hired the firm to investigate takeover targets. Investigators also are focusing closely on Drexel's junk bond operation and the elusive Michael Milken, 40, who rules it from a trading room just off Rodeo Drive in Beverly Hills. Question No. 3: Will the feds get Milken? The SEC is pursuing suspicions that Milken and some of the raiders he serves gained unfair advantages in takeover fights by violating requirements to disclose their holdings and intentions. DREXEL also is battling on a second front. In mid-February, Staley Continental, a Chicago food processor, filed a $220-million lawsuit charging Drexel with extortion. Staley's management claims that Drexel bankers tried to coerce it into mounting a Drexel-backed leveraged buyout of the company last November. Interviews with over 40 high-ranking Drexel officials strongly suggest that even if the government finds no clear violations of law, it may find plenty to which it objects. Securities law, much of it written in the 1930s, is often ambiguous and leaves open vast gray areas. Drexel, whose business strategy depends on constant innovation, ventured deeper than most institutions into the gray, marking paths that others followed. The firm often represents clients on both sides of a deal. Not long ago most investment bankers considered that an unethical conflict of interest even if the clients did not object. Drexel's don't. Drexel and its executives also have substantial, and highly profitable, interests in many of the companies they represent. Unavoidably, investment bankers are imbued with inside information about their clients. Some Drexel bankers also violated internal prohibitions on using strong-arm tactics to get business, suggesting that the firm couldn't control the employees it trusted to do multimillion-dollar transactions. Those practices are not unique to Drexel, and none appears to violate the law. But some Drexel executives fear the SEC may try to pressure the firm into signing a consent decree that would effectively make some of the practices illegal. Says Drexel Vice Chairman James Balog: ''There could be a censure. There could be an extension of administrative law.'' In a consent decree the SEC charges that a firm's behavior has violated securities laws. The firm neither admits nor denies breaking the law, but vows not to do what the SEC says it did in the future. The commission often uses consent decrees to put previously permissible behavior off limits without action by Congress and without getting its interpretation of existing statutes seconded by the courts. ''So far there is no smoking gun,'' says Frederick H. Joseph, 49, Drexel's engaging and articulate chief executive. But Joseph, a model of relaxed self- assurance who likes to sit with one leg hooked over the arm of a chair, plainly is anxious. ''I'd allow as how we've been among the most aggressive firms,'' he notes. ''Maybe the most aggressive. In this business we have to make all kinds of judgment calls. We spend millions of dollars a year on lawyers who look at what we are doing. I don't deny we break new ground. Normally that's considered creative. Now, when it's under a microscope, I'm worried about it.'' Drexel clearly is a champion innovator, but the same forces that fired its creativity also fostered an ethos that now has the firm in jeopardy. A decade ago the firm was a junior leaguer that felt its survival was threatened by its exclusion from the club of white-shoe investment banks that dominated the underwriting business. Its status as an outsider was the grain of sand around which gradually formed the pearl of Drexel's identity, its strategy, and its ) posture toward the world. Says a Drexel managing director, who does not mean to imply anything improper: ''When you're not in the club, you don't feel bound by its rules.'' The two most responsible for Drexel's rise were Fred Joseph and Mike Milken. Joseph, whose father drove a taxi, grew up a scrapper in the tough Roxbury section of Boston and graduated from Harvard (where he read Shakespeare and fought on the boxing team) and the Harvard Business School. He was hired for his first investment banking job by his current nemesis -- SEC Chairman John Shad, then an E.F. Hutton executive. Recalls Shad: ''He demonstrated excellent judgment.'' In 1974 Joseph became head of Drexel's dinky corporate finance department. Milken, the bewigged son of a California accountant, was toiling in Drexel's bond department, analyzing ''fallen angels,'' companies whose credit ratings had slipped below investment grade. All junk bonds were fallen angels until the invention of original-issue junk in 1977. The novel idea, not Milken's, was to sell bonds acknowledged from the start as especially risky, enticing investors with higher yields than they could get on investment-grade securities. The white-shoe firms made a few discouraging attempts to sell original-issue junk and then abandoned the business, deeming it unworthy of their attention. Milken and Joseph saw opportunity. SEIZING IT required unusual collaboration between corporate finance and trading. Drexel, like all investment banks, has a ''Chinese wall'' separating those departments to prevent inside information about clients, especially ones engaged in mergers and acquisitions, from slipping from the underwriters to the traders. But the junk bond market was wafer thin in the 1970s, and designing newly issued ones required a trader's intimate knowledge of what buyers wanted. Sharing respect and remarkably similar views, Joseph and Milken began operating as close partners and quickly established a virtual monopoly of what Drexel calls high-yield bonds. Milken's team had -- and still has -- the best trading operation in the market, so junk bond investors flocked to them. Companies wanting to issue junk flocked as well in order to reach Milken's buyers. So even when the market was small, it was big business for Drexel. The junk market began to expand geometrically in 1981 when Leon Black -- now 35 and co-head of Drexel's mergers and acquisitions department -- conceived the idea of using Drexel's junk network to finance leveraged . buyouts. Suddenly Drexel was a major dealmaker. Then the firm hit on a truly revolutionary inspiration: the junk bond takeover. A raider with relatively little cash could make runs at corporate giants with the money Milken raised from his junk investors -- or simply with promises to put up the money. The takeover fraternity flocked to Drexel, and by 1985 it became the most influential, and most feared, investment bank. AS DREXEL'S dealmaking grew, so did the dangers in that Joseph-Milken partnership. Most questions being asked about Drexel now involve practices that rose out of that close kinship between corporate finance and trading. Since Milken knows the junk market like no one else, has a close circle of investors who buy almost anything he suggests, and is known as a brilliant strategist, companies selling junk bonds to finance takeovers want to deal with him. Which means that Milken, the firm's most active trader, also plays a major role in its corporate finance and takeover business. With such phenomenal sums at stake in Drexel's takeover deals, how strong is the Chinese wall that bisects Mike Milken? He and his band of junk salesmen may turn out to be impeccably honest, but Milken's dual role raises unavoidable suspicions. With the enormous fees flowing in from its LBOs and takeovers, the firm began paying salaries and bonuses that seemed lavish even by investment banking standards. By FORTUNE's estimate Drexel paid its 10,000 employees roughly $1.7 billion last year, which works out to an average of $170,000 per person, including mail clerks. The firm's domination of the junk market -- Drexel underwrote 68% of the newly issued high-yield, low-quality bonds two years ago and 45% in 1986 -- gave Milken unprecedented power. As early as 1978 he had won enough clout in the firm to move the junk bond operation from New York to his native California. Until a few years ago junk bonds produced most of the firm's profits. Joseph says Milken's operation now generates only a fifth of Drexel's net income (an estimated $550 million last year). But Milken also is a crucial player in Drexel's investment banking activities, so his true contribution -- and influence -- remains much larger. John Kissick, 45, head of the firm's California corporate finance arm, guesses that more than half the investment banking business is from clients that have issued junk bonds through Drexel. According to internal figures FORTUNE has seen, Drexel credited its corporate finance department with net income of $260 million in 1985 (Joseph says the figure is inflated). Since dealmakers broke records in 1986, corporate finance profits certainly were higher last year, perhaps more than half of total profits. Milken also has remarkable influence over junk bond investors and issuers, some of whom have done fabulously by following his advice. Indeed, Milken is one of the most powerful financiers in U.S. history. One manifestation of that power is his ability to summon chief executives of major companies to 5 A.M. meetings at his home. Another is the feeling some institutional investors have that if they refuse too many Drexel bond offerings, they won't get a shot at the best deals. Says the president of a mutual fund company that holds nearly $1 billion of junk: ''There's a subtle pressure. If you reject a lot of their issues, you won't be their first call on a really good one.'' Some Milken underwriting clients also are big buyers of Milken junk bonds. Drexel encourages other issuers to raise more money than they need and invest some of the surplus in junk. G. Chris Andersen, a top Drexel banker, estimates the firm raised $2 billion of such ''overfunding'' last year. ''One thing we know for sure,'' he says, ''is that companies don't go broke with too much cash.'' Carolco Pictures, which will produce Sylvester Stallone's Rambo III, took an extra $5 million that it raised through Drexel and invested it in Memorex bonds Drexel also underwrote. Carolco President Peter Hoffman is a friend of Milken's brother, Lowell, who also works in Drexel's high-yield operation. ''No one analyzes the credits that closely,'' says Hoffman. ''You trust the Milkens to know what they're doing.'' Michael Milken's tangled dealings with junk bond investors, issuers, and issuer-investors create inherent conflicts that only a Solomon could fairly resolve. One knowledgeable critic is Julian Schroeder, a key member of Drexel's corporate finance group for ten years. Schroeder left Drexel -- Joseph says he was sorry to lose him -- in 1985 to launch an unsuccessful congressional campaign and now works as an independent financial consultant. Says he: ''The basic problem with the firm was that Mike was and probably still is largely running his own operation. No one told him what he could and could not do. Fred ((Joseph)) did everything he could to guide and push Mike in a constructive direction and curb some of his overly aggressive tendencies, but even Fred was limited. That has certainly contributed to the overly aggressive atmosphere that the SEC is looking into.'' JOSEPH DISAGREES: ''Mike looks like Darth Vader because he never talks to the press, but he is not the monster people wish he were.'' Joseph is proud of Drexel's informal management style, which he credits with keeping the firm's entrepreneurial spirit alive. He says he confers with Milken by phone roughly twice a day and that Milken is too reasonable to insist on doing anything with which Joseph resolutely takes issue. The boss adds that Milken is not as autonomous as outsiders believe. He reports to Edwin Kantor, 54, Drexel's shrewd head of trading. And Joseph says all but the most ordinary offerings must pass muster in two committees. One, concerned with credit quality, is chaired by Stephen Weinroth, a corporate finance veteran who is clearly committed to avoiding underwriting junk bonds that would be too risky. ''We can't afford to kill the golden goose,'' he says. The other committee, under Kantor, evaluates each deal's marketability. Joseph says Milken sometimes disagrees with the committees and doesn't always prevail. The rest of Drexel's employees also are supposed to follow the rules, but penalties for violating them seem dangerously mild. A paternalistic believer in what he terms ''fixing people'' rather than firing them, Joseph says he goes into fits when subordinates make serious errors of judgment. He adds that Drexel dismisses ''a few'' workers annually for disciplinary reasons. Joseph now worries that the firm's reputation for aggressiveness and the vast amounts of money it deals with might have induced wrongdoers to regard Drexel as an ideal place to work. If such ''adverse selection'' was attracting criminals, Drexel's recruiting practices failed to screen them out. Before the firm hired Marty Siegel, says Joseph, some senior Drexel executives had heard rumors about Siegel's insider trading. But Joseph says no one mentioned that to him until after Boesky was caught. Drexel's dealmaking drive sometimes gets out of hand. One deal the firm deeply regrets doing, says Weinroth, is an $85-million financing in December 1985 for Grant Broadcasting, a start-up TV station operator. Exceptionally risky even by junk standards, the deal offered bondholders annual interest of up to 17.25% (some ten points more than the prevailing Treasury bond rate) plus shares of Grant stock. Drexel kept 3% of the issue for itself along with 7% of Grant stock and took two seats on the company's board. It sold the rest of the bonds privately to customers such as First Executive, a life insurance company (23% of the issue), and Lorimar Telepictures (1%). Lorimar also was a supplier of TV shows to Grant's stations. Just seven months after the bond sale, Grant stopped paying the suppliers of its TV programs, Lorimar included. By last December, Grant was behind by $25 million and went into bankruptcy. The Drexel employees on Grant's board resigned a month before, citing a potential conflict of interest. Now creditors are accusing the company's management of self-dealing and illegal business practices. Says Weinroth, whose quality-control committee approved the bond issue: ''That was one of the all-time worst deals we ever did.'' Lorimar followed Drexel into another swamp last year. For much of 1986 Lorimar was trying to buy six TV stations owned by Kohlberg Kravis Roberts, the leveraged-buyout firm, for $1.4 billion. Drexel was the banker advising both Lorimar and KKR. But not even the mighty Milken could put together a deal that made sense for Lorimar, largely because Lorimar had agreed to pay more than most investors figured the stations were worth. Lorimar has since backed out of a companion deal to buy an Indianapolis TV station that happens to be 9% owned by Mike Milken. Lorimar walked on that one after the station filed for bankruptcy. Drexel executives are quick to defend their cozy network of borrowers, lenders, buyers, and sellers. Says one: ''The way these things seem to fit together quite nicely is not by accident. The greater your contacts, the more things fit together over time.'' He says he sees nothing wrong with Drexel's behavior: ''When we have more than one client in a transaction, balancing both sides is critical so no one gets screwed.'' His concept of fairness seems odd. Most companies pay investment bankers those lofty fees to get an edge in negotiations. Drexel bankers have trashed the old club's unwritten rules -- and sometimes Drexel's own as well. A high-ranking Merrill Lynch banker remembers co- managing a 1981 junk bond issue with Drexel for Volt Information Sciences, which prints directories for phone companies. As he tells the story, Drexel arranged the roadshow that introduced the company's managers to potential bond buyers. On a flight to Chicago the Merrill team found itself booked in coach while the Drexel bankers and Volt management had first-class tickets. Ditto for the hotel booking in another city: Drexel and Volt in one place, Merrill across town. THIS MUCH sounds like little more than a childish prank. But Merrill says Drexel also changed the site of the Chicago meeting with investors to a new location. Merrill got word of the change too late to alert its customers; they showed up at an empty hall. Surprise: Drexel sold more bonds in Chicago than Merrill Lynch. Says the Merrill Lynch banker: ''Disinformation like this is not to the benefit of the client, to whom co-managers have a fiduciary responsibility. When you put your own interests ahead of your client's, where will it stop?'' Joseph, who was running Drexel's corporate finance department at the time, does not deny that such incidents occurred. ''When I heard the first story about sending guys to the wrong hotel, I said I never wanted that done again.'' He concedes, however, that Drexel bankers have pulled similar stunts since. Drexel bankers sometimes get tough with customers as well if it will help land their underwriting or acquisition business. According to a participant at a takeover seminar at the University Club in New York in 1985, Chris Andersen told the audience that an effective ploy is to call Company A with the suggestion that it make an offer for Company B. Part II of the message: If you're not interested, we're going to suggest to Company B that it take you over. ''We're a big firm,'' says Joseph. ''We have a lot of very aggressive people here. Some departments are worse than others, some guys we've got to haul back, and we've fired some for disciplinary reasons. It would be naive to say no one ever stepped over the ethical lines we set. But the guys knew what the lines were.'' Joseph says he knows of two or three companies that recently have felt threatened by Drexel's business solicitations. One is Staley, the corporation charging Drexel with extortion. Drexel is fighting the suit. Last fall Staley was preparing to sell common stock through Merrill Lynch and First Boston when, it says, Drexel began calling with its leveraged-buyout proposal. The company says Drexel threatened to trade Staley stock in a way that would frustrate the stock offering if Staley stuck with its original plan. Staley charges that when it tried to sell the stock in November, Drexel manipulated the market so that it could not get an acceptable price. Executives in Milken's junk bond department boasted to the company that Drexel controlled more than 5% of Staley's stock, the lawsuit charges. Staley claims Drexel did not disclose the position to the SEC, as required by law, explaining that disclosure would be ''bad for business.'' The company finally raised the money it needed with a preferred-stock offering. Joseph says when he heard Staley felt threatened, he told a subordinate to stop whatever was going on. Joseph also says he refuses to take on underwriting clients that seemed afraid of Drexel. ''We're not in the protection business.'' DREXEL MAY EMERGE unscathed from the SEC's microscopic investigation. But simply being suspected of major transgressions has already hurt the firm. It has sold $8 billion of new junk bond issues since Boesky told his terrible tale in November, but much of that was already in the pipeline. Drexel's ability to generate new business seems severely impaired. Few of its high-paid professionals have fled, but hiring new talent is tough. Paul Higbee, a Drexel recruiter, says he must convince job candidates that the firm's bankers don't have ''horns and tails.'' Says Higbee: ''Questions about integrity are hard to deal with. There are no statistics to prove you're honest.'' So long as those questions about integrity remain open, Drexel is unlikely to get many sensitive merger and acquisition jobs. Competitors, many of whom learned how to kick and gouge watching Drexel, are exploiting the opportunity for all it's worth, going after underwriting clients and the junk bond buyers who were so crucial to Drexel's success. Says Drexel's Balog: ''If one of our competitors was a wounded animal in the jungle, I don't know that we wouldn't do the same.'' How far Drexel ultimately falls will hinge on what the SEC finds. It seems safe to assume that Drexel will survive even if investigators uncover the worst. But it seems equally certain that Drexel's days as the world's most fearsome money machine are past.