Former Drexel Burnham Lambert Inc. chief Frederick Joseph testified against the man who led the firm to Wall Street stardom as the government finished the second phase of its pre-sentencing case against Michael Milken. Also Tuesday, the former president of an important Drexel junk-bond customer said Milken offered him a personal investment in a 1985 takeover after his company bought a large stake in the deal. The testimony by Richard Grassgreen was important because it was the first indication Milken may have directly given big clients equity in the leverage buyout of Storer Communications Inc. Taking the stand nearly four years after Drexel and Milken were linked to wrongdoing in the government's insider trading probe, Joseph said Milken may have violated company policies related to Storer investments and misled him. Government charges against Milken are being aired at a pre-sentencing hearing before U.S. District Judge Kimba Wood. Prosecutors claim Milken broke the law beyond criminal charges to which he has pleaded guilty and deserves a lengthy prison term. The hearing is to resume Thursday with testimony on the last of three alleged illegal transactions, involving trading in Caesar's World Inc. securities in 1983. A sentencing date has not been set. Grassgreen, formerly president of Kinder-Care Inc., testified as part of his own agreement to plead guilty to two felony charges related to pocketing up to $500,000 from investments made by his company. Tuesday's testimony focused on the $2.5 billion buyout of Storer by Kohlberg Kravis Roberts & Co., for which Drexel provided financing in late 1985. Prosecutors claim Milken misappropriated valuable Storer equity warrants, or rights to purchase Storer stock, and used them to lure customers into buying riskier Storer securities. Under questioning from Assistant U.S. Attorney John Carroll, Grassgreen said that after committing Kinder-Care to buying $5 million in preferred stock in Storer he was told by a Drexel executive about the warrants. When Grassgreen asked whether Kinder-Care could buy some of the warrants, he said Milken told him, ``No, it's for you and Perry,'' referring to Kinder-Care chairman Perry Mendel. Grassgreen testified he believed he was offered the warrants because of his longstanding relationship with Drexel and the company's role in the Storer deal. But Grassgreen contradicted testimony last week by Drexel executive Thomas Connors. Also, none of six government witnesses on Storer directly backed the bribery charge against Milken. Grassgreen said under cross-examination by defense lawyer Arthur Liman that Milken was unaware of Grassgreen's lawbreaking and that all investments made with Drexel in a relationship dating to 1978 were based on merit. Grassgreen has agreed to plead guilty to pocketing commitment fees paid by Drexel to Kinder-Care for investing in four takeover deals and to failing to disclose his personal stake in Storer to his company. He resigned last week as president of Montgomery, Ala.-based Enstar Group Inc., Kinder-Care's successor. Milken, 44, pleaded guilty to six felony counts related to illegal trading and agreed to pay $600 million in penalties. He faces a maximum 28 years imprisonment. Joseph testified under Drexel's agreement to cooperate with the government in settling criminal charges last year. Drexel now is in Chapter 11 bankruptcy proceedings. He said he did not learn about a Drexel-related investment partnership known as MacPherson Investment Partners that was formed out of the Storer deal until 1988. MacPherson consisted of Drexel clients, money fund managers, Drexel employees and a trust in the name of the children of both Milken and his brother, Lowell, who also worked for Drexel. Joseph said the stake for the trust for the Milkens' children should have been disclosed to executives of the firm because of Drexel's role in creating and trading the securities. Disclosure was required to ensure the investment complied with federal and firm rules. Joseph said he believed the decision to give partnership stakes to fund managers whose institutions bought risky Storer securities also violated Drexel guidelines against giving ``favorable treatment'' to institutional investor accounts. Joseph also said that he asked Milken in the fall of 1988 whether any fund managers had invested in Drexel partnerships and Milken said no. Under cross-examination, Joseph said that Drexel employee partnerships had taken equity stakes in other leveraged buyout deals. Joseph also conceded that Milken was not responsible for determining whether investments needed to be disclosed and that Milken routinely consulted Drexel executives about personal investments.