Insider Trading: It’s a Free-for-All Enterprise
It was a merry, merry month of May for Gary Lynch, the Securities and Exchange Commission’s 35-year-old chief of enforcement who got yawns last November when he announced a special SEC probe of insider trading by market professionals. His project stirred no discernible fear on Wall Street, but Lynch is having his laugh at last.
The reason: a grand-slam month with three major insider-trading cases against pros, plus an important victory in an appeals court. May 6: The SEC scored a victory over one of the nation’s premier investment banks; First Boston Corp. agreed to pay $400,000 in disgorged profits and penalties. May 12: The SEC’s dogged pursuit of Donald Levine across international boundaries into the very heartland of Caribbean bank secrecy paid off; Levine, former managing partner of Drexal Burnham Lambert, is the first senior banker to be indicted for securities fraud. May 28: The first criminal indictment was recorded against arbitrageurs--stock pros who profit from short-term market swings; the indictment included three young traders and Michael David, 27, until recently an associate in the prominent New York law firm of Paul, Weiss, Rifkind, Wharton & Garrison.
It’s safe to say that the SEC recaptured public attention with these cases. It surely sent a chill down the Street--paper shredders moved into high gear from New York to the Bahamas--but these indictments and others soon to follow won’t resolve the commission’s enforcement problems. For one thing, budget-mandated staff cuts hit the SEC just as the universe of insiders ballooned. For another, “insiders” aren’t who they used to be. Unless you’ve been nodding over your Barron’s lately, you know that today’s miscreant insider is more likely to be a 23-year-old stockbroker than a corporate captain. Of the 50 people named in insider-trading indictments in New York (the hub of such offenses) since January, 1985, only one--repeat, one--was a classic corporate insider. Eleven worked in law firms, four were investment bankers, two were arbs, 11 were stockbrokers, four were financial printers, one was a dentist, one was a police officer and one was R. Foster Winans, the Wall Street Journal reporter convicted for leaking stocks that he was about to tout in his market-gossip column. (Another victory for the SEC: On May 27 the U.S. Court of Appeals upheld Winans’ conviction.)
That’s the most common delusion about insider trading--who’s doing it. This erstwhile criminal prerogative of the elite has become a mass-market crime. A passel of unorthodox new “inside” sources have transformed--one could say democratized--the trading game. These days, market-sensitive information can be had from messengers, typesetters, proofreaders, cabbies, legal secretaries, even--in one SEC prosecution--a blabby psychiatric patient. The manic megabuck pace of corporate raids has generated ingenious new categories of abuse, unfamiliar forms of market manipulation by a motley gang of new players. Targets and tenderers, their employees, tax advisers, lawyers, bankers, accountants and the parasitic pack of peripheral paper-mechanics who service these corporate monopoly games have dazzling opportunities to get rich quick. Mushrooming stock prices and high-leverage option contracts; the awesome march of megamerger, acquisition, buyout, buyback, tender, takeover, divestiture and rumor, rumor, rumor; deregulation and computerized buy-and-sell programs; proliferating mutual funds, ballooning institutional assets and the introduction of global securities markets; intense pressure for short-term profits (to the detriment of long-term investing)--anyone can add to this list but, collectively, these are the major forces that have transformed financial markets. In this deal-making ambiance pre-public knowledge creates tantalizing, often irresistible, temptation.
The second most popular misconception about insider trading is what constitutes such pre-public knowledge. Surprise! Truth is largely irrelevant; fact and fiction are equally valuable currency. If all recent takeover stories had been true, the world would now be one vast mega-multinational. You’ve noticed that much of the best action is in companies that don’t change hands? “Rumor-insiders” put the rest of us in the position of neophytes in Monte Carlo’s Salon Privee --born to lose. Then we have fads and fashions among the analysts. Stock groups move in and out of favor faster than shoulder pads and miniskirts. Analysts can move the multiples up and down as easily as Paris drops hemlines, and don’t tell me that they’re looking at the fundamentals--else why would technology stocks, still dogs so far as earnings go, be making a comeback?
Scabrous rumor rings of arbs and trading junkies have learned to manipulate the multiples and the averages in a whipsaw, seesaw, speculative spiral that makes the market significantly more precarious for the casual investor today than ever before--even in the treacherous ‘20s. These are the true “insiders”--rumor-hustlers and sophisticated market manipulators. True or false, their tips move prices. Obviously there’s a correlation between trading volume and trading violations, yet while volume jumped more than 400% the SEC’s enforcement staff was cut, and enforcement actions over this period declined by more than 20%. As proof of soaring abuse, public complaints to the SEC more than tripled--from 8,500 to almost 29,000 in four years.
Thus the revival of proposals to eliminate sanctions against insider trading. Proponents sound a lot like the NORML (legalize pot) crowd, but these advocates are the pin-striped LL.D. and MBA gang with (presumably) an Establishment bias. There are perplexing questions here: Does widespread flouting of a law create lawlessness? If a law cannot be enforced (speeding, tax evasion, illegal aliens, drug abuse come to mind), if the subliminal message is that crime does pay, is it better to wipe it off the books? Is this pragmatic ethics? Wimpy law enforcement?
The SEC brought 13 insider-trading prosecutions in 1984, 20 last year; the known universe is in the high hundreds (documented instances forwarded from the New York exchanges); realistic estimates are in the high thousands.
John Olson, head of the American Bar Assn. task force on insider trading, says, “We’re fighting human nature.” Too many deals, too much money, too many opportunities. Consider Michael David, who reportedly gleaned his takeover tips by sneaking peaks at his bosses’ notebooks. Or Bank Leu, a Bahamian subsidiary of a Swiss bank where Levine opened his account in 1980. In vivid testimony in London, the bank’s general manager testified that he and other senior officers earned more than $1 million piggy-backing on Levine’s trades and knowingly participating in the cover-up.
The cases that the SEC does bring are a deterrent, Gary Lynch says. There is no evidence that this is so. Despite the cautionary effect of the May indictments, Lynch and the SEC are a long way from curtailing the greedy rampage.
