Global Trading Is Making SEC Task Tougher

On July 22, as the Securities and Exchange Commission was basking in its success at making some spectacular insider-trading cases after extracting the key evidence from foreign governments, the high court of the Bahamas brought it back down to Earth.

The SEC had asked the court to force a Bahamian bank to identify the investors behind three Panama corporations that, through the bank, had actively traded in the stock of Louisville Cement Co. during its secret 1984 talks to be acquired by a French firm. The commission had even enlisted the Bahamian attorney general’s office to present its court case.

But the Bahamian judges bluntly rebuffed the SEC. As an American agency, the SEC had no standing even to sue the bank in the Bahamas court, the judges ruled. Moreover, the Bahamas attorney general himself had no standing to bring the case as long as he was representing the Americans.

SEC officials say they are still trying to obtain the bank evidence through other means. “In the short term, the ruling is an obstacle,” said Michael Mann, the SEC enforcement official in charge of such international projects. “In the long run, it’s no obstacle because we’re working to establish precedents that will help us gather evidence abroad.”

Yet the ruling demonstrates that while trading in American stocks can be initiated and to some degree executed from almost anyplace in the world, the SEC’s legal jurisdiction generally extends no further than the Coast Guard’s. The limits of the commission’s influence are likely to be defined even more sharply as securities trading continues its evolution into the business of a globally interconnected marketplace.

Already several U.S. stock and commodity exchanges have forged trading links with exchanges in other countries, of which the American Stock Exchange’s linkage with the Toronto Stock Exchange, covering six stocks in a pilot program, is the only one to consist of two primary markets in two different countries. American brokerages are doing more business with overseas trading floors, and even their capital is taking on a foreign flavor--witness the recent purchase of a stake in Goldman, Sachs & Co. by Japan-based Sumitomo Bank.

Many American companies have their stock listed on overseas exchanges; SEC Chairman John Shad said 473 companies already have stock listed in more than one country. ITT Corp. is perhaps the most broadly listed, with its stock traded on 12 major foreign exchanges as well as the New York Stock Exchange. IBM, another multinational stock, is listed on the Tokyo exchange and in seven European countries.

With the proliferation of cross-border trading, American regulators face the prospect of exporting their own standards of corporate disclosure, market surveillance, and anti-fraud enforcement abroad, or accepting the lower standards often in effect elsewhere. They are doing their planning now with only a hint of the capabilities that technology may offer investors, brokers, or crooks.

“We’re talking about being futurists here,” Mann said.

American regulators do know that if trading ever becomes genuinely global, involving exchanges in exotic locations outside such capitalist centers as the United States, Canada, Britain, Hong Kong and Tokyo, they could be in for some severe cultural shocks.

Similar Regulation

As SEC Chairman Shad marveled in an interview, “in some places they take two or three months to settle trades and have a 40% fail rate.” That compares to the five business days for settlement--delivery of and payment for ordered securities--on U.S. exchanges, and to fail rates, meaning the non-completion of contracted trades, that reach 2% to 3% on the New York Stock Exchange only on exceptionally bad days.

So far, except as visions of the distant future, no one has seriously proposed trading links between any but the most homogenous cultures. Said American Stock Exchange President Kenneth Leibler of his market’s link with the Toronto exchange: “Much of the regulation in the U.S. and Canada is as similar as you’re going to get in two different countries.”

Nevertheless, as the volume of foreign transactions in U.S. securities mounts, so will the pressure on the SEC’s budget. This is particularly true if the commission is resolved, as Mann says, to keep illegal traders aware that “just because they’re outside of the U.S. we’re not going to go away.” One insider case alone, involving Santa Fe International, sent commission investigators to London, Paris and Switzerland.

Asked how his budget will accommodate the increasing expenses of multinational investigations, Shad said simply: “We’ll need more.”

In fraud cases involving insider trading and other offenses, the SEC’s most critical need is access to important evidence overseas. This includes bank account records, brokerage receipts and telephone records--the very bread-and-butter of fraud investigations.

Some regulators fear that as stock trading becomes internationally integrated, the SEC’s ability to draw in the threads of evidence will diminish. If stocks are traded in a global 24-hour market, the ultimate scenario, it could be possible to manipulate an American stock without performing a single transaction on American soil.

“The great horror story is that it’s 3 a.m. on New York, and the stock of an American corporation is being traded on the Tokyo Stock Exchange, and after some inquiry you find out that the order was placed through a Hong Kong bank by a Liechtenstein trust whose principals are three Panamanians, none of whom is a U.S. citizen,” mused Ira Lee Sorkin, the SEC’s New York enforcement chief, in a recent interview. “What do you do at that point?”

The commission’s thrust so far has been to try negotiating bilateral agreements with overseas regulators ensuring its access to important evidence. The agency’s model in its effort to negotiate agreements guaranteeing its access to key evidence overseas is its 1982 pact with Switzerland, which had long been known for elevating bank secrecy to a sovereign principle. The 1982 accord has enabled the SEC to crack some major insider cases, including the Santa Fe case, in which foreign investors working through Swiss banks ordered stock in the company allegedly on knowledge of its secret talks to be acquired by the Kuwaiti government.

Most recently, the agreement enabled the commission to freeze more than $1 million in allegedly illegal profits held in a Swiss bank by Elie Mordo, a foreign resident who allegedly bought RCA stock after learning that his grandson, a junior employee of the Lazard Freres investment banking firm, was working on RCA’s acquisition by General Electric. Mordo was forced by the SEC to give up those profits; his grandson, Marcel Katz, and Katz’s father, Harvey, were also forced to give up their trading profits.

The case was the first in which the commission managed to freeze assets held by a suspect overseas, rather than in the United States.

Even where the spirit of cooperation is present, however, legal obstacles may exist to full-bore evidence-sharing. Before approving the Amex-Toronto link, the SEC required assurances that its information-gathering efforts would not be impeded by laws at the national and Ontario provincial level forbidding the transfer of official documents abroad. The best it could manage was an informal agreement from the Ontario Securities Commission that evidence requests in fraud cases would be honored.

SEC officials argue that as securities trading becomes internationalized, most countries will have an incentive to help the commission ferret out fraud that may take place within their borders. “It was clearly adverse to Swiss interests to be a haven for people who want to rip off investors,” Shad said in explaining Switzerland’s willingness to dilute its bank-secrecy laws. Mann added, “No nation endorses fraud.”

True. But few define all varieties of fraud in precisely the same way, or include identical activities within the definition. “Many parts of the world don’t have the same view of what’s good or bad as the SEC,” said Harvey Pitt, a former SEC general counsel now in private practice in Washington.

In Switzerland, for example, it is legal for a corporate executive to trade his own company’s stock on non-public information, which would be a clear violation of U.S. insider-trading rules. The difference had an impact on the SEC’s Santa Fe International investigation, one of the largest insider cases in history. Swiss authorities withheld crucial evidence from the commission for months, until it could show that its targets were not executives of Santa Fe.

In Britain, where cross-border securities trades with American markets may grow in importance, ethical standards for brokers differ in at least one important way from those United States: The British consider it an inherent conflict for a broker to deal with a customer as a principal, not a middleman--that is, to sell a customer stock from its own inventory instead of bringing together two private owners. (Principal transactions are conducted by different firms.) In the United States, such principal transactions are routine.

American Assets Help

Pitt agrees that as countries discover that their own citizens are being victimized by sharp practices on their securities markets, “they’ll have a built-in incentive to come to grips with this issue.” But it will be a slow process. “Shad will have less success at the outset than he expects with his bilateral agreements, and more success at the end,” Pitt said.

American regulators also expect to maintain influence over foreign brokers, financial institutions, and investors that have American-based assets. One reason for the willing cooperation with the SEC of Bank Leu, the Swiss bank whose Bahamas branch harbored the ill-gotten gains of insider trader Dennis Levine, was that it had American assets and U.S. business relationships that it wanted to keep free of any clouds.

That provided an incentive for the bank to disclose evidence that tied the trading unmistakably to Levine, a former mergers professional at the investment house of Drexel, Burnham, Lambert, regardless of Bahamas’ bank secrecy laws. In return, Bank Leu won for itself an exemption from SEC prosecution in the case.

The implications of global trading extend far beyond anti-fraud enforcement of American fraud rules. Shad, the SEC chairman, notes that the standards governing how much information companies must disclose to their shareholders vary widely from country to country. Shad at one time proposed bringing regulators together to devise a common prospectus for all companies listed on international exchanges. His conclusion: “It would be an interminable process. You start with the differing accounting standards required in each country, and go downhill from there.”

The SEC’s latest notion is to designate certain major companies as “world-class” corporations based on the amount of their stock in public hands, the caliber of their financial history, and so on, and allow them to do multinational securities offerings under their home country’s disclosure rules. Shad argues that if any disclosure inadequacies were truly material, that would show up in the offering’s market price as a discount to comparable securities.

Some regulators question how much genuine interest there is in the global, 24-hour securities trading foreseen by the market’s more creative visionaries. “On the immediate horizon, there’s no real interest in linkages with less-developed exchanges outside London, Tokyo and Amsterdam,” said Brandon Becker, assistant director of market regulation at the SEC.

He also wonders whether, given the domination of stock trading by large institutions with plenty of access today to foreign trading markets through “upstairs” arrangements--that is, brokerage trades conducted off the trading floors--there will be enough interest from individual investors to make elaborate trading networks worth building.

“Is the retail investor really going to want foreign stocks, given currency risks and so on, or will he just want to buy some mutual fund specializing in foreign stocks?” he asked.

Leibler of the American Stock Exchange acknowledges that institutional investors have little need for the service provided by the Amex-Toronto link. “We’re not providing a market that someone can’t reach any other way,” he says. “But we have provided one we feel is quicker and more efficient.”

In any event, the Amex-Toronto arrangement is geared toward serving small investors, as it provides guaranteed best-price execution on either exchange only for orders of 1,000 shares or less. Since the beginning of 1986, only 700,000 shares have been traded over the link, which allows members of either exchange to execute trades at the best price they find on either floor. Of the Amex’s 900 listed stocks, 16 are to be added by the end of this month to the six already subject to the link as part of the pilot project, with the remaining 14 stocks already listed on both exchanges to be added to the link by the end of the year.

No Explosive Demand

Most early experiments in multinational exchange listing have demonstrated less than explosive demand. ITT told the SEC recently that, despite its stock’s listing on 12 foreign stock exchanges, virtually all trading in ITT takes place on the New York Stock Exchange during regular New York business hours. IBM said that of its stock’s total worldwide trading volume in the first six months of 1986 of 202 million shares, fully 172 million shares were traded during normal business hours on the New York Stock Exchange. About 2.7 million, or 1.3%, were traded on the Tokyo Stock Exchange, where IBM has been listed since 1976.

Securities professionals also differ over the American markets’ ultimate role in a global trading network. Some people, like Shad, believe that securities issuers are chiefly interested in multinational trading so they can gain easier access to the tremendously active and capital-rich U.S. market. This orientation, Shad argues, will allow the SEC to retain sufficient leverage over foreign issuers to ensure that the commission has some authority over their behavior.

Others are not so sure. Edward F. Green, another former SEC general counsel now in private practice, said, “I’m convinced that without significant flexibility at the SEC you won’t see foreign issuers issuing in the United States.”