Suspicions About Arbitrage Business Likely to Increase in Aftermath of Boesky Case

The two rumors had swept Wall Street for months.

Government watchdogs wanted to nab an “arb.” And they were investigating the most legendary of the breed, risk arbitrageur Ivan F. Boesky.

But rare was the view that the Securities and Exchange Commission would succeed on either score.

“The SEC had tried so long to get an arb,” said one top takeover entrepreneur who frequently deals both with the SEC and with Boesky. “But were they succeeding? No. And would they get Ivan? Never.”

Wall Street’s shock at Friday’s announcement that Boesky had received confidential takeover information illegally from former investment banker Dennis B. Levine already is giving way to worry about the case’s potential chilling effect on the business of legitimate takeover arbitrage.

Going Straight to Congress

“A lot of people are going to be outraged and they’re going to take it straight to the Congress,” predicted a professor at an Ivy League college who often testifies on takeover issues but requested anonymity. “I don’t believe it’s true that every arb in the country is stealing confidential information. But this is sure going to restir that controversy.”

Just as takeover fever remains stubbornly rooted in corporate America despite a two-year campaign by big business and some in Congress to break it, concurrent suspicions persist that takeover arbitrageurs are only as successful as their illicit network of tipsters.

Since they make their money betting on the outcome of takeovers, the contention goes, arbs naturally would be tempted to make deals with people who have access to confidential information about impending takeovers before they become public knowledge.

And now that the most successful of these Wall Street speculators has agreed to return $50 million in profits gathered from just such a network--and to pay an additional $50-million fine--”people are going to forget that these are sophisticated people who know how to value securities, and (they will) write them all off as crooks,” predicts a takeover expert at a major Wall Street law firm.

Exposure of Scheme

“It’s definitely a strike against the arbs,” said David Batchelder, president of Mesa Petroleum, the Amarillo, Tex., company headed by takeover artist T. Boone Pickens.

But is the exposure of Boesky’s scheme tantamount to an admission that there can’t be successful legal arbitrage without insider trading?

“Clearly,” says Batchelder, “the answer to that has got to be no.”

In fact, several corporate executives who regularly get inquiries from arbitrageurs say the number of calls from arbs has declined dramatically and their line of questioning has become much more cautious in the six months since the SEC exposed Levine, the former Drexel Burnham Lambert managing director who apparently was the ringleader of the biggest insider trading network ever uncovered by U.S. officials.

And yet takeover rumors have been no less rampant or less accurate. SEC sources say they have no evidence that arbitrageurs have been any less aggressive or have made less money.

SEC Chairman John S.R. Shad, in fact, speaking at a news conference Friday announcing Boesky’s disbarment for life from the U.S. securities industry, expressly made the point that “risk arbitrage is not illegal.”

But because “it is illegal to trade on material, nonpublic information,” Shad said, the settlement with Boesky “will have a significant impact on many of the people engaged in risk arbitrage, in making sure they don’t step over the line.”

Wouldn’t Address Issues

No arbitrageur contacted by The Times over the weekend would address these issues on the record. But the gist of their remarks was that while they are prepared for a new round of public debate and they will exercise greater caution when trading on tips, Boesky’s exposure has actually brought them some relief.

“None of us knew what the SEC was fishing for,” said a trader at one small New York arbitrage firm. “I, for one, am relieved that they weren’t concocting some kind of insider trading charge based on the legitimate way we go about our business.”

Said another: “They didn’t get Ivan because they finally proved what a lot of people seem to think--that we’re all crooked. They got Ivan because they got Levine. I’m in shock now. But I’m also relieved. Tomorrow, I can get back to business as usual.”

Business as usual for a risk arbitrageur means buying stocks upon announcement of a takeover, betting that a deal will be completed, or in anticipation of a takeover or other change in corporate ownership. The hope, naturally, is to sell out at a profit.

Tense and Risky Business

This is a tense and risky business even when the arb is betting on the outcome of a deal that actually is in the works. If he is to make a profit, he must put up enormous sums of money because the difference between what he pays for stock in a company about to change hands and the price he sells for when the deal is finished is often very small. Moreover, arbitrageurs run the risk that the deal won’t go through and the stock price will actually fall below their purchase price.

The risk is compounded when arbitrageurs invest extensively in stocks of companies only rumored to be the subject of takeover bids.

It is the latter type of arbitrage--which Boesky himself dubbed “pre-arbitrage”--that has sparked so much controversy in recent years.

Buying Up Large Blocks

By buying up large blocks of stock in such companies, grouse the same critics who refer to Boesky as “Ivan the Terrible,” arbitrageurs drive up the price of the stock and can force the company onto the auction block by effectively inviting others to buy their stakes.

This derivation of the business also has lent itself to accusations that arbs guess right about many of these secret deals not because they are uncannily astute but because they are paying tipsters to steal confidential information.

Even among corporate executives who both feared him and loathed his chosen profession, Boesky was regarded as the hardest working and smartest of his breed. His frenetic 20-hour work days and addiction to poring over corporate documents in search of deals in the making are as legendary as his reputation for being a steely loner who never shared information with the rest of the arb pack.

Such was his reputation that a huge cadre of rival speculators made their living by scouting Boesky and mimicking his trades.

With Boesky and his huge pool of speculative capital out of the picture, Wall Street takeover advisers and takeover entrepreneurs predict, rival arbs will have an opportunity to earn larger profits for themselves.

These sources see virtually no validity in speculation that Boesky’s departure from the business will ultimately lead to fewer takeovers.

Widely Predicted

“People who say this is going to cut down on takeovers don’t know what they’re talking about,” Pickens said. “Arbitrageurs are just people who come into a situation believing they can make money in it. They don’t cause it.”

What is widely predicted is yet another round of insider trading charges. Boesky, like Levine before him, has agreed to cooperate in investigations by the SEC and the U.S. Attorney’s office.

“I’d be surprised to find that Ivan was tipping anybody,” said Batchelder. “The question is were other people tipping Ivan?”