Fairness for Investors : SEC Wages War Against the ‘Insiders’
Ivan F. Boesky was the biggest, but he was hardly the first. In fact, the millionaire stock speculator, whose sensational undoing was announced last Friday, fell victim to the 107th insider trading case brought by the Securities and Exchange Commission during the Reagan Administration.
That is an unprecedented number for any presidency, and it is no accident that it occurred when Ronald Reagan was President and the business world was gripped by merger mania.
Under the Reagan Administration, the SEC has soft-pedaled some of the commission’s earlier crusades, such as those aimed at uncovering corporate fraud and guaranteeing stockholder rights, on grounds that the government should avoid intruding into corporate board rooms and executive suites.
Level Playing Field
By contrast, the campaign against insider trading has proved a natural for this market-oriented Administration because the drive aims chiefly at ensuring a level playing field for all investors. “Essentially, insider trading is the few taking advantage of the many,” says SEC Chairman John S.R. Shad.
Shad, who has spearheaded the five-year drive against using undisclosed corporate information to turn quick profits in the securities markets, says the illegal practice undercuts the “expectation of fairness” that investors need when they buy and sell stocks and bonds.
And that, Shad says, has impact far beyond individual investors whose losses become the inside traders’ gains.
Investor Confidence
“Our nation’s economic growth depends on investor confidence in the securities markets,” Shad said in an interview Thursday. “People will be less willing to place their money at risk in securities if they believe that insiders, who have access to material non-public information, are using it to take advantage of them.”
The Reagan Administration has brought its free-market tendencies to bear on insider trading just as the mushrooming growth of corporate takeovers and the increasing complexity of the securities markets have vastly expanded the prospects of enormous profits from the practice.
In this era of corporate mergers, hosts of attorneys, consultants and financial experts have early access to privately held information that could affect the value of stocks of the many companies involved in takeovers.
Corporate takeovers are not part of every insider trading scheme. Undisclosed information about a company’s profits or losses is commonly the source of illegal profits. But, because takeovers have such a volatile impact on stock prices, they play an increasingly common role. Among the SEC’s charges against Boesky’s investment firms is that they turned a $4-million profit when the price of Nabisco Brands stock skyrocketed after R.J. Reynolds announced its intention to take it over.
And corporate raiders make tempting political targets. In the galaxy of practicing capitalists, raiders occupy a role somewhat akin to that of Darth Vader, with the reputation of having a greedy desire for quick profits but no concern for long-term corporate health. Boesky and other arbitrageurs--financiers who buy up the stock of takeover targets with the hope of reselling it to the raider at a profit--are an intimate part of the process.
The raiders argue that their predatory ways keep management on its toes and force it to operate more efficiently and profitably than it otherwise might.
But Felix Rohatyn, senior partner of the investment house of Lazard Freres & Co. in New York, told Congress last year that threatened hostile takeovers are increasingly distracting corporate managers from the task of improving corporate productivity and competitiveness. The huge sum of money managed by arbitrageurs, he said, “has as its basic purpose the destabilization of a large corporation and its subsequent sale or breakup.”
The SEC cites other reasons as well for the mushrooming of insider trading cases. For example, the mounting sales of options to buy stocks in the future at a specified price has increased the reaping of quick and enormous profits from relatively small investments. The development of a global financial community has brought more players into the game and provided new havens for them to stash their profits away from SEC scrutiny.
The SEC has made its campaign against insider trading pay off. Boesky alone has agreed to return $50 million in illegal profits, pay an additional $50-million fine and plead guilty to one criminal charge. Even before that case, the commission over the last two years had forced the targets of its investigations to relinquish $27 million in profits and pay $600,000 in penalties.
“We settle 80% to 85% of our cases with court-approved consent decrees and civil injunctive action,” said Chiles Larson, the SEC’s deputy information director. This means the inside trading suspect, without admitting guilt, agrees to give back allegedly illegal profits and never to violate securities law again.
To Rep. Charles E. Schumer (D-N.Y.), a member of the House Banking Committee, the SEC’s stunning successes prove that Congress should not tamper with existing laws governing insider trading. “The SEC’s got tough and good laws,” he said.
But Sen. William Proxmire (D-Wis.), who will be chairman of the Senate Banking Committee next year, insists that the law must be strengthened. To inhibit corporate raiders, he has proposed that the voting rights to which stock owners are entitled in determining company policy be deferred until the stock has been owned for 60 days.
“Those who come in at the last minute, arbitrageurs and others,” should not have the same immediate voting powers as those who have held stock for a considerable period of time, Proxmire said.
T. Boone Pickens, chairman of Mesa Petroleum and one of the most aggressive corporate raiders, scoffs at that suggestion.
“We don’t need any more rules,” he said. “Ownership is ownership. It doesn’t make any difference whether you got it this morning or 10 years ago. It’s yours.”
Proxmire, although conceding that Pickens has “a reasonable point of view,” said that the great financial weakening of corporations that occurs when they seek to protect themselves from hostile takeovers may require “extraordinary efforts to prevent the merger mania from pushing our economy over the cliff.”
James H. Lorie, a University of Chicago professor of business administration, noted that existing law leaves many gray areas for the SEC’s enforcers. As now written, Lorie said, the law leaves unclear numerous important issues: whether former corporate employees qualify as “insiders,” for example, and whether the knowledge of when and where key corporate executives have held meetings constitutes “inside information.”
In fact, the SEC has no exact legal definition of “insider trading.” The closest way to describe it, according to an SEC spokesman, is the purchase or sale of securities by persons in possession of material non-public information in violation of a trust.
Gary G. Lynch, the SEC’s enforcement chief, said it is perfectly legal to trade on merger rumors and gossip. What is not legal is not always so clear, and an SEC official cautioned that writing the law more precisely could perversely make it more difficult to punish inside traders.
“In many instances,” said the official, who asked not to be named, “where you try to fine-tune, what you really do is provide someone with a road map” on how to circumvent the law.
Kenneth Scott, a Stanford University law professor, added that too strict a curb on the exchange of routine information about companies could have the unintended effect of disrupting the market that helps keep stock prices in line with the actual values of the companies.
“The laws that are in place are clearly adequate to deal with the Boesky situation,” Scott said. “As long as we focus on the extreme, clear-cut cases of theft (of information), I think we’re probably on pretty solid ground. If we move into (trickier areas), the uncertainty and the costs are pretty high, and the benefits are pretty dubious.”
The Supreme Court has dealt several blows to the SEC’s campaign against inside trading. In 1980, the court threw out the conviction of Vincent Chiarella, a financial printer who had profited from trading in securities of a yet-unannounced merger candidate. In printing the prospectus for the deal, Chiarella had been able to figure out which companies were behind the disguised names that had been used on the early draft of the document.
After that ruling, the SEC tightened its definition of “inside trader” to include anyone who gains information from someone known to be an insider, even if the insider had not intended to convey the information.
Three years later, the court overturned the SEC’s censure of securities analyst Raymond Dirks, who had acted on an inside tip from an employee of Equity Funding of America. Dirks had sounded a public alarm of fraud at Equity Funding, but only after he told his own clients to sell the stock.
Insider trading was subjected to dramatically stiffer penalties in 1984. Congress gave the SEC, which previously had been able only to force inside traders to give up their profits, the power to ask federal courts to impose treble damages.
The 1984 law also increased the maximum criminal penalty for willful violation of the 1934 Securities Exchange Act to $100,000, which was 10 times the amount that had been set when the law was enacted. And it made clear that its penalties could be applied to trading in stock options as well as stocks.
But Congress and the SEC failed to write an exact definition of “insider trading,” and that question remains unanswered today.
However “insider trading” is defined, the SEC does not know how common it is. “I don’t know how much undetected trading goes on,” Lynch said. “It’s impossible to quantify.”
In any event, sentiment appears to be growing in Congress that the SEC needs greater resources to combat it. “They probably need more money,” Schumer said.
Proxmire, although conceding the SEC’s effectiveness in the Boesky case, said: “There is a question whether they have adequate resources.”
Shad himself, a vice chairman of E.F. Hutton before heading the SEC, issued no such complaint. About 10% of the commission’s yearly total of 330 enforcement actions involve insider trading, he said, although the commission probably devotes a greater share of its resources to those cases because they are so complicated.
Ironically, the series of insider trading cases developed during the Reagan Administration caught up a high Reagan appointee last year--W. Paul Thayer, then deputy secretary of defense, who subsequently resigned. Thayer, who had been chairman of LTV Corp. and a director of Anheuser-Busch Breweries Inc., was accused of passing inside stock tips to his broker, his doctor and other friends before he entered government service.
Thayer admitted in court in March, 1985, that he had lied about his actions to SEC investigators, who charged that his group of friends had reaped $1.9 million in illegal profits from his stock tips. He pleaded guilty to obstruction of justice charges and was sentenced to four years in prison.
The SEC under Shad took action against another former Administration official, Thomas C. Reed, who had been a member of the White House National Security Council staff. Reed resigned and paid back $427,000 in profits that the SEC contended he had realized in Amax Corp. stock options based on confidential information from his father, an Amax director.
But Reed was acquitted of criminal charges that he had obstructed the SEC’s investigation. Criminal charges are typically harder to make stick than civil penalties, according to SEC officials, because the evidence is almost always circumstantial unless a member of a conspiracy turns against his companions, as Boesky reportedly is doing.
Shad said he regretted that the securities markets had been hurt by “a lot of uncertainty, speculation and rumors” over what Boesky has been telling federal investigators in New York. Although he refused to disclose any details of the investigation, he predicted that more inside trading cases would result from Boesky’s cooperation.
Staff writers Paul Houston and Robert A. Rosenblatt contributed to this story.
