Boesky Case Is No Reason for Open Season on Wall Street

The insider-trading case against takeover speculator Ivan F. Boesky and the widening scandal that threatens to engulf Wall Street has outraged the public--and rightly so. The actions of Boesky, who has agreed to pay $100 million in fines and returned profits and to plead guilty to a criminal charge, have eroded confidence in the financial markets and further damaged the integrity of a profession already shaken by earlier insider-trading cases.

The Boesky affair also has focused renewed attention on the controversial issues of corporate takeovers and high-yield, or junk, bonds. Some say that it illustrates the need to strengthen insider-trading regulations, curb corporate takeovers and control the role played by these securities. It would be a mistake, however, to lump these issues together and rush to write new legislation. Before any action is taken by Congress, it is important to untangle the related yet distinct issues raised by the Boesky case.

Although Boesky, according to the Securities and Exchange Commission, made millions by buying the stock of takeover targets, his case is not really about corporate takeovers. Rather, it is a clear-cut example of insider trading. The SEC already has--quite properly--broad powers in regulating this area, and there is no evidence that they require strengthening at this time. In this regard the SEC has resisted efforts by Congress to draft new legislation that might narrow the definition of insider trading, which is now interpreted by the commission and the courts to mean engaging in securities transactions on the basis of material information not available to the general public.

The fact that the SEC was able to persuade Boesky to agree to plead guilty, pay $100 million and cooperate with its investigation is, in a way, proof enough of the commission’s power. The difficulty in investigations of insider trading lies not in a lack of authority or poorly written laws but in building a case to prove that such trading took place. The use of sophisticated computers, which can spot unusual market transactions before the announcement of important corporate news, has helped. But it can be difficult to link an individual trader to a series of transactions. The solution is not new laws but painstaking legwork. And, as in any investigation, the traditional tool of a cooperative witness, such as Boesky, can break a case open.

The SEC’s decision to subpoena Drexel Burnham Lambert Inc., the biggest issuer of high-yield bonds, as part of its inquiry has sent shock waves through the junk-bond market and aroused a great deal of concern on the part of companies that rely on these bonds. But the use of junk bonds in financing contested takeovers, while significant, has been overstated. Of the $14.7 billion in junk bonds issued in 1985, only $1.4 billion were used to finance six contested takeovers. Preliminary figures for 1986 suggest that the percentage of these bonds used to finance contested takeovers will be no greater than in 1985.

The fact is that most junk-bond issues have been used to finance growing companies, such as MCI Communications Corp., and to pay for traditional investments such as plant and equipment acquired by long-established corporations. To restrict substantially the sale of junk bonds as a result of concerns fueled by the current SEC investigation would take away an important financial instrument that has helped the economy and created jobs. It would be unfortunate if the widening probe sent the junk-bond market tumbling any more than it has.

While care should be taken in using the Boesky case as an excuse for tightened insider-trading laws or curbs on junk bonds, one good effect of the case might be scrutiny of certain possibly undesirable aspects of recent takeovers. “Poison-pill” defenses, the elimination of pre-emptive rights traditionally granted existing shareholders and the issuance of two classes of common stock, one without voting rights, are takeover-inspired tactics that may lead to abuses and should be examined.

But even with takeovers we should be cautious in any attempt to draw up legislation, because we lack hard data about the effects of takeovers. What is needed is a detailed study of the transfers of wealth in both successful and unsuccessful takeovers, as well as in friendly mergers.

Although takeovers often seem to have no immediate benefit to the economy, they can sometimes have beneficial outcomes--ousting an incompetent group of managers, improving productivity or reducing costs--and, recognizing this, legislators have been reluctant to step in to curb them. The acquisitions of three major U.S. oil companies by three other oil concerns prompted an attempt to place a moratorium on mergers and takeovers. But the move failed in the Senate. A subsequent watered-down measure calling for a study of the effect of mergers never made it through a conference committee.

The SEC’s current investigation of insider trading will undoubtedly continue for some time, and it would be wise for lawmakers to await the results before drafting new laws. In the end the SEC’s success in uncovering Boesky’s actions and the trembling that it has caused in Wall Street may turn out to be the best deterrent against illegal financial manipulation that anyone could ask for.