‘Insider’ Ties to Key Firms Heighten Fears on Wall St.

Like suburbanites who discovered hard drugs had moved from the ghetto to their own neighborhoods, Wall Street’s blue-blooded firms learned last week that the taint of insider trading is not necessarily confined to the world of “junk” bonds and Drexel Burnham Lambert Inc., a controversial ringleader in the corporate takeover business.

The charges of illegal information-swapping against senior officials of Kidder, Peabody & Co. and Goldman, Sachs & Co. and a guilty plea by takeover superstar Martin A. Siegel “was exactly what people around here feared most,” said a trader at a specialty investment house in New York. “Things like that aren’t supposed to happen to firms like Kidder and Goldman.”

Some close observers of the securities market draw a distinction between charges filed late last week against executives of Kidder and Goldman and last year’s insider trading charges that brought the downfall of Drexel mergers specialist Dennis B. Levine, high-flying speculator Ivan F. Boesky, and a crop of young lawyers and investment bankers.

“Up till now, it’s been just eager Yuppies and sort of fringe operators,” said James Treadway, a former SEC commissioner. “Now it seems to be spreading to the heart of things. It’s mind-boggling.”

As the events rattled Wall Street, they brought fiery predictions of new regulatory legislation from some on Capitol Hill, and caused many market watchers to consider again the range of broad questions raised by the 9-month-old scandal. They asked again how much harm the scandal will do the firms, what kind of new regulatory initiatives may be in store, and what the firms themselves can do internally to prevent the recurrence of such developments.

The new charges were all the more unsettling because of the sterling reputations and impressive history of 118-year-old Goldman, Sachs and 122-year-old Kidder, Peabody.

Unlike Drexel, a spunky parvenu that emerged from obscurity in this decade, Goldman, Sachs has been “the very picture old-line, blue-chip respectability,” and a firm that attracted the best of corporate clients, said Alan Bromberg, a securities expert and professor at Southern Methodist University.

The elite firm, the fifth-largest on Wall Street, has boasted of its rare participation in hostile takeovers, and its attempts to inculcate high moral standards to the young financiers that it often recruits from college and grooms to rise through its ranks. Two years ago, Goldman ranked among the companies included in a book about “The 100 Best Companies to Work for in America.”

Co-chairman John Whitehead told the authors that Goldman did not cultivate the kind of aggressive individualism that has recently gotten young investment bankers at other houses in trouble. “We’re not looking for erratic superstars,” he said. “We don’t like big egos here.”

But one product of the Goldman, Sachs system was Robert M. Freeman, the 44-year-old head of the firm’s arbitrage trading unit, who was booked last week for his alleged part in a multimillion-dollar insider-trading scheme.

Kidder, Wall Street’s 12th-largest and a firm that was organized even as Gen. Robert E. Lee and Gen. Ulysses S. Grant met at the Appomattox Courthouse, has also long enjoyed gilt-edged social connections. Recently, though, the firm has tried to shake its cautious image to compete with the larger firms that had overtaken it, and last year agreed to be acquired by General Electric Co. to give it access to more capital.

Before he left to join Drexel last year, one of those who tried to maintain Kidder’s reputation was Siegel, who headed Kidder’s mergers section and made his name fending off corporate takeover artists.

“The Yuppies that were going to jail last year must have learned their tricks somewhere,” Bromberg said. “It looks like the prosecutors are now catching the people that taught them.”

More Risky Game Seen

Experts like Bromberg already are predicting that at least in the short term the latest round of charges will help chill risk-arbitrage, or speculation in the stocks of corporate takeover targets, and thus slow the frenzy of mergers. “It’s getting a lot riskier to play the arbitrage game,” Bromberg said. The recent cases are taking some big arbitragers out of the game, “and without the free flow of information, the game will become a lot more risky.”

“The firms are going to put less money in takeover stocks, they’re going to put it in later, when they can’t make as much money,” he said.

Some continue to minimize the scandal’s long-term effects on Wall Street firms. After all, they point out, although the market for junk bonds--high-yield, high-risk debt often used to finance takeovers--tumbled after Boesky agreed to pay a $100-million fine in November, it has largely recovered.

The public still seems to regard the scandal as wrongdoing by individuals, rather than institutions, experts say.

But some experts believe there are dark clouds on the horizon, particularly amid hints of further revelations of insider trading by some of Wall Street’s largest fish. Treadway, the former SEC commissioner, cites the threat of corporate lawsuits against investment houses that are alleged to have abused their clients’ trust.

FMC Corp. Suit Cited

Last December, for example, FMC Corp. sued several investment firms alleging that insider trading added $225 million to the cost of its recapitalization plan. The company said it was forced to pay shareholders $10 more a share because the price of its stock had been raised as word of its stock repurchase plans were leaked by investment bankers.

Similar suits “could put some of the firms out of business,” Treadway said. “This is serious stuff for them.”

Others say that while the public has so far been forgiving of the misdeeds, if corporate guilt were established it could take a heavy toll. E. F. Hutton’s earnings have recently suffered, the firm has acknowledged, because of the lingering effects of its multimillion-dollar check-kiting scheme that was disclosed in 1985.

Cities turned to other companies to handle their bond underwritings, and some stockbrokers moved to other companies, observers note.

Moreover, although the flood of business-school talent that has helped nourish investment banks has not slackened since the scandal began, promising newcomers may avoid a company with a tarnished reputation. “Students are concerned about such things,” said Burton Malkiel, dean of the Yale School of Organization and Management. While insider trading offers the temptations of huge short-term profits “the long-term negatives can be considerable.”

The other threat looming before the investment industry is the possibility that Congress will legislate new controls on takeover activities. Legislators have toyed with plans to control corporate “raiders” and their huge borrowings, but only modest changes in the laws have been enacted so far.

Sees ‘More Impetus’

“But with every one of these new cases, there’s more impetus for them to do something,” Treadway said. He predicts that the Democratic-controlled Congress will consider rules to limit the activities of arbitragers, perhaps including regulations that would require arbitragers to publicly disclose what stock they buy, and even what information was the basis for their purchase decisions.

Others expect management of the securities houses themselves to take steps to put their own houses in order. They may try to put more into information systems to more closely monitor the decisions made by subordinates. But any proposal that limits the flexibility of an arbitrager or an investment banker to make deals quickly would take a toll on the company’s profitability.

Some observers say the only real solution is a change in the corporate culture of the firms. Srully Blotnick, a business psychologist in New York, said the firms need to reduce a destructive level of competitiveness that drives professionals to try to outdo each other, no matter what the cost.

“These cases aren’t about greed, they’re about overcompetitiveness,” he said. “These are obsessively competitive men who are constantly comparing how much money they’re making, like athletes in a locker room comparing their performances. And these guys hate to lose.”

Managements “have got to get across the idea that these values aren’t for most--not if you’re going to break the law,” Blotnick said.