Jefferies Case Widens Scope of Insider Inquiry : Regulators Scrutinizing the Mechanics of How Mergers Are Effected

The case against Boyd L. Jefferies, chairman of the Jefferies & Co. securities brokerage, represents a dramatic expansion of the 10-month-old insider-trading investigation to include other kinds of securities law infractions and may lead authorities to other high-level Wall Street officials who have broken a variety of trading laws.

By providing a concrete illustration of the way that investors can secretly and systematically work with brokerage firms to circumvent the rules, securities law experts said Thursday, the case may also inspire Congress to tighten rules governing disclosures of stock holdings.

Federal prosecutors and Securities and Exchange Commission officials have repeatedly described their interest in exploring other kinds of securities law violations since last May’s arrest of former investment banker Dennis B. Levine touched off an investigation into illegal swapping of stock information.

‘Parking’ Arrangement

But the inquiry had largely remained focused on the principal subject, Ira L. Sorkin, former SEC regional director in New York, said. “Now they’re looking at a whole new areas--net capital requirements, disclosure of stock positions, record-keeping. They’re looking at the mechanics of how mergers are effected. That makes it a very important broadening.”

Authorities’ willingness to bring felony charges in the Jefferies case also indicates how seriously they consider such violations, the experts said.

In the Jefferies case, authorities found that arbitrageur Ivan F. Boesky and Jefferies had orally agreed that the brokerage executive would buy stocks from Boesky, then later sell them back to him. This “parking” arrangement enabled Boesky to buy more stock with borrowed money than he was legally permitted to do under the SEC’s so-called net capital requirement rules.

Alan Bromberg, securities law expert at Southern Methodist University, said securities authorities have long been interested in the way arbitrageurs work behind the scenes with “block traders” like Jefferies. The arbitrageurs, who speculate in stocks involved in takeovers, often turn to firms like Jefferies’ to buy huge amounts of stock when trading is halted on exchanges or when they want to trade in greater secrecy.

Such huge-scale trades can quickly move stock prices up and down, yet the investors “do not have to disclose what they own, what they paid for it, or who’s in a investor group with them,” Bromberg said.

Authorities have not been able to explore such relationships very well, he said, adding, “Even if you’ve got your hands on documents that set out the trades, it’s hard to prove anything’s going on.”

‘You Can Be Lost’

But Boesky, who has cooperated with authorities since settling SEC charges last November, apparently tipped off prosecutors to the oral agreement with Jefferies--and perhaps also to many other arrangements that may soon come to light. “Without that kind of guide, you can be lost in a pile of documents,” Bromberg said.

A detailed, highly publicized case such as Jefferies’, Bromberg said, may provide enough evidence of such “institutional” abuses that Congress may tighten up rules to prevent takeover violations. It might, for example, require investors to disclose their holdings in a stock when they have amassed a 2% stake, rather than after purchasing 5%, the current disclosure threshold.

Or they may change securities law so that investors are required to make their disclosure of such holdings within one or two days of reaching the threshold, rather than the current 10 days. Increasing the amount of information available to others in the market this way would presumably help them to better defend their interests against the maneuverings of takeover stock specialists.

A second illegal scheme revealed in the Jefferies plea was a classic market manipulation. Jefferies purchased several million shares of stock for a securities underwriter to help the underwriter raise the stock to a certain target price by the date the underwriter’s client was planning to offer its block for sale.

‘More Direct Harm’

Such manipulations “create more direct harm than insider trading,” said Helen Scott, securities law professor at New York University. “People buy a stock at a falsely inflated price, then get hurt when it falls. This is real fraud.”

She said the infractions uncovered in the Jefferies case may in some sense be more dangerous than insider trading violations, because the wrongdoers “are acting in their institutional roles. They’re not individuals violating their duties to their organizations.”

Observers said Jefferies may know of violations by other highly placed industry figures because of the central position he has held in the world of corporate takeovers. Prosecutors said that Jefferies is continuing to cooperate with their investigation.

“This guy sat in the center of the takeover game; he could see the whole landscape,” a former federal prosecutor said. “You’ve got to believe he knows lots, and is willing to tell it to minimize his punishment.”