Have Wall Street Firms Gotten Too Big to Keep Secrets?
The disclosure Monday of yet another major insider trading scandal raises anew the question of whether Wall Street can really keep a secret.
Some academics and law enforcement officials interviewed Tuesday criticized the big Wall Street firms for not doing enough to keep sensitive information from leaking out. They say mergers and acquisitions departments at the main investment banking firms have swollen so much in the past 10 years that hundreds of employees at each firm may have access to supposedly confidential information. And they question whether the firms really monitor whether their customers are involved in suspicious trading.
The Securities and Exchange Commission on Monday charged a 24-year-old trainee analyst at Morgan Stanley & Co. with leaking information on at least 25 pending mergers, leveraged buyouts and stock tender offers. The leaks were to a Taiwanese businessman who allegedly made $19 million in profits from trading on the confidential information.
The case is said to be the second-largest insider trading case ever brought by the SEC. It suggests that despite the wave of highly publicized SEC prosecutions of well-known Wall Street figures such as Ivan F. Boesky and Dennis Levine, illegal trading is still flourishing.
Gary Lynch, the SEC’s chief of enforcement, confirms that levels of suspicious trading are again creeping up after a lull immediately after the Levine and Boesky cases were filed in 1986. Lynch on Tuesday declined to comment on whether firms are doing enough to police themselves.
But Samuel L. Hayes III, a professor of investment banking at Harvard Business School, says the expansion of mergers and acquisitions departments has made it “very, very difficult for these firms to institute the kinds of detailed, continuous auditing and oversight that seems to be necessary.”
For the firms, increasing the size of highly profitable “M&A;” departments has been more important than maintaining limited access to highly confidential information, he says. He suggests that the case of Stephen Sui-Kuan Wang Jr., the Morgan trainee accused of insider trading, raises the possibility that there is now a “structural vulnerability” to leaks and illegal trading in the investment banking industry.
As the number of mergers and hostile takeovers burgeoned in the late 1970s, the big investment banking firms created separate M&A; departments, which quickly became the main profit producers for many of the firms. The departments advise and help raise financing for companies planning acquisitions, or that are trying to defend themselves against takeovers.
Morgan Stanley has an estimated 200 employees with access to confidential information on M&A; deals. Shearson Lehman Hutton says it has 70 investment bankers, which, combined with support personnel, brings the number of people with access to information in its M&A; department to well over 100.
But industry officials say that no matter how rigidly they try to prevent insider trading, there is little that can be done if an individual is bent on breaking the law.
William Fitzpatrick, chief counsel for the Securities Industry Assn. in New York, said: “The problem is that you can have the best procedures in the world, but if someone is bound and determined to do something dishonest, there’s no way to prevent it.” He added: “You can put all kinds of alarms and deterrents in banks, but people still rob banks. The best you can hope to do is catch them.”
One practice that has come under criticism this week is the hiring of large numbers of new college graduates in two-year training programs. The programs thrust the untried, would-be investment bankers into the maelstrom of merger and takeover planning, giving them access to a great deal of sensitive information. Enforcement officials have raised questions about why a 24-year-old trainee would have access to details of 25 of Morgan Stanley’s most sensitive pending transactions. Goldman Sachs, First Boston, Shearson Lehman Hutton and Paine Webber all have programs similar to Morgan Stanley’s, their officials confirmed.
The programs are viewed in part as a way of attracting low-cost help to do much of the routine work involved in assessing the value of transactions.
Stung by Criticism
Officials at these firms Tuesday declined to say whether they are going to review their programs in the wake of the Morgan Stanley incident. But one industry official said the fact that some employees are young and inexperienced doesn’t necessarily mean that they pose a greater risk of cheating.
The official noted that in prosecutions in the Levine and Boesky cases the individuals who have been convicted so far have been senior, well-known industry figures, not youngsters.
Morgan Stanley, stung by criticism that it may have been lax in guarding the secrets of its clients, on Tuesday asserted that it has tight procedures in effect that have been regularly reviewed and upgraded. A spokesman, Peter Roche, said that, after an earlier insider trading scandal at the firm in 1981, Morgan Stanley adopted stricter procedures that included more physical security for sensitive documents and stepped-up monitoring. Roche said additional steps have been added more recently, and they were reviewed last year both by the SEC and an outside law firm retained by the investment bank. He said the procedures were found to be “state of the art.”
The procedures range from a “Chinese wall”--rules meant to forbid M&A; staff from sharing information internally with the firm’s securities traders--to handbooks spelling out how to handle documents and telephone conversations. “What you have here is a system that in our case is reviewed by the SEC and our outside counsel and was found to be as good or better than any other firm’s on Wall Street,” he said.
Roche also disclosed that Wang and all other trainees were required to attend several classes and briefings on ethics and securities law. In addition, they were obliged to sign forms acknowledging that they were aware that it is illegal to disclose sensitive information.
But some enforcement officials say that even if illegal disclosures can’t be prevented, firms could do much more to detect suspicious trading once it has occurred.
“You don’t prevent it, you detect it,” said one SEC official who isn’t directly involved in the case. The official said firms could do more to check up on clients who have a pattern of making unusual trades just before major deals are announced. Instead, he says, firms in general seem reluctant to challenge good customers.
In the Morgan Stanley case, Fred C. Lee, the Taiwanese businessman who allegedly profited from the leaks, is said to have made many of his trades through accounts at Morgan Stanley as well as other brokerages.
Roche said the firm did notice unusual activity in Lee’s accounts and investigated. But he said Morgan’s compliance department dropped the investigation after deciding that the trades were legitimate. Morgan Stanley determined that “these were transactions that could have taken place based on public information.” It was only after SEC and New York Stock Exchange officials noticed a pattern of suspicious trading that the SEC investigation was launched, lawyers for the agency said.
Lee’s lawyer, Michael Perlis, said much of Lee’s trading could be attributed to information that already was public.
Charles Schwab & Co., the discount brokerage firm through which Lee is said to also have made some of the stock and options purchases, refused to answer questions Tuesday about whether the firm had detected any unusual activity by Lee.
