Why Investigation of Bush’s Stock Sale ‘Just Didn’t Pan Out’

What Lisa Meulbroek best remembers about the day in 1990 when she handed her four-page report to two young enforcement lawyers at the Securities and Exchange Commission was their disappointment.

Meulbroek was working in the SEC’s Office of Economic Analysis at the time. Fresh out of MIT, she had just done her doctoral dissertation on insider stock trading. The SEC lawyers, excited about a hot insider-trading case they had been pursuing for several months, had asked her to analyze trading patterns in a small Texas oil-and-gas exploration company.

Their target: George W. Bush, son of the president of the United States.

“There was just this sense among the enforcement lawyers that this was going to be an opportunity for them to have a fairly high-profile case,” Meulbroek, who now teaches corporate finance at MIT, recalled in an interview Friday.

“And it just didn’t pan out.”

Indeed, Meulbroek’s report was instrumental in turning the tide in Bush’s favor 11 years ago this month--a watershed moment that helps explain why, after four months of investigation by apparently gung-ho lawyers, the SEC closed the case on Bush’s sale of 212,140 shares of Harken Energy Corp. Bush was a director of Harken.

The SEC did not exculpate Bush. Rather, its investigating attorneys concluded only that they lacked sufficient evidence to prosecute him for illegality or fraud.

Meulbroek’s analysis determined that a critical event necessary to justify civil or criminal charges of insider trading simply hadn’t happened: Harken’s stock price did not collapse, as investigators thought it had, when the company announced a record $23.2-million loss two months after Bush’s stock sale.

Until today, not even Meulbroek is certain just why the stock didn’t tank--one of the enduring mysteries in the case. But she and others who were then at the SEC say that her July 7, 1991, conclusion was the beginning of the end of the enforcement division’s File No. MHO-3180, the SEC’s investigation of George W. Bush.

A detailed review of more than a dozen internal SEC memos and letters and hundreds of pages of Harken documents that the agency amassed in the case, along with interviews with Meulbroek and the broker who told the SEC he initiated Bush’s stock sale, leave another crucial question unanswered:

Who stepped up to buy Bush’s stock, at a time when Harken was bleeding red ink and Bush was trying to raise cash to pay off the loan he used to buy into the Texas Rangers baseball team?

“Bush didn’t even know who the buyer was at the time. He still doesn’t know. No one but me ever knew who the buyer was. And no one ever will know,” said Ralph Smith, the now-retired Los Angeles institutional trader who represented that buyer in the sale.

“It’s nobody’s business. There isn’t anything there. And nothing was done wrong.”

Bush has said repeatedly through the years that the SEC’s investigation was thorough and that it cleared him of any wrongdoing, beyond the technical violation that he reported the sale to the SEC eight months late.

It was that tardy report filed in March 1991 that caught the eye of the enforcement division’s lawyers and launched the SEC probe on April 5 that year, according to the agency’s internal documents in the case. The SEC has been releasing some of those files, stack by stack, to the Washington-based Center for Public Integrity and to newspapers, including The Times, under the Freedom of Information Act.

The SEC’s probe has been dogged by skepticism and partisan challenges almost from the start. The agency’s chairman at the time was Richard C. Breeden, a staunch supporter of Bush’s father, who appointed him to the post.

Breeden has maintained that he distanced himself from the staff’s investigation, giving the agency’s lawyers a free hand. And the internal documents released so far show no indication of political interference or pressure from the top.

The documents chronicle a probe spanning 4 1/2 months. It included at least four lawyers in the SEC’s enforcement division, led by Assistant Director Herbert F. Janick III, who is now general counsel at UBS PaineWebber Inc.

Those SEC lawyers, most of whom have left the agency for private practice, still decline to comment on the case.

In recommending that the case be closed, the three investigating lawyers stated in a memorandum to their division chief: “The staff’s investigation indicates that there is insufficient evidence to establish three necessary aspects of a possible insider trading case.”

The investigators never interviewed Bush. But they extensively questioned Harken’s chief in-house lawyer, the company’s outside counsel and Bush’s personal lawyer, who together handed over boxes full of internal memos, board meeting minutes and other confidential correspondence.

The SEC lawyers also questioned stock trader Smith for more than two hours in a conference call, and Smith turned over copies of most of his notes on the sale.

“The SEC did their job,” Smith said in an interview last week, adding that it was the only time in 25 years as an institutional trader that he had been contacted by SEC investigators.

“I think they went further than they needed to just to make sure they crossed all the Ts and dotted all the I’s. This was the president’s son, after all.”

Put In Call to Bush

Smith was sitting at his desk at Sutro & Co. on the 34th floor of the Arco Towers in downtown Los Angeles on June 8, 1990, working the phones. He was making “cold calls” for a client when he found himself speaking for the first time in his life to a president’s son.

The calls were based on research Smith had done on Harken after one of his clients--”an institutional investor,” is as far as he’ll go in identifying the buyer--expressed interest in buying a large block of Harken shares. He said he tried several other major shareholders before calling Bush.

The mystery over the buyer’s identity raises the question of whether someone was doing Bush a favor, and why. But securities law doesn’t require a buyer to be identified except when acquiring more than 5% of a company or representing a company director or officer.

Through SEC filings, Smith said, he had learned that Bush was among the Harken directors who had reported large share holdings in the company. Bush was hardly the largest; a Saudi Arabian businessman and the Harvard University endowment fund, for example, each held millions of shares, SEC files show.

But, Smith recalled, he thought he would take a shot at the president’s son, and he called him at the Texas Rangers’ front office.

“Mr. Bush said he might be interested [in selling], but he said he had to check out some things first and that I should call back in a couple weeks. I just assumed he had to check out if he could legally sell.”

Two weeks later, Smith called back, and Bush “said he checked it out and he’d be willing to sell a block of stock,” Smith recalled. “He told me how much he had to sell, and that was that. I called the company’s counsel to make sure it was clean stock, and we made the buy.”

“His trade was smooth as silk,” Smith added, calling Bush “a very nice man” and “a straight shooter.” Smith said he has been an ardent Bush supporter ever since the deal.

Ten months passed before Smith heard from the SEC. The enforcement division had just learned of Bush’s late filing of a Form 4 that reported the June 22, 1990, sale eight months late. He was required to report it by July 10.

That and other details had aroused the SEC’s suspicions. One internal SEC “confidential advice memorandum” explained:

“This investigation arose from Enforcement’s concern as to several facts surrounding this stock transaction. Bush sold a large portion of his Harken stock (approximately two-thirds) at approximately $4 per share six weeks before the public announcement of a company [restructuring] which resulted in a significant decline in its stock price.

“Immediately following the announcement of the reorganization, the price fell to 2 3/8 per share.”

That’s where the investigation began. That’s also where it would end.

Directors’ stock, like the more than 300,000 shares Bush held at the time, is subject to an array of restrictions. For example, securities law barred Bush from soliciting a buyer for his stock.

Corporations also have internal rules that prohibit directors from selling stock just before or after significant events, such as announcements of earnings, mergers or internal reorganizations that could affect their stock price.

Those rules exist in part to avoid illegal trading based on a director’s inside knowledge of significant upcoming events. And among the three key elements the SEC would have to prove to justify action against Bush is that he deliberately acted outside the law or the rules with motives of personal gain.

It was the first of the elements that the agency realized it couldn’t prove, SEC documents indicate.

In fact, after he spoke with Smith the first time, the SEC case files show, Bush contacted Harken’s chief counsel seeking a formal opinion on whether he could legally and properly sell his shares. The in-house counsel called the company’s outside lawyers for a second opinion.

“Based on the information they had,” one SEC memo stated, “they saw no reason why Bush could not sell his stock.” The company’s lawyers also checked with Harken’s chairman and another key board member who was a lawyer and major shareholder.

None of them, the SEC later concluded, “knew of any inside information that would prevent Bush from selling his stock, and neither of the [corporate counsels] objected to Bush’s proposed sale.”

In light of that, the memo added, “it would be difficult to establish that, even assuming Bush possessed material nonpublic information, he acted with ... intent to defraud.”

The second element for the SEC to prosecute the case focused on what Bush knew and when he knew it before the stock sale.

Several internal SEC memos said Bush had seen only one document during the first week of June--three weeks before the sale--that forecast a $4.2-million loss in the quarter that would end that month, a loss consistent with Harken’s performance in preceding quarters.

In the end, two months after Bush’s sale, when the company released its second-quarter 1990 report, it showed the far worse $23.2-million loss, which reflected write-downs related to the accounting of Harken’s sale of a chain of Hawaiian gas stations that the SEC had ordered Harken to restructure.

If Bush knew the extent of those looming losses before selling his stock, the SEC investigators reasoned, it would flag possibly improper inside trading. And there is at least one internal Harken document the SEC obtained during its probe that suggests Bush did know a big write-down may be coming.

The investigators had the minutes of a meeting of the audit committee of Harken’s board of directors from June 11, just 11 days before Bush’s sale.

Bush was a member of the audit committee and present that day when a representative of Harken’s outside auditing firm told the members that “there was a potential write-down that might occur” during the quarter. That write-down “could be potentially significant, but the amount is not identifiable at this time.”

For weeks during this period, company documents, including minutes from directors’ meetings, warned in general terms of Harken’s worsening financial condition and a liquidity crisis.

Ultimately, though, not even that mattered.

It was Meulbroek’s report on what happened to Harken’s stock when the company announced its big second-quarter losses on Aug. 20 that tipped the scale.

If investors didn’t view that report as “materially” affecting the company, and show it by selling off shares and driving down the price, there would be no case, the SEC lawyers concluded. And Meulbroek found that, in the end, it didn’t.

Harken’s stock opened at $3 a share on Aug. 20, her report stated. The earnings report came out at 9:34 a.m. that day. For three hours, nothing happened. Then, as the SEC’s initial investigative documents indicated, the stock nose-dived by 21% in the afternoon, closing at $2.37.

But Muelbroek, reasoning that Harken was a thinly traded stock, decided to analyze the stock’s movement on the following day as well, which was standard practice at the time. She discovered that the stock rebounded to recover all its losses of the previous day, closing at $3 on Aug. 21.

“Unless another reason exists for the price rebound on Aug. 21, the most likely explanation for the increase is that investors overreacted to the earnings announcement, recognized their error, and corrected it,” her report said. “Such price reversals are rare but not unheard of.”

The bottom line: The announcement had no “material effect” on the stock. So, even if Bush knew it was coming two months before, that knowledge was worthless, Meulbroek’s findings concluded, although she said Friday, “We still don’t know what caused the stock to rebound that day.”

In one of their final memos on the case, the SEC lawyers ended by citing Meulbroek’s report, then stated, “For the reasons set forth above, we recommend that this matter be closed.”

By the end of that year, Harken’s stock had tanked, selling as low as $1 a share. But in the interim, Saddam Hussein had invaded Kuwait, Bush’s father was mobilizing for the Persian Gulf War, and the only ace in the hole for Harken was an exclusive contract to explore for oil off Bahrain--in the heart of the war zone.