Insider trading: what it is, why it's wrong

Inside trading: Loosely defined, an insider profits from access to material, nonpublic information.

Michael Levine, the Drexel Burnham Lambert merger specialist caught by the Securities and Exchange Commission, had access to confidential information about pending mergers. Mr. Levine had a trust relationship, as a lawyer does, with merger clients. He broke that trust, and violated securities law, by trading on that information and selling it to Ivan Boesky.

Congress has tried to narrow the definition of an insider, but the Securities and Exchange Commission likes to keep it vague; this keeps people from slipping through loopholes. It also makes it tough, however, to catch an inside trader.

The stock exchanges have sophisticated computer systems for detecting unusual trading activity that occurs before corporate news breaks. But connecting the inside trader with specific information at a specific time is difficult. Most tips are passed by word of mouth.

Often the SEC gathers enough circumstantial information (phone records, trading records, etc.) that someone confesses or fingers another in exchange for full or partial immunity from prosecution.

The SEC enforcement efforts are to ensure that the formation of capital takes place in a fair market.

If the 1 in 5 Americans who owns stock, or the millions with retirement funds, perceive that they are at a distinct disadvantage in the market, this may curb investing. A less liquid market could increase the cost of raising money and slow economic growth. Arbitrage:

Mr. Boesky was the dominant arbitrage player on Wall Street. But arbitrage is not illegal. Commonly, it's the practice of speculating on the outcome of a publicly announced merger, tender offer, bankruptcy, or company restructuring.

``Arbs'' disturb corporations because they're not ``loyal'' shareholders. They analyze a deal, then may snap up millions of shares in expectation of a better offer. This can facilitate a hostile takeover.

Since information cuts the risks involved, arbs pride themselves on ferreting out news about a takeover before it is announced. But speculating ahead of deals eventually led Boesky to buy inside information from Levine. Boesky went from being an arb to an insider.

--D.C.S.