SEC aims high in crackdown on insider trading
He was known as ``Mr. Diamond.'' He is said to have made lunchtime forays to public phone booths to conceal his trading in accounts held by a Bahamian bank. His biggest score is alleged to have been a cool $2.7 million in May 1985 when R. J. Reynolds bought Nabisco Brands. In the largest insider-trading case ever, the Securities and Exchange Commission alleged earlier this week that Dennis B. Levine, a Drexel Burnham Lambert managing director, had pocketed some $12.6 million in illicit profits since 1980 by using confidential information about pending mergers. The SEC charges Mr. Levine profited from 54 stock and option trades over the last 5 years while working at four Wall Street firms.
SEC-watchers say the Levine case is significant not only for its size but for its place in the framework of commission enforcement efforts. It represents what may be an opening salvo against insider trading based on the merger mania of the past few years.
SEC enforcement chief Gary Lynch said last November he was ``troubled'' by heavy trading in companies labeled as takeover targets. ``There is something going on in the market, and we intend to get to the bottom of it,'' he said.
Commission officials are hinting that more major insider cases will soon be made public. In fact, it is generally believed that takeover-related insider trading is rife on Wall Street. Analysis of Levine's trades shows that only about half of his alleged insider trades had anything to do with his normal merger duties.
This is prompting speculation that some arbitrageurs whom Levine is reported to have had frequent conversations with may also be under investigation by the SEC.
Former commission officials say the agency is too understaffed to catch most trading culprits. But a few selected cases can ``reinforce the SEC's view of appropriate conduct on Wall Street,'' one securities lawyer says. This tactic may be the best use of limited resources.
``The reality is that there are 100 to 200 individuals in positions on Wall Street with comparable opportunities [for insider trading]. If the SEC can stop one, there's a broad deterrent impact,'' says Joel Seligman, a professor at George Washington University's National Law Center.
Wall Street brokerages (none of which were charged in the Levine case) are examining their internal controls. Merrill Lynch is reviewing trading records of investment banking employees. Drexel has hired an outside company to review its trading controls.
Most firms discourage trading by employees and require all trades to be reported to the firm. When brokerages do catch workers in illegal activities, it often goes unreported. Management usually ``just gives them the boot,'' says Perrin H. Long at Lipper Analytical Services.
The Levine case and other recent cases blunt criticism that the SEC only goes after the small insider profiteers such as financial printers, secretaries, etc.
``Taken together with the First Boston case, it's indicative of the harder look the SEC is taking at major investment banking firms,'' says John Olson, securities-law partner at Gibson, Dunn & Crutcher in Washington.
Earlier this month, First Boston Corporation, another major investment banking firm, agreed to give up $132,138 in profits and pay a $264,276 fine (double the profit) for trading based on nonpublic information. That is a minor sum for a firm that trades billions of dollars daily. But it was the largest fine levied under the Insider Trading Sanction Act of 1984.
The SEC charged the firm had breached the ``Chinese Wall'' that separates information known to the corporate finance department from the trading department.
In January, Cigna Corporation sought First Boston's advice about adding $1 billion to its casualty loss reserves. A First Boston trader heard about it and sold Cigna stock from the firm's portfolio, according to the SEC. First Boston's president called it an ``inadvertent'' violation of its restricted-list rules.
When an investment bank has a business relationship with a corporation, its name goes on a list that prohibits trading of securities in that firm. Cigna was on the list, but the trader apparently did not see it. First Boston settled the case without admitting or denying guilt.
Mr. Seligman at George Washington University sees the First Boston case as part of an effort by the SEC to close a legal loophole created by the Walton v. Morgan Stanley case in 1980. That earlier case appeared to allow investment banks greater leeway in using nonpublic information to trade securities.
Finally, the Levine case and an earlier case point to improving surveillance by the stock exchanges and the SEC's beefed-up overseas sleuthing skills. In February, a group of overseas investors surrendered $7.8 million in profits allegedly gained by trading on confidential information about Santa Fe International Corporation.
Is insider trading really harmful?
``It can have direct and harmful effects on market participants, especially when you're dealing in options,'' says John Sturc of the enforcement division of the SEC. He points out that in the Santa Fe case several professional traders were forced into bankruptcy.
Some free-market enthusiasts contend that chasing insider trading is a waste of government resources. Let stock prices reflect all information, inside or not, they argue. But one securities lawyer likens this to a poker game where some players have aces up their sleeves. As a consequence, he says, fewer people will want to play.
Mr. Sturc at the SEC concurs: ``Insider trading goes to the heart of the perception and reality of fairness in the market place. For capital to be formed, participants must be assured they will have equal opportunity to obtain the benefits -- or incur the risks.''