A message to Wall Street
THE case of Ivan F. Boesky gives new meaning to the phrase ``information economy.'' Mr. Boesky, whose settlement with the Securities and Exchange Commission was announced late last week, is estimated to have made $50 million in illegal profits by trading stocks on the basis of inside information. The $100 million penalty assessed him was the largest ever ordered by the SEC.
The penalty sends an important message to Wall Street.
Acting on tips from former Drexel Burnham Lambert managing director Dennis B. Levine, Boesky bought stock in companies that only a few people knew to be targeted for acquisition. When the takeover bid was announced, the stock price would rise, and Boesky would sell his holdings, making a bundle.
He would also thereby deprive the original owners of the stock, who would not have sold so cheap if they knew how the price would rise, of some of their rightful gain. The knowledge - or well-founded suspicion - that such trading is going on weakens public confidence in the capital markets, which in turn has its deleterious effects on the economy as a whole.
And this is why insider trading is illegal.
There seem to be many shades of gray on Wall Street, and not just in the flannel suits so many of those in the securities industry wear.
When does information become ``public''? And what sort of responsibility does anyone with nonpublic information have, anyway - to his employers, the investing public, or anyone else?
Some advocates of extreme laissez faire policy would note, for example, that Boesky did not betray a fiduciary responsibility to a client - as Mr. Levine, for instance, did. But by trading on nonpublic knowledge, he disturbed the equilibrium of the marketplace as surely as Levine did.
And given that Ivan Boesky has been so strongly identified with arbitrage - the practice of buying stocks in one market and selling them in another for a slight price advantage - it is worth noting that many Wall Streeters have had quite successful careers in arbitrage while maintaining strict policies against trading on nonpublic information and other dubious practices.
Historically, though, Wall Street has not had much of an internal restraint mechanism. Regulation has developed only as certain abuses have been identified; meanwhile, investors have tended to try whatever scheme they could think of to make money, until and unless it is outlawed - and as we see, even that doesn't always stop everyone.
The small investor, particularly on US stock exchanges, is much better protected from abuses today than was the case in decades past. In the global capital marketplace, however, control of insider trading is necessarily going to be a relative thing. Those close to Wall Street and other financial centers are presumably always going to have an information edge on the proverbial ``little guy'' out in Anytown, USA. This is one of the reasons for the institutionalization of the securities industry and one more argument for small investors to protect themselves by investing in mutual funds rather than single issues.
But a case like that of Ivan Boesky - expected to widen soon to include a number of other investment houses - is sending shock waves through the securities industry. It shows how federal authorities can use a good, strong case against an inside trader to give a clear signal to the investment community about what is unacceptable.
Several specific steps to control inside trading suggest themselves:
Beefed-up congressional appropriations for the Securities and Exchange Commission to give it as much help as possible to do its work effectively.
Keeping up the pace of the commission's investigations.
Tougher SEC policies on disclosure of plans for mergers, acquisitions, and other such deals. The less time information remains in the shadowy ``nonpublic'' realm, the less temptation there is for investment bankers, lawyers, journalists, financial printers, and others to trade on it unfairly if not illegally.
Greater efforts by investment houses and other firms to instill a strong sense of ethics in their employees, particularly the younger ones who arrive on Wall Street with lots of ambition but a paucity of moral sense. (Many of those tripped up in the insider-trading scandals of the past year have only been in their 30s; this may mean that older, established securities professionals know not to do such things - or then again it may mean that they know not to get caught.)
Vigorous enforcement by the federal authorities of the insider-trading laws is important, and is a good investment in maintaining public confidence in the fairness of the capital markets.