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Inside traders' unfair advantage

By HR / June 16, 1986



THE federal authorities are charging on apace in their campaign against illegal insider trading in stocks. This move is useful and appropriate.

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Dennis Levine, a Drexel Burnham Lambert managing director, has pleaded guilty in the largest insider-trading case ever brought; now he is said to be ``cooperating'' with the authorities as their investigations continue. More cases are expected.

Four of the five young men alleged to make up another Wall Street insider trading ring have also pleaded guilty. And on another front, a federal judge has ordered a financier to forfeit $3.5 million in insider trading profits, the largest such penalty to result from a trial.

Insider trading involves profiting from trades in a particular stock on the basis of nonpublic information -- typically concerning a not-yet-announced takeover or merger plan.

Insider trading is illegal on the grounds that it is unfair to those who do not have insiders' information.

Modern computer surveillance techniques notwithstanding, insider trading is virtually impossible to eradicate without grievous damage to civil liberties. The Securities and Exchange Commission (SEC) and Justice Department are striving to control such trading to the extent possible, however, because each incident of insider trading is not only a breach of trust by those involved but a blot on the reputation for openness and fairness of the United States capital markets as a whole.

If the game is thought to be rigged in favor of a knowledgeable few, the SEC feels, investors will take their dollars elsewhere, to the ultimate detriment of the US economy.

Hence the current crackdown -- which is not being universally applauded. There is a ``market efficiency'' purist view that insider trading is bad only because it is illegal, and that most insiders are presumably not doing it.

If it were understood that insiders would be trading freely on the basis of their nonpublic knowledge, these purists believe, stock prices would quickly reflect that knowledge, and even the humblest investor, poring over the agate-type stock listings in the local newspaper, could see that something was afoot with this or that stock, and act accordingly. (Of course, under this scenario, the insiders still get a huge share of the goodies when the deal goes through.)

No one believes the Ivan Boeskys and Boone Pickenses of the world can be kept from having an information edge over the folks buying mutual funds at Sears. Some observers do feel, though, that if the SEC forced companies to disclose more information more expeditiously, the twilight zone of nonpublic information would be narrower and less tempting.

Also troubling to many is that the SEC seems to be widening the definition of insider trading (a matter of case law, not statute) to include not only those with a fiduciary relationship to a specific client but anyone with nonpublic knowledge. Some arbitrageurs are worrying that the SEC may start calling them in to explain themselves anytime an educated guess or on-target intuition pays off.

Of course, insider trading needs to be seen in the context of the financial environment. Clearly the Reagan administration's antitrust policies have led to more mergers and presumably more opportunity, at least, for insider trading.

The increased interest in trading in stock options -- more difficult to track and requiring less money in relation to potential profit -- and the vagaries of the United States tax code, particularly with regard to oil companies, are also factors.

Investment banking is enjoying a particular vogue at the moment. The best and the brightest from the business schools are heading in great numbers toward careers in ``doing deals,'' rather than as line managers for the nation's industrial corporations.

With Wall Street in a charging bull market even as farmers and manufacturers are facing trying times, if not disaster, the disparity between the true producers in the national economy and the mere manipulators seems all the more apparent.

But, alas, it has ever been thus. The annals of US business history include slick dealmakers like Jay Gould as well as those whose long-term investments helped enrich the whole country. Still others, such as Andrew Carnegie, were basically in the latter camp and yet went through periods of speculative investment.

Insider trading is a breach of trust -- not unlike the espionage cases that have garnered such headlines recently. A forceful, straightforward enforcement policy such as we have seen in these latest cases should enhance public confidence and work to reinforce investment houses' own ethics codes.

The Wall Street firms, for their part, will have to consider whether they have adequately inculcated in their employees a sense of honor and trustworthiness adequate to temper ambition, and a respect for not only the letter but the spirit of the law. That process clearly needs to continue.