SEC Attack on Insider Trading Deserves Kudos

On June 18, 1815, Wellington defeated Napoleon at the Battle of Waterloo, which is in present-day Belgium. News of the victory, coming over land and sea by king’s messenger, was slow to reach the London Exchange where government bonds were traded.

But Nathan Rothschild, founder of his illustrious family’s British banking house, got his news by carrier pigeon and knew the British had won. Yet on the morning of June 19, he sent his men onto the floor of the exchange to sell, not buy, British government bonds. Other traders, believing Rothschild to have received news of a defeat, began to unload bonds also, and prices fell precipitously. Then, just before the correct news from Waterloo reached London, Rothschild again sent his men onto the floor, this time to buy.

So Rothschild won, but how many bondholders lost? What Rothschild did--manipulation by an exchange member--clearly would be illegal today, thanks to the Securities and Exchange Act of 1933, which set up our Securities and Exchange Commission. You might reflect on that fact as you follow the debate over insider trading that is going on now between Wall Street and Washington.

Five-Year Campaign

The SEC, as we know, is cracking down on insider trading--generally interpreted to mean dealing in public stock and bond issues on information not available to the public. It has charged investment banker Dennis Levine with having made more than $12 million trading on inside knowledge of companies involved in mergers. Levine denies the charges, which a federal grand jury is investigating, and a hearing is scheduled for today in U.S. District Court in New York. In another case, the SEC has charged five young Wall Streeters with profiting from inside information obtained through a law firm.

The cases continue SEC Chairman John Shad’s five-year campaign against people trading on confidential information that they obtain as a result of their position--whether as corporate officer or corporate printer, legal counsel or legal clerk. To Shad, a former Wall Street investment banker himself, such trading “benefits the few at the expense of the many and impugns the integrity of the securities markets.” For Shad, there is no question that it should be stopped lest investors lose confidence in the honesty of the markets.

Surprisingly, not everyone agrees. Shad and the SEC have come in for strong criticism, most notably from the Wall Street Journal and its sister publication, Barron’s Business and Financial Weekly.

Fulfill Original Mandate

These publications accuse the SEC of stretching the insider trading law to pursue a quixotic vision of equality of information. The critics lambaste the SEC for trying to protect some mythical “little guy,” who knows better than to try to play with the big boys in the marketplace anyway. Finally, say the critics, the SEC threatens to hobble the capital markets by stopping the sharing of confidential information.

What’s the truth of the matter? That the SEC and Shad are on the side of the angels. First of all, in seeking to encourage maximum availability of information, the SEC is fulfilling its original mandate, which was to remedy the abuses of the 1920s, when speculators secretly put together pools to manipulate such stocks as General Motors and RCA. The SEC’s remedy for secrecy at that time was disclosure.

And full and timely disclosure is the SEC’s demand today as it is faced with a whole crowd of sophisticates--investment bankers, arbitrage traders and the like--who are having an inordinate effect on the markets by such activities as putting companies “in play” or buying and selling stocks and options in advance of merger announcements. The SEC would not be dreaming if it saw at least the potential danger of manipulation in arbitrage portfolios put together to invest in takeover candidates.

The trouble with smart-money games in capital markets is that they lead to disasters affecting far more than the markets themselves. The games of the 1920s led, of course, to the market crash and Great Depression. And, lest we forget, the games of the 1960s, played by go-go mutual fund managers, led to the collapse of brokerage houses and tremendous losses for investors in 1970.

If the SEC were only trying to protect the “little guy” from a recurrence of such disasters, it would still be doing its job. But, in trying to assure the integrity of the markets, the SEC probably is thinking more of the major institutions, which control a majority of the market’s stocks and bonds and account for the great majority of its trading.

Manipulation and its inevitable disastrous aftermath would have extremely serious consequences for the corporations whose stocks those institutions hold, which is to say for a goodly chunk of the U.S. economy. Shad and the SEC deserve applause.