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A Bigger Stick Against Inside Traders

News: Analysis & Commentary: PROSECUTIONS


Will faster tracking and more criminal charges stem the tide?

In March, Michael G. Sargent got some disturbing news: The Securities & Exchange Commission had filed civil charges alleging insider trading against the Massachusetts dentist. But the real shocker came on May 7, when the U.S. Attorney in Boston indicted Sargent on charges of lying to the SEC and reaping illegal profits.

The government alleges that Sargent learned in late 1994 that Mark IV Industries Inc., an electronics conglomerate, was preparing to buy Purolator Products Co., an air-filtration and auto-parts company. The alleged tipster: a friend whose business partner was a Purolator director. Now what seemed like an easy $140,000 in trading profits from buying and selling 20,400 Purolator shares could land Sargent in jail (table). Conviction carries a possible 10-year prison term and a $1 million fine. Says Gary C. Crossen, Sargent's attorney: "I'm confident my client will be vindicated." A civil case is pending against Sargent's friend. The Purolator director is not implicated.

Chasers of the fast buck, take heed. As insider trading continues to mushroom, the chances of getting caught--and severely punished--are rising. Using a nonpublic tip to trade stock may seem like a harmless way to turn a quick profit. But federal prosecutors increasingly are targeting alleged insider traders for criminal charges and prison sentences, in addition to SEC civil action. "Nationwide, there's criminal law enforcement interest in these cases. We're starting to work more closely with federal prosecutors," says William R. McLucas, the SEC's enforcement chief. Of course, regulators catch only a small portion of insider traders. And while there are no hard statistics on the trend, McLucas says criminal cases nationwide are clearly on the rise.

Hardly a week passes without word of more insider-trading probes. On May 7, the Pacific Stock Exchange asked the SEC to investigate trading patterns suggesting that a dozen investors with ties to toymaker Hasbro Inc. may have benefited from insider information. The probe began after a surge in risky call options before Mattel Inc. announced its failed bid for Hasbro in January. Two days later, the SEC fined a half-dozen people accused of illegally trading on leaks about Microsoft Corp.'s failed plans to buy Intuit Inc. in late 1994. An Intuit spokesman says the SEC found no wrongdoing by the company or its officers. Hasbro says no company executives have been implicated there, either.

STEADY STREAM. Government numbers can only hint at the pervasiveness of insider trading. The SEC brought 45 cases in 1994 and the same number in 1995, slightly exceeding the previous peak of 43 in 1989. More than 9,000 buyout deals were done last year, up 20% from 1994. And with mergers running at about 1995's pace, regulators are girding for a steady stream of cases, since high merger activity generally spawns bouts of insider trading.

Improved detection means more people are likely to get caught. The self-regulatory organizations, including the National Association of Securities Dealers, New York Stock Exchange, and American Stock Exchange, have spent millions on sophisticated surveillance systems that automatically spit out unusual trading patterns. The NASD's new system can isolate suspicious trading in days rather than months. Last year, the NASD referred 113 cases to the SEC for possible insider-trading scrutiny, a 24% increase over 1994.

Still, a lot of investors do get away with it. The perpetrator is most likely to be an executive or family member who tips off friends. Not atypical: Thomas J. Farrell, an ex-Gannett Co. executive who pleaded guilty in Manhattan's U.S. District Court in March to apprising friends about a merger of two thrifts. The SEC settled charges with five others involved in a civil case. "The law applies to anyone--whoever it is--who hears inside, nonpublic information, even from a `friend of a friend,"' says Massachusetts U.S. Attorney Donald K. Stern.

Which is not to say the financial community has been abstaining. On Apr. 25, for instance, Edward W. Eizman, a Las Vegas insurance man, pleaded guilty in U.S. District Court in Manhattan to using tips from a Wall Street lawyer to make insider trades in 1994 and 1995. The trading netted him $132,000.

One reason investors are willing to chance it: The SEC's civil penalties--returning ill-gotten gains, a fine, and a promise not to do it again--aren't all that strong a deterrent. That's why McLucas and the self-regulatory organizations are helping prosecutors bring more criminal cases. To win convictions of insider trading, prosecutors must prove an intent to defraud--a tougher standard than the mere proof of insider trading required in civil cases. But that's not stopping the feds. In San Francisco, the SEC meets quarterly with prosecutors to develop cases. "We have several major cases going on right now," says Michael J. Yamaguchi, U.S. Attorney for the Northern District of California.

NUMBER CRUNCH. One ongoing probe involves California Micro Devices. On Dec. 19, Ronald A. Romito, its former chief accounting officer, agreed to plead guilty to one criminal count of insider trading. He sold 7,500 California Micro shares in May, 1994, while aware that the company had overstated its quarterly product shipments and filed false accounting reports. As part of his plea deal with prosecutors and the SEC, Romito is returning $86,000 in illegal stock-sale proceeds and paying fines and interest of $14,153. He also agreed to cooperate with the investigation of possible financial shenanigans at the semiconductor maker.

Punishment can be more severe. On May 3, an insider-trading scam involving AT&T stock proved costly to Joseph Cusimano, a 46-year-old former toy-company exec, and Robert Allen, a 59-year-old retired telephone-company engineer (no relation to AT&T's chairman). Judge John S. Martin Jr. of the U.S. District Court for the Southern District of New York sentenced Cusimano to 21 months in prison and a $1 million fine. Allen got four months in jail and a $50,000 fine.

The feds are hoping that beefed-up regulatory surveillance and stiffer sanctions will finally stem the tide. "The investing public...has the right to expect that those with insider information won't have an unlawful advantage," says U.S. Attorney Stern. Jail terms instead of wrist slaps may send the message that insider trading is a serious crime.By Michael Schroeder and Any Barrett in WashingtonReturn to top

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