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Insider Trading: The Street's Noxious Weed

By Gene Marcial One of the oldest games on Wall Street is again front-page stuff. It's obvious that those who persist in illegally trading on inside information haven't been scared off after the scandals of the 1980s when the heralded "Masters of the Universe" -- Mike Milken, Ivan Boesky, and hordes of other smart Wall Street investment bankers and traders -- were handcuffed by then-U.S. District Attorney Rudy Giuliani and sent to prison.

Why is it that government regulatory agencies, despite all the laws and reams of regulations against stock fraud, seem ever helpless and ineffective in preventing or curbing such stock manipulation and fraud?

TANTALIZING PROSPECT. The recent headlines on the arrest of ImClone ex-CEO Sam Waksal on charges of insider trading bring back memories that Wall Street would rather forget. Still, the Waksal case is no surprise to observers of the Street.

Apart from the investment bankers and brokers who've been jailed and fined enormous sums of money, scores of other CEOs and corporate executives before Waksal had also succumbed to the tantalizing prospect of enriching themselves from illegal insider trading -- buying and selling stocks based on information materially affecting a public company that hasn't been publicly disclosed.

In my 1995 book, Secrets of the Street -- The Dark Side of Making Money, I noted that many years after the Milken and Boesky scandal, despite what the government said it did -- a "thorough reexamination of the rules and practices of Wall Street" -- it's still business as usual for Wall Street insiders. "Illegal insider trading abounds," I wrote then. "It happens daily, hourly, every minute of every day, and sometimes on Sunday, too."

STREET WALKERS. The book noted that since before the days of J.P. Morgan, insider trading has been rampant, and it still is: "Insider trading and market manipulation are still the most zealously desired play in the financial world."

Indeed, it could be said that insider trading is the second-oldest profession. After all, people who have access to inside information and who sell their integrity for illegal profit are financial prostitutes. They undermine public trust in one of the basic tenets of capitalism: Maintenance of a level playing field in the capital markets.

The Waksal case underscores the feeble effects of the Financial Disclosure rule, known as Reg FD, that the Securities & Exchange Commission imposed in the hope of preventing any delay or nondisclosure of relevant, material information. Reg FD requires that companies publicly report any important corporate development -- immediately. That has caused a blizzard of information from public companies.

EXCLUSIVE PRESERVE. But in many cases, Reg FD has tended to confuse rather than enlighten. The public isn't helped much because the information dished out is often inconsequential or at best, incomplete. Corporate executives are precluded from publicly discussing anything they haven't publicly announced. The result: Less information is shared with the public.

Privately, however, corporate executives continue to reveal or leak important information to relatives, close friends, or favored partners. So the basic ingredients for insider trading are still there, except that they've become even more of an exclusive preserve -- accessible only to those blessed by the CEO or top brass.

From what has been reported in the media, this seems to have been the case at ImClone. The Food & Drug Administration had been back and forth with the drug company on the agency's process of looking at ImClone's application for approval of its Erbitux anticancer drug (see BW Online, "What ImClone Knew: Don't Ask Congress").

AGENCY DISCLOSURE. Since the FDA had raised questions about Erbitux, insiders were aware of what the agency was thinking. Under Reg FD, ImClone officials weren't supposed to discuss the FDA's concerns until ImClone disclosed it publicly first. But analysts and investors weren't told of the FDA's concerns, while ImClone insiders were selling shares.

Two thing are wrong with this picture: The FDA always keeps anything it does very close to its vest. Yet it necessarily telegaphs its thoughts or concerns to the company whose product it's reviewing. Why shouldn't the FDA inform the public as to the stages of its approval process at the same time that it discusses them with corporate officials? That would truly be fair disclosure -- the very essence and purpose behind Reg FD.

The second point: Where were the watchdogs of the Nasdaq and the SEC when Waksal's two daughters, his father, and his sister were selling huge blocks of ImClone shares? Shouldn't somebody have rung a warning bell and raised a red flag? The same was true when top Enron execs started selling heavy loads of its shares way before that company's scandal exploded into public view. Ditto of insider selling at other big companies now under scrutiny.

FASTER DISCLOSURE. The SEC is expected to come out soon with another set of rule changes on financial reporting by companies and corporate executives in the wake of the Enron debacle. Among these "reforms" is requiring companies to speedily file their annual reports and details of trading of company stock by insiders.

Another proposed change: Require companies to disclose important events as they occur, rather than weeks or months later in their quarterly or annual reports. If such a rule had existed, ImClone would have been required to immediately disclose what the FDA had been seeking on its Erbitux application.

But such a rule should also require the FDA or other regulatory agencies that have the power of life or death over public companies to do the same -- at each stage of their approval processes.

The tragedy is that with all the brainpower at all the regulatory agencies and in Congress, and despite all the rules and laws on the books, illegal insider trading goes on. Marcial is BusinessWeek's Inside Wall Street columnist

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