Not Quite Cricket In The Cityby
The pattern is all too familiar. For no apparent reason, a company's share price skyrockets on the London Stock Exchange and its trading volume surges. Alarm bells ring at the exchange, which demands an explanation. Within hours, a major announcement--the company is in merger talks or is planning a share buyback--reveals what the excitement was all about. And embarrassed exchange officials begin yet another investigation into why everybody and his brother had the news before they did.
London's dirty little secret is that share prices routinely spike in the four or five trading days before major corporate announcements. Twice in six months, unusual trading in the shares of investment bank S.G. Warburg Group PLC forced it to reveal talks with a merger partner. Two other merchant banks, Kleinwort Benson Group PLC and Smith New Court PLC, likewise have had to announce takeover discussions prematurely. British oil company Lasmo, paper manufacturer Portals, tobacco company Rothmans International, and even Sleepy Kids, the tiny firm that licenses a cartoon character created by the Duchess of York, all had pre-news share-price hikes in the past nine months. All deny involvement in any leaks and are unable to explain how they occurred. And recently, several banks were suspected of short-selling Eurotunnel shares, some on the London Stock Exchange, in advance of a new stock issue.
Certainly, somebody's spilling the beans in London. What's less certain is that anyone is going to do anything about it. The LSE, upset by the apparent rise in insider dealing and the harm to the exchange's reputation, so far has failed to arrest it. As Europe's other major bourses make insider dealing a top priority, Britain's Conservative government officials, who decide when to prosecute for insider trading, seem unruffled by the trend.
POLITICAL HAY. Insider dealing has been a criminal offense in Britain since 1980, but critics say enforcement has been almost nil. The Department of Trade & Industry, led by Michael Heseltine until his promotion last month to Deputy Prime Minister, is responsible for investigating and prosecuting cases. The stock exchange has referred more than 64 cases since 1991, but the DTI won't say whether these are pending or have been quietly closed. One celebrated investigation was dismissed without prosecution a year ago when the DTI could prove no wrongdoing: Lord Jeffrey H. Archer, former Conservative Party deputy chairman and best-selling novelist, was charged with buying shares in a television company on whose board his wife sits, then selling after a takeover bid was announced.
Smelling a good issue, the opposition Labor Party considers insider dealing to be a sign of systemic regulatory failure and promises to clean things up if it wins the elections to be held by May, 1997. Jonathan Church, a DTI spokesman, says his department is doing its best within the confines of the system. "The offense of insider dealing is very difficult to prove," he says. "It's the Home Office's responsibility to seek changes in legislation."
The DTI has brought just 34 cases in 15 years. By comparison, the U.S. Securities & Exchange Commission has pursued more than 450 cases since 1980. In the past three years, the DTI has opened seven cases involving 15 individuals. Of those, six were found guilty and nine were acquitted, for a 40% success rate. In the same period, the SEC has lost no more than a handful of its 110 cases.
Critics say that with detection and punishment so rare, insider traders are emboldened. "When these problems aren't dealt with, people interpret that as a sign we're not serious about cleaning up the market," complains Alistair Darling, Labor's spokesman on financial issues. His solution: wholesale reform of the regulatory system, including eliminating the confusing array of self-regulatory bodies and tying them all into one agency. While this agency would not be an independent, SEC-like body, it would have expanded powers to pursue insider dealing.
EMERGENCY BRAKE. The stock exchange isn't completely powerless to prevent the spread of the insider virus. Chief Executive Michael Lawrence would not comment for this story, but through a spokesman points to several recent measures. For example, last fall, the exchange announced that it would alert traders by way of electronic screens when a company's shares are trading outside normal ranges. The exchange can even stop trading if it appears that price-sensitive information has leaked.
Critics claim that the government is largely indifferent to the problem. That conclusion isn't surprising. In March, the government allowed the sale of its 40% share in two utilities to go forward, even though officials admit they knew that the regulator might soon force both companies to lower rates. The government's prospectus did not mention a possible rate cut. One day after the sale, in which the government raised $6 billion, the regulator's announcement sent the shares plummeting. An internal investigation, just ended, cleared the Treasury officials involved of any wrongdoing.
In fairness, however, all blame doesn't lie with those in office. Some of the disparity in successful enforcement in Britain and the U.S. can be explained by wide differences between British and American securities laws. The SEC relies heavily on civil law, where the burden of proof required to obtain a conviction is much less stringent than under criminal law. And when the SEC pursues criminal cases, lawyers make heavy use of plea bargaining. They can grant immunity to important witnesses or allow defendants to plead guilty to minor offenses in exchange for information.
British law allows only criminal prosecution, so the government must prove beyond a reasonable doubt that a trader obtained inside information--and willfully violated the law. Such standards amount to requiring written confessions. There's no such thing as plea bargaining.
As London struggles, authorities at other major European bourses seem more gung ho. France's securities watchdog, the Commission des Operations de Bourse (COB), in 1989 was granted SEC-like powers to obtain search warrants, seize evidence, and even pursue cases without going through the courts. In six years, it has started 494 investigations, of which 135 were referred to court. Since 1991, when the law took full effect, 27 COB insider cases have resulted in sanctions of one kind or another. In one famous example, a Finance Ministry official last year was sentenced to two years in prison for passing on inside information about packaging company Pechiney's intentions to acquire Triangle Corp., a U.S. company.
More recently, in late July, COB authorities alleged that some banks may have engaged in insider trading in Eurotunnel Group stock in the three months before the troubled Anglo-French company issued new shares. Two underwriters in the issue, Swiss Bank Corp. and Salomon Brothers Inc., later disclosed they are the focus of the investigation. As underwriters, they were privy to the price and issue date for the new shares. The COB is examining whether they used that information to sell short large numbers of existing shares in the belief that the new ones would depress the price. Both banks say they acted properly and expect to be cleared of any allegations of wrongdoing.
The London Exchange now trades more foreign than domestic stocks and competes with the New York Stock Exchange for new listings. If London's market is seen as opaque, it could lose out over the next decade as newly privatized companies choose where to list. Investors need to know that Britain's financial system doesn't let insider traders get off scot-free.