The Corner

With the pages full of Wall Street investigations since the Dotcom Bubble burst, the Madoff Scandal, the housing bust and the recent European financial meltdown you would think that Wall Street was never worse—not so. Back in the 1980s a group of arbitragers were caught manipulating markets.

Arbitragers (arbs) are called the pilot fish that swim along with sharks such as the famed T. Boone Pickens and Carl Icahn. Once a tender offer or merger is announced the arbs load up on the stock of the target company in the expectation that its value will rise. The risk they take is that the deal might fall through and instead of receiving the premium price being offered by the acquirer they might end up with a bundle of stock whose vale had plunged below the price they paid for it.

During the early 1980s the most prominent of the arbs was Ivan Boesky, who went to great lengths to argue that he and his counterparts were not mere speculators out for a killing. The service the arbs performed, according to Boesky, was to free small shareholders of the risk and waiting involved in the period between the announcement of a merger and its successful execution. Although arbs made many millions on deals such as those involving Gulf and Getty, they also lost bundles on deals that collapsed, such as Pickens bid for Phillips Petroleum and Chicago Pacific’s leveraged buyout of Textron.

It was customarily assumed that the success of arbs such as Boesky was based on exhaustive research, solid analysis and good luck. It turned out the truth was more ordinary and greedy. In November 1986 the Securities and Exchange Commission (SEC) made a startling announcement. The federal government had been investigating Boesky for some time and had uncovered evidence that he illegally obtained insider information on mergers and takeovers before they were made public. Boesky admitted to the crime and agreed to plead guilty to a criminal charge and pay a penalty of $100 million. He was also barred from the securities business for the rest of his life. At the same time, the SEC indicated that it would aggressively pursue its investigation of the takeover activity.

The Boesky case was an offshoot of a wide-ranging investigation by the SEC of insider trading by Wall Street professionals. Earlier in 1986 the agency had brought charges against investment banker Dennis Levine, who cooperated with the authorities and revealed that among his other illegal activities he had arranged to sell Boesky information on deals before they were made public. This allowed Boesky to load up on stock with knowledge that as soon as the deal was announced, its value was bound to soar.

In his book “Levine & Company: Wall Street’s Insider Trading Scandal,” Denis Levine writes, “The answer to the question ‘What is Dennis Levine?’ is this: he is indeed clever and greedy, but he is no anomaly. He is Wall Street’s worst nightmare come true… The most stringent system of ethics and the highest standards would not have stopped Levine. He scuttled into his career with a predisposition toward crime.”

Although Boesky was charged and went to prison, he in a sense got the best of the SEC. In the days before his indictment was made public, Boesky unloaded more than $440 million of his holdings in stocks involved in takeovers. Boesky correctly anticipated that these shares would plunge in value after the announcement that the entire takeover fraternity was being investigated. Many have called the move by Boesky to exploit the knowledge of his own legal troubles the ultimate form of insider trading.

Yet federal prosecutors did benefit greatly from Boesky’s willingness to cooperate with their investigation; they used information from him as the basis for a wave of subpoenas that were served on leading players in the takeover game. Boesky reportedly also led investigators to an informant who provided the basis for the arrest of three other top arbitragers in February 1987: Robert Freeman of Goldman Sachs, Richard Wigton of Kidder Peabody and Timothy Tabor, who left Merrill Lynch. That informant turned out to be Martin Siegel (formerly of Kidder Peabody), who pleaded guilty to insider trading charges and paid a fine of $9 million. After several months the government was forced to drop the chargers against the three arbs because it was not prepared to proceed with case, though Freeman later pleaded guilty to one count of mail fraud (and was sentenced to four months in prison and paid a fine of $1 million). The investigations of Wigton and Tabor were dropped in 1989.

The next target of the investigation was Boyd Jefferies, chairman of Jefferies Group, a brokerage firm that had worked closely with Ivan Boesky. Jefferies admitted engaging in securities violations including a stock parking scheme with Boesky. This was followed by the announcement in June 1987 that Kidder Peabody had agreed to pay $25 million in fines to settle a sweeping set of insider trading allegations brought by the SEC. At the end of the following year Drexel Burnham Lambert, an old line brokerage firm, paid a fine of $650 million. In 1989 Drexel’s Michael Milken was indicated on racketeering charges; the following year he pleaded guilty to six counts and paid a fine of $600 million.

Quote of the Week: “Fortune favors the bold.”—Virgil

Bart Ward is the chief executive officer of Ward & Co. Ltd. an Anoka based registered investment advisor – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.

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