ANNUAL COST OF INSIDER TRADING PUT IN THE MILLIONS.

Byline: Dylan Ratigan Bloomberg Business News

Illegal insider trading costs investors millions of dollars a year by inflating the cost of mergers and acquisitions, according to a Harvard Business School study.

Between 1974 and 1990, bidding companies paid an extra $4 billion as a result of trading on information unavailable to the public, according to Lisa Meulbroek, a Harvard University finance professor.

``Insider trading is tremendously costly for the bidding companies,'' Meulbroek said.

Meulbroek compared 112 mergers preceded by illicit insider trading with 112 where there was none. She found that when insiders ran up the stock price of the company being acquired before the announcement, buyers ended up paying a 30 percent higher premium for the company, on average, than they otherwise would have.

If that formula is applied to one recent example, Gillette Co. shareholders will pay $770 million more for Duracell International Inc. because of a run-up in the share price allegedly caused by trading on insider tips. The Securities and Exchange Commission said 18 people made $1 million by relying on inside information to trade Duracell options in the two days before the $7.82 billion transaction was announced.

``Insider trading is very costly for the buyer - too costly,'' said Jeff Wardlow, a fund manager at Loomis Sayles & Co., which owned 309,160 Gillette shares as of June 30. ``The only way to avoid it is to rely less and less on investment banks, which you can't always do.''

The SEC sued Lennox SA of Lugano, Switzerland, over the Duracell trades. Lennox bought most of the 1,700 questionable Duracell call options on behalf of 16 unidentified Italian customers, said Catherine Shea, assistant chief litigation counsel at the SEC.

Gillette and Duracell declined to comment.

Executives generally expect to pay a premium for companies they acquire. The premise of Meulbroek's paper is that once other things that affect an acquisition have been backed out, such as whether or not it is hostile, for cash, for stock or resulting from an auction, the target's stock price jumps an average 9 percentage points more than it would have without illegal trades.

Some companies have sued their investment banks for artificially inflating the price of a merger by leaking news to certain individuals before it was publicly disclosed.

In a 1983 case, Litton Industries Inc. sued Lehman Brothers and Dennis Levine, who was working at Lehman, alleging that Levine leaked Litton's plans to buy Itek Corp.

Litton, based in Woodland Hills, maintained that Levine and others he tipped off bought massive amounts of stock, driving up the stock price from $26 to $33 a share. That run-up, Litton said, inflated to $48 a share the price Litton eventually paid for Itek. After an appeals court ruled in Litton's favor in June 1992, the suit was settled.

To be sure, the insider trading premium paid by an acquiring company's shareholders benefits those who hold stock in the company being purchased. In the Gillette case, the estimated extra $770 million went to Duracell shareholders - including those who traded on the inside information.

Some investors say insider transgressions don't matter to them.

``You can't worry about insider trading like that. It is going to happen,'' said John Hammerschmidt, a fund manager at Turner Investment Partners, who held 332,880 Gillette shares as of June. ``What matters to us is whether or not the acquisition will add to earnings. If so, that's all we care about.''

The Duracell buyout is expected to add 10 cents a share to Gillette's earnings in 1997.