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The bad barrel.


Jay Leno, the comic, tells of the timehe performed in rural Alabama and told his bagel joke. No one laughed. He was morose--until it dawned on him: Suppose they don't know what a bagel is?

"How many of you know what a bagel is?' heasked, peering out at his audience. A lone hand went up, and a burly man exclaimed, "A bea-gel is a huntin' dog!'

Something like that happened recently on WallStreet. Not until the notoriety of Dennis Levine did many denizens of the financial community seem to know what insider trading was. They assumed it was a form of thievery practiced by a handful of corrupt individuals. Few believed it was systemic. In this sense they were kindred souls of Washington officialdom, which at first did not comprehend why Michael Deaver might have behaved improperly because in Washington trading on relationships is normal.

Yet the question begs to be asked about theripening scandal on Wall Street as it does about Deaverism: Are just a few apples rotten, or is it the entire barrel?

Wall Street elders insist that up-and-coming investmentbankers like Dennis Levine, who pleaded guilty to parlaying insider information to build a $12.6 million fortune, are merely the rotten apples in an otherwise clean barrel. Maybe 1 percent are rotten, it is commonly said. "I firmly believe it's an aberration, and it's happening at the fringe,' observed Shearson Lehman Brothers CEO Peter Cohen last July. Most of the press coverage of the Levine case has adopted this tone--Levine and his cronies were yuppies, members of a uniquely corrupt generation, and were motivated by personal greed.

The people who say this are, I fear, hiding fromthe truth. As in the case with Washington lobbying or political fund-raising, or municipal corporation, the problem is more endemic than episodic. Dennis Levine may be a thief, but the culture or ethos of Wall Street bears at least a measure of blame. It looks very much as if yuppies weren't the only ones stealing, or as if Levine and his friends did it at least as much to impress their superiors as to shovel fast money in their pockets. During the time he worked at three investment banks, Levine is alleged in 54 instances to have used insider information to buy stock in companies about to be acquired or to make other deals. In more than half of these transactions, neither Levine nor his employer were insiders. This suggests that Levine relied for his tips on a network of people who may not think it unusual (or wrong) to pass along such information. In the Levine case alone, investment bankers at three separate firms and a distinguished takeover attorney have been indicted. Several of the culprits pocketed no money. Perhaps they were just trying to impress, showing off their credentials as movers and shakers, proving to their bosses how well connected they were.

Another piece of evidence: It is not uncommonfor the stock price of a target company to climb days before a merger is announced. This has been the pattern in too many mergers. For example, in the five days prior to RCA's merger with General Electric, 10 million RCA shares--2 percent of its stock--changed hands. In the two days before the merger, RCA's stock price rocketed from $48.75 to $63.50 per share. Similar run-ups in stock prices occurred prior to the mergers between ABC and Capital Cities, and General Foods and Philip Morris, among others. "Too many stocks have moved up before deals have been announced for it simply to be a random phenomenon,' George L. Ball, chairman and CEO of Prudential-Bache Securities, told a House subcommittee in June. Obviously speculators were operating on more than just hunches. Just as obviously, more than one rotten apple has been at work.

Dennis Levine thrived, in part, because he wasknown as someone with access to hot tips and secrets. The gregarious Levine spent much of his day on the phone swapping information. Partners marveled at how much Levine knew, how plugged in he was. They readily used his information to seek clients and to make investment decisions. At 33, Dennis Levine was awarded million-dollar bonuses, which makes his quite a different case from that of R. Foster Wynans, who claimed he was barely getting by in New York on a cub reporter's salary. Levine's boss at Drexel Burnham Lambert Inc., David Kay, chief of the corporate finance department, told The Wall Street Journal: "He could make things happen. . . . He was a tape watcher, and he would generate deals by knowing what was about to happen.'

It is not too far-fetched to surmise that Kayand other elders on Wall Street didn't want to know where their hotshot protege was getting his information. At the time the bottom line for them was information. Now that the botton line has shifted to containing the firms' embarrassment, Kay and his colleagues sound a bit like Captain Renault in Casablanca, who declared, "I am shocked--shocked!--to find that gambling is going on here.'

Wall Streets' professions of hurt innocence aredisingenuous. A great growth industry on Wall Street has been risk arbitrage, where people bet on the rise, or fall, of stock prices. There are many skillful players in this lucrative line of work, and the profits are so vast that today Salomon Brothers estimates that $10 billion of capital is in the hands of risk arbitrageurs, compared to only $10 million ten years ago.

Abritrageurs bridle, fairly, at the implicationthat they should be penalized for being smarter and more aggressive than a competitor in gaining corporate intelligence. They worry, fairly, that critics will lump the skilled hunch-player with the inside trader, and that in seeking to police Wall Street traders the Securities and Exchange Commission might inadvertently strangle initiative. But only a fool would believe that many risk arbitrageurs don't seek, and gain, inside information unavailable to other shareholders.

Laurence Tisch, currently the acting CEO ofCBS and one of this generation's preeminent investors, says he doesn't believe the barrel is rotten. But he does believe too many people on Wall Street are preoccupied with "getting that little extra edge.' Arbitrageurs, he says, "strive to get information that is not public. They keep calling companies and try to pick up little bits of information. It is not illegal. But it gets awfully close. . . . Little shareholders don't have the same edge. It becomes more and more difficult to separate the legal from the illegal.'

The issue here is broader than just risk arbitrage.It is the value system of Wall Street, a deregulated, in-bred community where high overheads and abundant opportunities for wealth propel investment bankers to generate ever more information, more fees, more short-term speculation. The resulting frenzy erodes long-term loyalties--to clients, to stocks, and even to firms, which is a major reason so many private Wall Street partnerships have been sold. Stock prices gyrate so wildly because the market is now ruled by impatient speculators rather than long term investors. Patience, a private virtue, becomes the first casualty. Faculty members at our leading business schools complain that many of their students are foresaking careers in corporate America, with up to half of them preferring the quicker upward trajectory offered by investment banking and consulting. Fewer students demonstrate the patience to serve apprenticeships. Many can't wait to get rich.

In a community unrestrained by patience ortradition, everything becomes a deal. Bankers are scored by how many deals they bring in. The fees and bonuses are elephantine, which helps explain the rush, these past few years, of so many unproductive mergers, of so many risky junk-bond deals, of so much choking debt exchanged for equity. Instead of serving as wise counselors who think of the long-term interests of the companies, investment bankers increasingly think only of the quick score.

And these values come from the top down, notthe bottom up. The yuppies are, in most cases, impressionable junior associates, who often derive their values, their do's and don'ts, from elder role models. We are dealing not just with a corruption problem, but also with a conformity problem.

In other contexts, we're beginning to comprehendthe impact of peer group pressure. We understand that teenagers drop out of school or have babies in part because of peer pressures that say It's OK. We know that some ghetto kids are, indeed, victims of unemployment or an indifferent or bad government, but that some are also victims of a bad culture. Why, then, should we be surprised that people on Wall Street conform to prevailing values?

It is quite an eye-opener to ask investmentbankers what they wouldn't do--what "deal' would you refuse to participate in? While reporting a book on Wall Street, I regularly asked that question and was stunned at how little thought many senior Wall Street executives gave to it. Usually, the question was greeted by a pained silence. And then you could hear the rusty parts of their brains clank like the Tin Man in The Wizard of Oz as they declared: "I wouldn't do business with the mafia,' or "I wouldn't do business with a bad credit risk.' Obviously, thriving Wall Street has devoted too little time to saying "no' or to pondering limits. Seeing themselves as part of a service business, investment bankers have adopted the self-concept of lawyers who make no moral judgments and excuse themselves by proclaiming that everyone has a right to trial.

Dennis Levine is a by-product of Wall Streets'lax value system, just as surely as Michael Deaver was influenced by what he thought normal in Washington and Janet Cooke was a by-product of the relaxed standards of the new journalism. The people who run Wall Street and the reporters who buy their excuses, in talking only about a few bad apples are leaving the whole barrel to rot.

They seem not to know what a bagel is.
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Title Annotation:insider trading in securities
Author:Auletta, Ken
Publication:Washington Monthly
Date:Dec 1, 1986
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