Raymond L. Dirks: Should he be praised as a whistle-blower for exposing the massive Equity Funding scandal in 1973 or censured by the Securities and Exchange Commission for profiting from it?

That question, which has caused extraordinary controversy within the securities industry and in government, yesterday came before the U.S. Supreme Court. The answer, expected by summer, could have a major impact on the legal responsibilities of broker-dealers, securities analysts and anyone else who makes a living trying to find out what's really happening on Wall Street.

The SEC's case against Dirks stems from the fact that before "blowing the whistle" on Equity Funding, he tipped off certain investors who were able to unload their Equity Funding stock before its collapse. Dirks' acts were illegal, SEC Solicitor Paul Gonson told the court yesterday, because anyone who acquires relevant nonpublic information about a corporation automatically assumes the status of an insider, subject to SEC penalties for passing on the data to someone who might profit from it.

That broad definition of insider is largely what has made the case so controversial. It was too broad even for the Department of Justice, which filed its own brief in the case opposing the SEC and saying that its approach "has serious consequences for federal law enforcement, which frequently depends on private initiative to uncover criminal conduct."

Few analysts, the Justice Department told the court, "will be willing to devote substantial resources and expose themselves to personal danger to investigate rumors of crime if they are forbidden to utilize the information they obtain until after it is fully revealed to the investing public."

The case stems from one of the largest corporate frauds of all time. The Equity Funding Corp. of America stunned competitors during the late Sixties by transforming itself almost overnight from a small Los Angeles insurance agency into a billion-dollar financial conglomerate: a dazzling "financial supermarket" selling insurance, mutual funds and tax shelters for the rich. Between 1967 and 1972, the value of its insurance in force rose from $54 million to $6.5 billion.

Dirks was a New York securities analyst at the time. In March 1973, Ronald Secrist, a former Equity Funding vice president, came to Dirks and told him Equity Funding was a fraud. The insurance policies, on which the empire was based, were phony.

Dirks eventually went to law enforcement authorities and the Wall Street Journal with his information, causing it to be exposed in an avalanche of publicity. Before he did this, however, he told five institutional investors, who then sold more than $17 million of worthless Equity Funding stock to unsuspecting purchasers.

For this, he was charged by the SEC with illegally aiding and abetting antifraud violations through the use of inside information. His censure was upheld by the U.S. Court of Appeals for the District of Columbia.

Gonson, SEC solicitor, said Dirks was "like a person who discovers a crime and on the way to the police station" helps himself to some of the fruits of the crime.

He explained to the justices yesterday that Dirks became an insider the moment Secrist told him what was going on at Equity Funding. He inherited the status, Gonson said, and with it the legal obligation of all insiders not to trade on the non-public information or pass it on for the financial benefit of others.

"Just as Secrist could not trade," he said, "Dirks could not trade, and the institutions could not trade."

"How far does this chain go?" Justice Lewis F. Powell Jr., asked the SEC lawyer.

It extends, Gonson said, to anyone who knows he or she has received insider information.

David Bonderman, Dirks' lawyer, said the "public policy implications" of the SEC's theory would be to discourage the kind of whistle-blowing Dirks risked in the Equity Funding case. It would encourage analysts "to do nothing, to be silent," he said, or risk being prosecuted for insider trading.

"Regulators cannot probe and uncover everything they ought to," Bonderman told the court. "What's to prevent future Dirks from being indicted? It's hard to think of anything that would be as contraindicated for someone who is disclosing a fraud."