When the Securities and Exchange Commission roared last week, Wall Street yawned.
Even though SEC enforcement director Gary Lynch declared last Monday that he was going to try to "get to the bottom" of illegal insider trading and professional rumor planting, New York securities experts said they believe abusive stock market practices will continue to grow. They said tough talk alone will do little to slow the spread of rumors and wild trading that have accompanied the recent surge in mergers and acquisitions.
According to Wall Street sources and Phillips Petroleum Co. officials, one deal that the SEC recently has been investigating -- which illustrates the complexity of the commission's job and the importance of the legal and ethical questions raised by Wall Street's current merger mania -- is the attempted takeover of Phillips Petroleum earlier this year.
Confidential depositions pertaining to the Phillips case -- first obtained by The American Lawyer and subsequently obtained by The Washington Post -- offer a rare glimpse inside the turbulent and often secretive world of hostile takeovers. The depositions also raise questions about the obligations of bidders and professional investors during takeovers, and about the SEC's ability to regulate the behavior of big-time players in the takeover game.
The SEC's problem is not that it has failed to prosecute any cases of illegal insider trading. The commission brought 24 insider-trading cases in 1983, 13 in 1984 and 20 in the 1985 fiscal year ended Sept. 30. Rather, Wall Street sources said, the problem lies with the type of cases the commission has brought and the fact that it is a small number of cases relative to what the number of abuses may be.
Illegal insider trading involves the use of nonpublic information by investors seeking to profit from sharp changes in the price of stocks. Lynch said an investor acting on such information must breach a duty to a company, a bidder, a shareholder or someone else, or must have received information from a person who breached a duty, to violate the law.
In a takeover bid, Lynch said, anyone who obtains nonpublic information in confidence may be violating the law if he trades on that information.
Well-publicized prosecution of insider trading cases involving corporate directors such as former deputy defense secretary and LTV Corp. director Paul Thayer have established a visible deterrent to corporate officers who might be tempted to profit by trading on confidential company information. But such cases do little, for example, to discourage professional Wall Street investors known as arbitrageurs and others from trading on confidential information or from planting false takeover rumors and then profiting on resulting stock price swings.
Skepticism about the SEC from securities lawyers, arbitrageurs and other market professionals partly reflects the fact that the commission has brought no insider-trading cases against arbitrageurs in recent years. Even as he vowed to investigate the "unsettling" spread of false rumors and information leaks that have led to heavy trading in takeover target stocks prior to merger announcements see chart accompanying story , Lynch conceded last week that it is difficult to prosecute professional traders. He added that the SEC's investigation of market rumors is not confined to professional traders.
"The problem in making a case against the professional trader is they're in the market all the time," Lynch said. It is much easier to "bring a case against an individual who trades two stocks a year than someone who is trading 20 stocks a day. If professional investors have received inside information, they have gotten it second hand or over the telephone. That is not traceable. It is much more difficult."
Still another complication is that what constitutes insider trading is unclear in many situations.
While SEC officials declined comment, Phillips officials said that the commission recently has been investigating the hostile takeover bid for the company that began 11 months ago. Phillips officials said the SEC contacted the company in late June or early July.
Phillips first received a hostile takeover bid from Mesa Petroleum Chairman T. Boone Pickens Jr. last December, and then in February became the target of New York investor Carl Icahn after Pickens reached a settlement with the Phillips board. Lynch refused to confirm or deny that the SEC is investigating the Phillips deal.
Questions raised by the circumstances surrounding the controversial Phillips takeover attempts have fueled skepticism about the SEC's ability to prosecute highly complex cases. Rep. Timothy E. Wirth (D-Colo.) has sharply criticized the commission for failing to pursue difficult cases involving insider trading by professional investors.
Francis M. Wheat, a former SEC commissioner and currently a director of Phillips, said last week that he is puzzled by the commission's failure to bring a case challenging some of the trading during that fight. "I really don't understand why they don't go hammer and tongs after that one," said Wheat, who was a member of the board that fought off Icahn and Pickens.
Questions about the Phillips deal have arisen because of confidential depositions taken by Phillips in a lawsuit against Icahn. The depositions describe a series of meetings and conversations between Icahn and Ivan F. Boesky, one of Wall Street's biggest, best known, and most successful, arbitrageurs.
Boesky was a major investor in Phillips stock during Pickens' and Icahn's hostile bids to acquire Phillips. Boesky and Icahn declined to comment on the SEC investigation of the Phillips deal.
When asked about the Icahn deposition last week, Boesky said, "This is, first of all, pretty old, stale information . . . . As far as anything having to do with internal workings of our company, whether it be buying stocks, selling stocks, communicating with bodies which govern us or not communicating with those bodies, this is something that is totally confidential and we would have no comment."
According to the depositions, public filings by the major players, interviews, and other public information, here is what happened in the Phillips deal:
On Oct. 23, 1984, Pickens began buying Phillips stock at a rapid pace, mostly at prices in the low 40s. By Dec. 4, Pickens owned about 8.9 million shares, or 5.8 percent of the company. That day, Pickens announced that he wanted to acquire the company and also said he would not drop his bid or sell his shares back to Phillips unless all shareholders were included in any deal.
Late in the evening on Sunday, Dec. 23, Pickens agreed to drop his bid and sell his shares back to Phillips in a deal that guaranteed him at least $53 a share in cash. Other shareholders were not offered the same deal, despite Pickens' earlier avowals.
As soon as the news broke, Boesky, who was vacationing in Barbados, received a call from his office in New York. As Boeksy tells the story, he was stunned by the news that Pickens had agreed to drop his takeover bid. Boesky had purchased millions of Phillips shares in the hope that Pickens either would acquire the company or force it to take steps that would raise the price of the stock. Anticipating a sharp drop in the price of Phillips shares that could cost him tens of millions of dollars when the market opened on Christmas Eve morning, Boesky immediately ended his family vacation and flew back to New York, but it was too late to unload the stock before the pricedropped.
Boesky was right about the market's reaction to the Pickens deal. With the threat of Pickens' takeover bid ended, Phillips stock dropped almost 10 points on Dec. 24, leaving Boesky and other speculators exposed to huge potential losses. Boesky owned 5.87 million Phillips shares on Dec. 31.
Enter Icahn. With Phillips stock now trading at depressed prices in the low 40s, Icahn aggressively began buying shares on Dec. 28. According to sworn testimony Icahn gave to Phillips lawyers in a deposition on Feb. 19, Icahn initially was not sure whether he would make a takeover bid for Phillips. Shortly after he made his first purchases of Phillips stock, Icahn said in the deposition, he received a telephone call from Boesky. Icahn testified that Boesky said, "I hear you are involved with Phillips."
Boesky also said he was upset about the settlement Phillips had reached with Pickens, according to the deposition. "He Boesky was really angry as to what they did," Icahn said. Icahn testified that Boesky suggested they should join forces against the Phillips board in a proxy fight. In such a proxy fight, they would have attempted to gain control of Phillips by having their own slate of directors elected to the company's board.
Icahn said in the deposition that he told Boesky he was not interested in joining him in a proxy fight, but Boesky continued to call Icahn. "He calls me every day," Icahn said in the February 1985 deposition.
Sometime in early January, Boesky and Icahn met at Boesky's estate in Westchester County, N.Y., to discuss "different strategies" they could use to increase the price of Phillips stock, Icahn said in the deposition. Among these strategies, Icahn said, was a possible joint takeover bid in the form of a tender offer for Phillips stock.
Icahn said he told Boesky, "The way to do this, if you are going to do anything, is to make a tender." Icahn also told Boeksy that he would have to put in $100 million to $150 million of cash to join Icahn in a takeover bid, according to Icahn's deposition.
The meeting ended without any agreement between the two men. But throughout January, according to Icahn, Boesky continued to call Icahn and ask what he was going to do with his Phillips stock. Icahn continued to buy Phillips shares at an increasingly rapid pace.
Late in January, Icahn decided he was going to make a takeover bid for Phillips, he said in the deposition. On Jan. 28, Icahn bought 2.74 million shares of Phillips from Boesky in a private deal worth about $47 a share.
On Monday evening Feb. 4, Icahn delivered a $55-a-share takeover bid to Phillips. Five days later, on Saturday evening, Feb. 9, Icahn invited Boesky to dinner at his home, according to Icahn's deposition. Over dinner, they discussed the possibility of Boesky joining Icahn in his takeover bid, according to Icahn. Meanwhile, Icahn testified in his deposition, Boesky had purchased "quite a bit of stock again . . . 4 to 5 million shares."
In the deposition, Icahn said he is not sure whether he learned of Boesky's purchases on Feb. 9 or a few days earlier. Icahn and Boesky met again on Sunday, Feb. 10, to continue their discussion about a possible joint bid for Phillips, according to Icahn. Once again, they did not reach any agreement, according to the deposition.
Over the next month, Icahn, the sole bidder, and Phillips management competed for stockholder support. Finally, on March 4, Icahn and Phillips reached an agreement in which Icahn dropped his takeover bid, Phillips paid him $25 million in cash to cover his expenses and Phillips offered all shareholders a package of securities with a face value of $62 a share. By March 31, Boesky had sold all of his Phillips shares.
Among the questions raised by the Icahn deposition are: Precisely when did Ivan Boesky buy the "4 to 5 million" new Phillips shares that he and Icahn discussed at dinner on Saturday, Feb. 9? If Boesky purchased those shares prior to the Feb. 4 public announcement of Icahn's takeover bid for Phillips, did he know that Icahn was going to make the takeover offer? If Boesky did know that Icahn was going to make the offer, did he learn about this from Icahn or from someone else?
More generally, is it fair to other traders in Phillips stock that the bidder, Icahn, and one major stockholder, Boesky, held extensive private conversations throughout the takeover battle? Does the fact that Boesky considered making a joint bid with Icahn make a difference in terms of whether those meetings were appropriate?
Securities rules require that any person who has possession of material, nonpublic information about a tender offer or proposed tender offer disclose the information or refrain from trading. A person also is prohibited from causing others to trade in securities that are or may be subject to a tender offer unless that confidential information is made public. These requirements apply only if a person knows, or has reason to know, that the information has been obtained directly or indirectly from the bidder, the target, or their respective insiders.
SEC enforcement chief Lynch refused to comment on the Icahn deposition or any details of the Phillips case. Lynch, however, did say, "We are looking at anyone who is trading during a period of time prior to the news announcement where we think there might have been leaks of nonpublic information. To the extent that an arb arbitrageur or anyone else is trading during that period of time, yeah, we would ask that person questions.
"Arbitrageurs make a living based on trading during the course of deals. So it is not unusual that you would have an arb taking a position after a public announcement. To the extent that an arb is taking a position before a public announcement, you have to ask yourself why and ask the arb why they are doing that. And to the extent they are getting material nonpublic information in violation of a duty from someone, they are liable as well as everyone else," Lynch said.
Despite Lynch's tough talk, securities lawyers and former SEC officials, cognizant of the difficulty in prosecuting complex insider trading cases, expressed doubts about the commission's ability to stop arbitrageurs from trading improperly.
Theodore Levine, former associate director of the SEC's enforcement division, summed up the skepticism of securities experts when he said, "Generally, when the commission looks at circumstances about why the arbitrageurs all bought or why [they] all sold in this context, they strike out."