First Boston Corp. yesterday agreed to pay a $264,276 penalty and repay $132,138 in profits it made by trading stock based on confidential, sensitive financial information about a First Boston client, the Securities and Exchange Commission said.
The SEC charged that First Boston, the nation's eighth-largest securities firm, had violated federal insider-trading prohibitions. In a settlement with the SEC announced yesterday, First Boston agreed to make the payments without admitting or denying the SEC's allegations.
But a First Boston spokesman acknowledged yesterday that a "very serious," if "inadvertent," violation of its regulations had occurred involving the use of the confidential information by its stock trading department.
The information concerned a serious financial setback for First Boston's client, Cigna Corp. Upon learning of the setback on Jan. 30 -- before the information was made public -- a First Boston senior trader immediately sold 21,000 shares of Cigna stock in the firm's account, buying it back later that day at a lower price for a profit of $102,500.
Some experts said the incident goes to the heart of an issue that plagues every major Wall Street firm: how to prevent conflicts of interest that can arise from the firms' dual role as an investor in stocks and a financial advisor to corporations.
While advising companies on acquisitions and financing strategies, Wall Street investment bankers regularly gain access to sensitive, inside information about financial developments and upcoming announcements. It is against the law for traders to use that confidential information to profit from buying and selling stocks.
However, according to some investment bankers, the so-called "Chinese Walls" that have been erected inside investment firms to block the leakage and improper use of such information frequently do not work. Instead, material, nonpublic information often is passed along from investment bankers to stock traders, some bankers and experts say.
First Boston spokesman James W. Hood, director of marketing, said the breach of the firm's Chinese Wall resulted from an oversight by one of its head traders.
According to the SEC, on Jan. 29, Cigna's chief financial officer told a managing director in First Boston's corporate finance department that Cigna would announce a $1.2 billion decline in the value of its assets the next day. The information was provided in confidence by the official of Cigna, a major insurance company, who was seeking advice from First Boston.
The First Boston managing director told one of First Boston's research analysts about the pending announcement. The analyst, following instructions from a senior analyst, passed the information on to First Boston's head equity trader, who makes decisions about the firm's trading activity, the SEC said.
The research analyst told the head equity trader that the information had come from First Boston's corporate finance department -- an indication that the information might be confidential. But the head equity trader immediately sold the firm's Cigna stock without checking to see whether it was permissible to trade Cigna stock.
Like other investment firms, First Boston maintains a "restricted" list of stocks that cannot be traded by the firm for its own account, for just such reasons. Cigna had been added to the list on Jan. 21, but the head trader said he did not look at the list before trading the stock on Jan. 30, the SEC said.
Neither the SEC nor First Boston identified the individuals involved in the incident.
First Boston's head trader sold 21,000 shares of Cigna stock shortly after trading began Jan. 30 on the New York Stock Exchange, at a price of $69.13 a share.
Word about Cigna's troubles apparently had begun to circulate on Wall Street, causing the stock price to tumble. Michael Steinhardt, head of Steinhardt Partners and a high-stakes stock trader, had told his firm that day that he had "some fancy information concerning Cigna," involving a possible write-off, according to a Wall Street Journal article in March. Steinhardt's firm sold 40,000 shares of Cigna at $66.50 a share, and bought back its stake just before trading closed that afternoon at $64 a share.
First Boston also bought 20,000 shares of Cigna at $64 a share near the end of trading, the SEC said. It made an additional $26,263 profit trading options on Cigna stock that day. Cigna announced the $1.2 billion write-off minutes after trading closed on Jan. 30.
In its consent agreement with the SEC, First Boston agreed to repay a total profit of $132,138 on its Cigna transactions, plus a penalty of twice that amount, or $264,276.
First Boston President Peter T. Buchanan sent a memo to employes yesterday saying the violation had been discovered first by First Boston, through its own internal review procedures. As it was conducting its review, it was contacted by the New York Stock Exchange, which had begun an investigation, Hood said. First Boston said it turned the results of its review over to the stock exchange and the SEC.
Buchanan said the disciplinary action was the first in the firm's 50-year history. "However, this reputation, which has taken us decades to build, can be severely damaged by just one unintentional incident," he said.
Hood said no disciplinary action was taken against any First Boston employe because "there was no intimation that there was any intention to defraud or deceive. . . . They simply dropped the ball."
An SEC enforcement official said the commission has no idea how often confidential financial information passes through the Chinese Wall in securities firms and is used improperly or illegally.
Joseph Auerbach, a professor at the Harvard Business School, said he believes the defensive systems within the firms are probably sound, minimizing abuses. "The last thing a major investment house wants is a reputation of not keeping that wall intact," Auerbach said.
"I think that, in most of the obvious cases, they [Wall Street firms] are pretty good at managing these conflicts," Wharton School finance Professor Morris Mendelson said in a recent interview.
Other experts disagree, describing a process of "winking and nodding" used to exchange information, as one investment banker at a prestigious Wall Street firm put it. "Technically, that is against the law, and we probably shouldn't do it," said the banker, who asked not to be identified.
He said the firm's investment bankers "call me all the time. I got a call from a guy on our [stock] trading desk, and he asked me about a company they were getting ready to invest in, that I had knowledge of because of our corporate finance work. I probably shouldn't have told him anything, but I did nod and wink over the phone. That is natural for someone to do when millions are being invested. Should I have done it? Probably not. Does it go on every day? You bet."