A Question of Integrity:
Promoting Investor Confidence by Fighting Insider Trading
---Remarks by Former Chairman Arthur Levitt of U.S. Securities and Exchange Commission
February 27, 1998, "S.E.C. Speaks" Conference
Good afternoon. I'm delighted to join you here today.
As a non-lawyer, arriving here from New York, I might have been slightly uncomfortable at first. But in my nearly five years at the S.E.C., I've come to recognize the pivotal role that your profession plays in keeping our markets honest and orderly.
Great lawyers have guided the S.E.C. throughout its history -- lawyers like William O. Douglas, Manuel Cohen, Stanley Sporkin, and Harold Williams.
The S.E.C. has stayed true to our mission of investor protection -- with a spirit of non-partisanship that has kept us focused on our mandate, through Administrations of both parties. Year after year, as William O. Douglas said, we are focused on being "the investor's advocate."
I'm gratified that thousands of people, with your expertise and your commitment to the law, come each year to hear a program called "S.E.C. Speaks." But the fact is, we're also here to listen.
We seek to renew our continuing dialogue with the legal community. We need to continue exchanging ideas - about the best way to protect investors, to refine our approach to regulation, and to uphold the spirit of equal justice before the law. Professionals in the law are society's "first line of defense." Your role is critical in upholding the highest standards of fairness in our marketplace. That's especially true of those who work with corporate clients as they tap the capital markets.
You recognize, as you pursue your work, that it's simply a question of integrity.
Sadly, we recently lost one of the most esteemed members of the legal profession -- a scholar who was a model of the integrity we all cherish.
In December, we mourned the death of Louis Loss - one of the icons of S.E.C. history. He was rightly called "the intellectual father of American securities law."
As an Associate General Counsel of the S.E.C., his work helped shape the meaning of securities regulation -- at a time when the field was in its infancy. As a Harvard Law School professor, his 11-volume treatise on securities law established him as a giant of legal scholarship.
Honoring his memory, I am pleased to announce today that the S.E.C. will dedicate a memorial in his honor.
This spring, we will re-dedicate the S.E.C.'s library as "The Louis Loss Law Library." This gesture will honor the man who did so much to shape our thinking -- about the law, about regulation, about the Commission, and about the highest ideals of integrity in public service.
In the spirit of Louis Loss, the S.E.C. carries on a tradition of looking at the securities laws as the safeguard of integrity in the marketplace.
Our system of law demands that the economy be organized to achieve more than just ruthless, relentless efficiency.
Honest commerce must also be guided by a spirit of fairness.
As Louis Loss recognized, the statutes establishing our regulatory system championed the idea of "the level playing field."
Honest trading, and equal access to material information. It's simply a question of integrity.
I'm enormously proud that our system is thriving today, and I know that all of you are, too.
Our markets are a success precisely because they enjoy the world's highest level of confidence. Investors put their capital to work -- and put their fortunes at risk --because they trust that the marketplace is honest. They know that our securities laws require free, fair, and open transactions.
After spending my professional lifetime in and around our markets, I know the value to our society in letting capital flow freely toward its most efficient uses. As long as the rules of the game are fair to all, investors' confidence will remain strong.
But if there is a perception of unfairness, there'll be no investor confidence -- and precious little investment.
Trading based on privileged access to information can demoralize investors and destabilize investment. It has utterly no place in any fair-minded, law-abiding economy.
It's a chronic danger. It's all too evident in today's marketplace. And it's a crime.
The American people see it, bluntly, as a form of cheating. They -- along with the S.E.C. -- have zero tolerance for the crime of insider trading.
Let's state it clearly, and in the un-ambiguous terms that it deserves: Insider trading is legally forbidden. It's morally wrong. And it's economically dangerous.
This form of corruption commanded the nation's headlines in the 1980s, when then-Chairman John Shad promised to come down with "hobnail boots" on anyone who dared to profit by stealing non-public information.
Remember names like Ivan Boesky? Dennis Levine? Martin Siegal? Those cases made the term "insider trading" meaningful to people all across the country.
Our enforcement efforts in the 1980s sent a strong signal to the investing public: People saw that dishonest dealers on Wall Street would be prosecuted, and lawbreakers would go to jail.
We aren't seeing as many headlines as we used to about insider trading. Perhaps we haven't been talking about it publicly as much as we used to, either. But it is every bit as much of a concern -- and just as much of a law- enforcement priority -- as it ever was.
Just this week, we heard the disappointing news of the arrest of eight floor brokers and others at the New York Stock Exchange, who are charged with unfairly using their position to make more than $11 million in illegal trading profits.
News like this creates the appearance that exchange insiders may be profiting at the expense of ordinary investors. Such headlines shake the confidence of average investors in the fairness of our markets.
We recently saw an especially shocking turn of events in New York: the indictment of several corporate compliance officers on insider trading charges. They're the very figures who are entrusted to guard the integrity of market information. They're the last people you'd expect to succumb to the temptation to break the law.
Most of you have probably read the story in the papers. A compliance officer from a New York investment bank was under investigation -- and she was caught boasting of her skill in insider trading.
She was recorded by investigators, on an undercover microphone, reveling in how much fun it is to sell non- public information to others -- and gloating that you probably won't get caught, unless you "get too greedy."
But it's not a question of degree -- of being excessively greedy. It's a question of right and wrong.
It's not as if insider traders wander innocently into gray areas near the boundaries of legality. They willfully stride across the bright line of the law.
Amid the current frenzy of corporate takeovers, the S.E.C.'s caseload of investigations is at an all-time high. We continue to bring 30 to 40 insider-trading cases each year. With the S.E.C.'s assistance, the criminal authorities are actively prosecuting suspects.
In recent years, the number of investment bankers and market professionals named as defendants has been lower than it was in the 1980s. This is probably a function, in part, of the securities industry's own vigilance and improved procedures. It's probably also partly due to the conscientious work of legal advisers, steering their clients away from potential trouble.
And it's probably also due to a healthy dose of deterrence -- the kind of deterrence that comes from seeing someone you know go to prison.
Yet the chronic problem is still out there.
Last year's highest-profile insider-trading matter was, of course, the O'Hagan case.
Now, since I'm not a lawyer -- and most of you are --I'm not even going to try to go into great depth about the legal basis for the decision in the case. I'm sure you will hear a great deal about that from other people at this conference.
But I will remind you of what James O'Hagan did.
He was a partner in a prominent Minneapolis law firm, which was working on a proposed bid by Grand Metropolitan to acquire Pillsbury. He wasn't working on the case directly-but he heard about it from his colleagues.
O'Hagan misappropriated, for his own advantage, confidential information about the proposal. He bought equities and options on Pillsbury stock before the announcement of the Grand Met bid. His profit on the illegal securities trades was about $4.3 million.
What O'Hagan did was simply wrong. It amounted to cheating by someone who abused his position of trust.
That's the plain truth. There's a boundary between what's right and what's wrong -- and O'Hagan clearly crossed that line.
That straightforward approach -- recognizing the common-sense distinction between right and wrong - recently carried the day in the United States Supreme Court.
As you know, the Court upheld the misappropriation theory as a sound legal basis on which the S.E.C. and the criminal authorities may prosecute insider trading.
As Justice Ruth Bader Ginsburg writes: "The [misappropriation] theory is also well-tuned to an animating purpose of the Exchange Act: `to ensure honest securities markets and, thereby, promote investor confidence.' "
From this non-lawyer's point of view, Justice Ginsburg's opinion is an excellent summary of why we must take this issue so seriously.
* * * *
I'm concerned about one, increasingly worrisome form of trading on the basis of non-public information. The S.E.C. is watching this situation very closely, and we hope that self-restraint will solve the problem -- before we have to step in.
The scenario is this: A company has material news that must be communicated to its shareholders and to the markets.
The news is big -- certainly big enough to move the price of the company's stock.
The company drafts a press release, setting the time for the announcement -- and putting an embargo on any disclosure of the news to the general public.
Before the public announcement, the company tells the news to some of its favorite Wall Street analysts. Or, it might arrange a conference call with a large number of analysts and selected institutional investors.
What happens next, we find troubling.
In the interval -- after the analysts know the news, but before the public knows it -- there is a great deal of unusual trading.
Well, it doesn't take Oliver Stone to imagine how that might come about. Any investor looking at this situation would think it's wrong for those who have received this information to trade before the public announcement -- or to tip off their friends, or their family members, or their colleagues in their firms.
My preference is that calls to analysts should not come before a press release, and that -- even then - these discussions should not divulge new material information not contained in that press release.
Legally, you can split hairs all you want. But, ethically, it's very clear: If analysts or their firms are trading -- knowing this information, and prior to public release -- it's just as wrong as if corporate insiders did it.
Securities firms are supposed to have information barriers to stop the spread of such data. But when we see trading spikes in this short time period, I worry about the effectiveness of those internal mechanisms.
There has been much discussion about how to handle conversations with analysts. I'm aware that one organization -- the National Investor Relations Institute --has issued guidance to companies about what steps to take. And many of you have probably helped your clients adapt such standards to their own situations.
I realize that such issues of selective disclosure are very sensitive. But I have two observations.
First, it is very clear to me -- and to the S.E.C.'s Enforcement Division -- that issuers should not selectively disclose information to certain influential analysts, in order to curry favor with them and reap a tangible benefit, such as a positive press spin.
Second, you should counsel your clients that - during the window of time in which only some analysts have been told material information -- the news has not yet been publicly disseminated. No one who knows that information should be trading.
* * * *
Our markets are strong because investors are confident of their basic fairness. Trading on inside information -- and giving early tips to other potential traders - damages the entire structure of our markets, because it deeply shakes this vital investor confidence. It can especially demoralize individual investors.
I've been talking to average investors all over the country -- mostly through the S.E.C.'s series of investor "town meetings." I ask individual investors about their impressions of the securities markets -- and I hear a lot about their fear of being cheated by insiders.
The bull market stampede may continue, they say - but they worry whether "the little guy" is at risk of being crushed.
Individual investors think -- and I passionately believe -- that the proverbial "little guy" on Main Street should have the same fair chance as the "big guys."
Our law has no tolerance for favoritism. It holds no place for privilege. Everyone deserves a fair shot at success in our nation's securities markets.
Well-connected people don't deserve any greater chance for success than the average citizen. Nor do the friends and relatives of those well-placed people, who may reap unfair profits because they happen to know the news before it breaks.
The process of capital formation is not an insider's game run for a select group of those "in the know." It's an expression of our democracy's faith in fundamental fairness.
It's simply a question of integrity.
The S.E.C. has always maintained a vigorous enforcement program. We punish every kind of abuse of the federal securities laws.
Yet there is something about our campaign against insider trading that seems to resonate especially profoundly. When we prosecute those who make money stealing confidential information, it is a symbol of our nation's basic philosophy of fairness.
The refusal to tolerate the "gaming" of the markets by a select few -- those who have access, power, or relationships with friends in high places -- is uniquely American. It's an expression of our democratic ideal: The law applies to all of us -- no matter who we are, no matter who we know.
I believe that investors -- along with securities professionals and regulators -- are justified in having a strong degree of confidence in the integrity of our system. The rest of the world envies America's markets for their honesty, for their regulatory structure, and for their strong reliance on the law.
Investors believe that America's markets are fair, and that the law protects them. That's why an unprecedented number of investors are doing business in this country.
Think of the problems in countries that fail to maintain such investor confidence. Investors insist on a "risk premium" -- perhaps it's better to call it an "integrity premium" -- when they can't trust the honesty of a market.
Maintaining investor confidence is the key.
As lawyers, you can help in our campaign to keep the process fair and honest. As you know, through your experience, lawyers play a special role in our society --and they have a unique responsibility in our marketplace.
Those who specialize in securities law -- as do most of you, here in this audience -- have an enormous amount of influence on the conduct of business.
Warning clients away from the temptation of insider trading -- and helping prevent lawbreaking before it can happen -- is a crucial, continuing role for you, as officers of the court.
Because of the cloak of confidentiality that drapes lawyers' conversations with clients -- and because of your role in providing sound advice -- attorneys are in an excellent position to be candid about the dangers of insider trading. You can closely evaluate your firms' and your clients' procedures to prevent the misuse of confidential information.
At the same time, you should not use unreasonable fears of potential insider liability -- as some lawyers are doing in the municipal finance market -- as an excuse to prevent issuers from disclosing information to the marketplace.
Reaching the right balance, in cases such as these, is the crucial factor in providing wise counsel. It's a matter of asserting good judgment and strong ethical standards.
It would be ideal if your counsel could always provide clients with the kind of tough, timely advice that would prevent insider trading before it has a chance to happen. None of us is naive enough to think that is always possible. But strong words from you surely can deter a great deal of lawbreaking.
And if your good legal advice is not heeded, we are prepared to step in.
The S.E.C., other law-enforcement agencies, and the stock exchanges are in this battle for the long haul. We intend to make prosecutions a high priority.
Today, millions of Americans are investing their faith-- and investing their future -- in our capital markets. I am personally counting on you -- as professionals in the law-- to continue doing your part, too.
Investor protection is our legal mandate.
Investor protection is our moral responsibility.
Investor protection is my top personal priority.
Let's keep up the fight for fairness in our society. Let's continue defending the cause of honesty in our marketplace. Let's redouble our efforts to eradicate the crime of insider trading.
It's simply a question of integrity.