The SEC v. the American shareholder: the Drexel Burnham case

National Review, Nov 25, 1988 by Henry G. Manne, Larry E. Ribstein

ON SEPTEMBER 7, 1988, the U.S. Securities and Exchange Commission filed a long-awaited civil lawsuit against the investment-banking firm of Drexel Burnham Lambert. The complaint is a litany of securities violations that includes insider trading as well as various other claims that are quite technical and therefore devoid of news appeal. A criminal indictment also seems likely in the near future.

But Drexel's alleged wrongdoings are not the only tale to tell. Lurking in the Drexel case is a story of questionable government maneuvers against a firm that has played a major role in the modern takeover movement. The heart of the matter is not securities fraud at all; it is government hostility to takeovers and, more generally, government protection of certain firms and individuals from competition.

The events that finally led the SEC to Drexel began at least as early as December 1985, when Bank Leu International, in return for a grant of immunity, gave the SEC records of illegal trading by its client, investment banker Dennis B. Levine. Based on these records, Levine was indicted in May 1986. Harvey Pitt, Bank Leu's counsel at the time, said that the SEC let Bank Leu off the hook because the Commission "was looking . . . for a major player in the investment community."

It first appeared that the "player" was the rapacious arbitrageur, Ivan Boesky. Levine told the SEC that Boesky had paid him for secret information about takeover and restructuring targets and had used this information to make millions in insider-trading profits. In November 1986, Boesky settled insider-trading charges by paying $100 million in profits and penalties. He was barred for life from the U.S. securities industry and is serving time in a minimum-security prison.

For all the $100 million, the Boesky settlement was still so generous that it suggests the SEC was even then looking beyond Boesky to a different target. The settlement left Boesky, a man who admitted to blatant insider trading on a grand scale, free to trade securities in any market outside the United States. Boesky was allowed to keep more than half of his estimated wealth from suspect securities trades.

Most tellingly, the SEC gave Boesky enough advance warning of his prosecution to permit him to sell almost $500 million in securities before the SEC's case against him was made public. (Apparently the SEC is not disturbed by all forms of insider trading.) Even after his settlement, Boesky was given additional time-until April 1988-for an orderly sale of his holdings. While the SEC undoubtedly feared that word of these sales would collapse securities markets, Boesky clearly was the primary beneficiary of the delay.

IF THE SEC had already targeted Drexel, the deal with Boesky gave it what it wanted. And the SEC's complaint against Drexel demonstrates the Commission's heavy reliance on Boesky's testimony. Even so, the SEC could not establish a case against Drexel with Boesky's testimony alone. He is after all a convicted felon and a notorious liar. He portrayed himself as a legitimate businessman in his book Merger Mania. Arbitrage. Wan Street's Best-Kept Money-Making Secret at the same moment that he was secretly buying information from Levine. These and other problems with Boesky's credibility may also account for the U.S. Attorney's delay in seeking a criminal indictment against Drexel. In short, the government's case against Drexel needed more power than it seemed to have.

Realizing the weakness of its case, the SEC apparently decided to try to influence the outcome in advance. Beginning in November 1986, a regular drumbeat of news stories, primarily in the Wall Street Journal, quoted "lawyers familiar with the government's investigation," "people familiar with the government's investigation," "legal sources with knowledge," "sources," and so forth. The most likely explanation for this "inside information" is that SEC sources regularly gave the information to the Wall Street Journal. If this is the case-and the SEC at least knew of the "leaks" even if they were not authorized-the SEC's approach stands in stark contrast to its silence during the Boesky proceedings, when Boesky was allowed to unload his cache of securities unhindered by public scandal.

The anonymous sources, whatever their true identity, announced each turn in the government's investigationsuch as the transactions the government was investigating, that Boesky's allegations were supported by a "paper trail," or that one of Boesky's affiliates gave documents to the SEC. The sources disclosed tbe SEC's "Wells request," a traditionally confidential notification designed to allow a defendant to rebut charges before the Commission files them publicly. And in what might have been a final flourish, the SEC took the unprecedented step of announcing this June that a civil complaint against Drexel had been approved, while it delayed the actual filing of the complaint until September.

This constant stream of innuendo, for almost two years before the filing of a civil complaint, created public antagonism against Drexel and cost Drexel valuable reputation and business. All of this made the SEC's case seem stronger than it was, and may have undermined Drexel's right to a fair trial.