Of Loose Lips and Stock Tips

By Janice Castro

The dramatic crackdown against insider trading has been haunted by a strange irony: no specific statute outlaws or even defines the crime. Using the broad | antifraud provisions of federal law, prosecutors have been expanding the reach of prohibitions against insider trading on a case-by-case basis. Over the past few years they have won decisions in numerous courts, but none of those precedents have been explicitly endorsed by the U.S. Supreme Court.

Last week the court came close, upholding the mail- and wire-fraud conviction of R. Foster Winans, a former Wall Street Journal columnist who was paid by stockbrokers to leak information about upcoming stories on particular companies. The court also let stand his conviction on a securities-law violation. Investigators had feared that an adverse decision in the Winans case could cripple their efforts to go after big-time insider traders like Ivan Boesky and Dennis Levine. The high court's action, said Gary Lynch, head of enforcement for the Securities and Exchange Commission, "is tremendous news. It's an affirmation of our insider-trading program."

But while the decision gave prosecutors a big lift, it left the law that governs insider-trading cases as murky as ever. By a vote of 8 to 0, the Supreme Court ruled that Winans had violated general laws that prohibit wire and mail fraud. On the separate issue of whether Winans had been correctly convicted of breaking federal securities laws, the court split down the middle, 4 to 4, a decision of no value as a legal precedent. Thus the court has still not settled the question of when insider trading is a violation of the securities statutes. At the same time, though, the Justices' broad interpretation of the wire- and mail-fraud laws has given companies a powerful new weapon for preventing employees from leaking all kinds of information, not only to stockbrokers but also to rival corporations and journalists.

The legal controversy over insider trading dates back at least to the beginning of the century. In 1909 the Supreme Court held that a corporate director could not legally profit from buying his company's stock based on information about the firm that he had concealed from another shareholder. But that case was too narrow to serve as a model for other insider-trading cases. The nearest thing to a definition is a provision in the Securities Exchange Act of 1934 that prohibits using a "manipulative or deceptive device" in connection with the purchase or sale of a stock. In recent years, prosecutors have developed their own broad definition of an insider trader: almost anyone who uses information he knows to be confidential to make a profit from the stock market. This applies not only to corporate officers but to lawyers, investment bankers and others who do work for companies and frequently have access to inside information.

In going after Winans, who had no relationship to the companies he wrote about, prosecutors were making their most ambitious effort yet to broaden the definition of insider trading. Winans was a regular author of "Heard on the Street," an influential Wall Street Journal column that can often make the stock price of a company jump or fall. In 1983 and 1984, Winans passed tips on what he intended to write about to two Kidder, Peabody stockbrokers, Peter Brant and Kenneth Felis. By knowing ahead of time whether a story would be favorable or unfavorable to a company, the brokers made profitable trades. Altogether, the group, which included David Carpenter, then Winans' roommate, earned about $690,000, of which only $30,000 went to Winans.

In court, prosecutors argued that Winans was guilty of "misappropriating" information that rightfully belonged to his employer, a violation of both securities laws and mail- and wire-fraud statutes (since the writer passed his tips by telephone). The Supreme Court agreed with regard to the mail-and wire- fraud charge. The Justices ruled that the contents of "Heard on the Street" were the "property" of the Journal and that Winans' misuse of the information amounted to theft.

Legal experts quickly pointed out that the court's ruling could have applications far beyond insider trading. For one thing, companies may be encouraged to prosecute employees who leak confidential information to the news media. Says Richard Rowe, a Washington securities-law attorney: "The decision certainly gives firms a club to hold over their employees' heads."

Lawyers at dozens of firms, including IBM, AT&T and Honeywell, are studying the Winans case to see if it can help them discourage departing employees from passing on technological secrets to competitors. In the past, companies have tried to control such leakage of information through civil suits, but now they may pursue criminal prosecutions. "The fact that you can go to jail will have a chilling effect on what you'll take along" when leaving a job, contends Niels Reimers, director of the Office of Technology Licensing at Stanford University.

Many legal experts think that Congress should now define insider trading rather than continue to force prosecutors to use sweeping antifraud laws to make their cases. Last week the Securities and Exchange Commission unveiled a long-awaited proposal for an insider-trading law. The measure would prohibit the "wrongful use" of "nonpublic information" about a company that could affect its stock price, or trading on such information that was "obtained wrongfully." While that language may not be a model of specificity, it is far less vague than current law. If Congress passes the proposal, the authorities will be able to go after insider traders with a rapier instead of a club.

With reporting by Jerome Cramer/Washington and Raji Samghabadi/New York