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                                                                                BUSINESS, Page 47

Trading on the Inside Edge


Stock deals based on priveleged information still go on, and
many of them are legal

By THOMAS MCCARROLL


    After Philip Schein, the CEO of U.S. Bioscience, told Wall
Street analysts last November that regulatory approval for the
firm's new cancer-therapy drug was imminent, there was a
stampede to buy the company's stock. By Jan. 7, Bioscience's
share price hit an all-time high of 85, before a 2-for-1 split
at mid-month. But on Jan. 31 came a shocker: a Food and Drug
Administration panel decided not to recommend approval of the
new drug, known as Ethyol.

    That sent the stock into a free fall. It plunged 46% at
the next session and never recovered. The shares are now
trading at around 11. But not all of Bioscience's shareholders
got pummeled. Schein and five vice presidents managed to bail
out just in time. In the period before the FDA's bombshell, they
unloaded 1.2 million shares at prices ranging from 38 to 77 1/2.

    Mere coincidence? Good luck? Or, as corporate insiders who
occupied decision-making positions and called the shots, did
they know something that other investors didn't? The Bioscience
executives refuse to say. But in a class action, a group of
angry shareholders accuse the officers of cashing in on private
information. The investors charge that the Bioscience insiders
knew Ethyol would be rejected by the FDA as too untested, and
that they deliberately misled the public about the prospects for
the drug in order to sell their stock at inflated prices.

    The Bioscience case represents the latest form of alleged
insider trading that is troubling Wall Street. Instead of stock
tipsters and takeover artists, though, the new cases involve
high-ranking executives whose jobs give them access to
privileged information about their business. And unlike the
scandals of the 1980s -- or the charges brought last week by the
Securities and Exchange Commission against investors Martin
Revson and Edward Downe Jr. and others accused of making at
least $13 million on inside information -- most of the trades
by corporate officers are technically legal and carried out with
the full knowledge of the SEC. But a recent spate of dubious
transactions by corporate higher-ups has investors crying foul.
Says Morris Levy, a Long Island, N.Y., securities attorney:
"Shareholders are being blindsided by corporate insiders because
the SEC is turning a blind eye and letting them run wild with
impunity."

    Like outside investors, corporate insiders are barred by
securities laws from trading on information, such as earnings
results and product announcements, before it is publicly
released. To guard against abuses, top officers are subject to
special regulation. They must, for example, report each of their
trades to the SEC by the 10th of the following month. And they
are subject to stiff fines and penalties for late filings.

    Still, improper trades by corporate insiders are hard to
police. Poor record keeping and lax enforcement by the SEC, for
example, have typically made such cases difficult to detect and
prosecute. Unless there is unshakable evidence to the contrary,
insiders can easily explain away questionable deals as simply
being fortuitous. And often even the most flagrant-appearing
trades can fall within legal bounds. The Bioscience
transactions, now challenged by shareholders as improper,
apparently satisfied SEC guidelines. Explains Robert Gabele,
president of Invest/Net, a Fort Lauderdale research firm that
tracks insider trades: "Many corporate insider trades are not
illegal, just unethical. There's a thin gray line."

    Discerning that line can be difficult. For instance, were
Household International executives Michael DeLuca and Donald
Lohmann just lucky when they elected to unload about
three-quarters of their holdings at between 53 and 55 a share
only days before the big Chicago-area financial concern revealed
problem loans? Household's stock sank 11 points in the aftermath
of the March 26 announcement. Neither executive is accused of
wrongdoing.

    Then there's the case of Browning-Ferris. Last August two
top executives at the Houston waste-disposal concern sold more
than $2 million worth of company stock. General counsel Howard
Hoover and chief financial officer R. John Stanton Jr. dumped
half of their holdings at about 27 a share. The trades
attracted little attention or suspicion until Browning-Ferris
surprised Wall Street with a gloomier-than-expected earnings
forecast and its stock plunged 19%. While most shareholders got
trashed, Stanton and Hoover avoided $468,000 in losses with
their timely sales. Disclosure of the trades led to the
resignation of both executives as well as an SEC investigation,
which is ongoing.

    But it is outside investors, rather than regulators, who
are applying the most pressure on corporate insiders.
Increasingly, shareholders are turning to the courts. There are
nearly 100 investor lawsuits pending against insiders, says
James Newman, publisher of the Securities Class Action Alert
newsletter, double the number of five years ago. Shareholders
at Compaq Computer, for example, sued last year after insiders
unloaded $16 million in stock just weeks before the company's
stunning revelation of an inventory glut and exchange-rate
problems. Compaq's stock dropped 27% on the news.

    Stung by criticism of lax enforcement, the SEC has been
pressured into cracking down. The watchdog agency has opened a
raft of investigations into cases involving corporate insiders
in recent months. In one of its toughest actions to date, the
SEC last October filed insider-trading charges against three top
officers at Shared Medical Systems. The executives, including
CEO R. James Macaleer, are accused of making false statements
about Shared Medical's financial health and then selling 157,400
shares, at 35 to 4114 each, before the Malvern, Pa., company
disclosed a sudden sharp decline in its earnings. The news sent
the stock tumbling to 27. The agency is seeking $1.7 million in
"unlawfully avoided losses," plus a civil penalty of three times
that amount.

    While corporate insiders have rarely faced criminal
charges a la Michael Milken and Ivan Boesky, observers expect
that to change. Says Robert Lamb, professor of finance at New
York University: "We may soon see corporate executives being
carried away in handcuffs."

    For now, though, the SEC is coming down the hardest on
insiders who fail to file timely forms disclosing their trades
and holdings. The regulatory agency won authority last year to
impose fines of up to $50,000 for late or omitted filings. It
also expanded the definition of insider. In the past, officers
from vice presidents to CEOs were required to file. But now the
category is defined by job function rather than by company
title. Typically, executives with major responsibilities,
including lab directors, actuaries and software developers, must
file.

    To improve surveillance, the SEC is beginning to use
computer data bases to keep track of the nearly 200,000 insider
filings that the agency receives each year. The changes have
already boosted compliance. The number of insider reports filed
after deadline has declined from 55% five years ago to less than
10%.

    Many critics, however, complain that the SEC's regulatory
bark is worse than its bite. They point to a case, decided last
month, involving Neil Rogen, founder and former chairman of
Memory Metals, who without admitting or denying guilt agreed to
a court order to settle insider-trading charges with forfeited
profits and fines totaling $6 million. The SEC, though, waived
the fines when Rogen said he didn't have the money to pay them.

    Some critics point out that one SEC decision may even make
it more profitable for insiders to act on privileged
information. Under pressure from probusiness lobbyists in
Congress, the SEC last year removed a 57-year-old regulation
that required corporate insiders who exercised options to wait
at least six months before selling the stock. The rule, which
accounted for the vast majority of violations by corporate
insiders, served partly to reduce the potential payoff for
improper trades. Now when insiders decide to unload their
portfolios, they can get a bigger bang for the buck by
exercising their options and immediately selling the stock. The
change in the law, according to some securities experts, was a
sop to Big Business. Says Levy: "The SEC has wiped an entire
class of violations off the books. It didn't stop the abuses;
it just pretends they don't exist." Insiders are already cashing
in. During the first three months of this year, insiders
exercised $1 billion worth of options, in contrast to $214
million in the same period last year.

    Still, it can pay to follow the insiders. Important clues
about a company's outlook can be gleaned by monitoring insider
transactions. Sometimes trades can be misleading, since some
firms allow insiders to buy or sell shares only during specific
periods, such as after quarterly earnings announcements.
Investors should be suspicious if insiders are selling near
yearly lows, when buying is expected. It may be time to unload
the stock. Similarly, if they are buying rather than selling at
high points, that can be interpreted as a good sign. More
revealing, though, is the number of insiders involved. Says
Invest/Net's Gabele: "I'd rather find seven vice presidents
buying 1,000 shares each than the president buying 5,000 shares.
The more insiders are acting in concert, the stronger the
consensus."

    But a note of caution is due. Insiders can blow it.
Anticipating a favorable business climate, six corporate
officers at Southwest Gas last year loaded up on the company's
stock at prices averaging 15. The stock climbed as high as 18,
but then the company was jolted by a succession of negative
developments. A ruling by the Office of Thrift Supervision
forced Southwest to set aside $17 million to cover bad loans in
its savings-bank division. And the company's request for a $43
million rate hike was put off by the Arizona public-service
commission. Southwest's stock hit the skids, sliding as low as
8 by August. It just goes to show that, even for insiders,
playing the market is not a science.