Letter Sparked Inquiry : How Trail of Deals Led to Boesky

NEW YORK —  The announcement that would electrify the financial world was only minutes away when Securities and Exchange Commission enforcement chief Gary G. Lynch assembled his staff in the hallway outside his office in Washington.

Before an astounded, cheering crowd of 150 SEC staffers, Lynch shared the secret that had consumed a dozen of his investigators for three months. The ringleader of the enormous insider trading scheme scandalizing Wall Street had led the SEC to an even bigger fish: Ivan F. Boesky, one of the richest and savviest stock-market speculators in America.

Boesky would be banished from the securities business, fined $100 million and charged with fraud, a crime that is expected to send him to jail for at least a few months.

Fear and Hysteria

That revelation two weeks ago of corruption at the highest levels of America’s investment community touched off fear and hysteria on Wall Street and stirred anew the crisis of confidence that has caused a small-investor exodus from the stock market.

But for the much-maligned and long-embattled SEC, never was there a finer moment than Nov. 14. Not only had SEC officials nabbed a key player in the ever-more-daring takeover game, but also they had done it without a single word of the investigation leaking out.

“Usually we don’t keep secrets from the guy sitting next to us, but this one was different,” one Boesky investigator recalls. “Nobody told me not to talk to my wife about it, but I assumed I shouldn’t, and didn’t.”

Only 18 months earlier, the SEC’s enforcement division was demoralized and reeling from criticism that it was inept at catching white-collar criminals.

Problems at Agency

It was an agency, one former SEC attorney recalls, whose enforcement chief “seemed to spend his time courting the industry” instead of investigating it. That man, John Fedders, then shellshocked his staff by resigning amid publicity about his marital and financial problems. Nor did the appointment of Lynch as Fedders’ successor innervate the troops. Although his thoroughness as an investigator and his knowledge about the takeover business are considered unparalleled among federal regulatory officials, he is so soft-spoken that many feared the agency would sink into oblivion.

Hence, his promise to bore into insider trading on Wall Street left many underwhelmed.

Even after the SEC exposed star investment banker Dennis B. Levine as the ringleader of the biggest insider trading scandal in history, there were plenty who grumbled that the SEC did not have the might to catch the real movers and shakers in corporate takeover circles. All they could get, the critics said, were the small-time crooks.

Catching Boesky was “really a vindication,” said one of the dozen SEC investigators who worked on the Boesky case day and night, weekday and weekend for three months. “Critics had said . . . we never got any arbs and that we’d never get any arbs.”

How they got not only an arb--short for arbitrageur--but the biggest arbitrageur of them all is a story that will not be fully told until the government’s investigation ends--at least a year from now, investigators close to the case say.

But the chain of events leading to this maelstrom began by chance one month after Lynch took office.

An anonymous letter postmarked in Caracas, Venezuela, arrived in May, 1985, at the New York headquarters of Merrill Lynch. It seemed that two stockbrokers in Merrill Lynch’s Caracas office were demonstrating an uncanny knack for investing in the stocks of companies just before a takeover sent the stocks’ prices soaring.

Identity Not Revealed

The letter writer, whose identity Merrill Lynch now says it thinks it knows but still will not disclose, accused the brokers of something far more serious than dumb luck: trading on corporate takeover information not available to the general public, a crime known as insider trading.

Even though no specific trades were identified, something about the allegations rang true. So, a team of Merrill Lynch investigators began examining the trading patterns of the two brokers, Carlos Zubillaga and Max Hofer.

Time after time, the brokers had invested small amounts of money in companies just before public announcements that the companies were being acquired. Suspicious, Merrill Lynch summoned them to New York.

Then, Zubillaga told company attorneys that he did have a tipster: a former Merrill Lynch broker in New York whom Zubillaga had met at a training session. That broker was Brian Campbell, whom Levine most often used to place orders on big takeover stocks. Campbell had left Merrill Lynch for a better job at Smith Barney three months earlier but had kept a trading account at Merrill Lynch.

Those trades, Merrill Lynch investigators found, did mirror many of those by the Caracas brokers.

More interesting still, all three accounts matched the trading patterns of one of Campbell’s best clients while he was at Merrill Lynch: the Bahamian branch of Bank Leu International of Switzerland.

Three Brokers Not Charged

(Zubillaga was later dismissed by Merrill Lynch and Hofer left the firm. Neither they nor Campbell has been charged with any wrongdoing, presumably because they are believed just to have piggybacked on Levine’s trades.)

Merrill Lynch’s enforcement chief at the time, Robert Romano, knew from the monthlong probe that it was time to turn the case over to the SEC. Not only were the trades suspiciously timed, but also they were originating at an offshore bank.

Someone, Romano suspected, was trying to avoid detection by U.S. authorities.

When Gary Lynch read all of this in a letter from Romano dated June 28, 1985, he had been on the job less than three months. But he had already identified insider trading as an area ripe for investigation and had appointed a team to review some suspiciously timed stock purchases.

Relations With U.S. Attorney

He had also been getting an earful from the SEC’s then-New York enforcement chief, Ira Sorkin, on the link between improved insider-trading fighting and better relations between the SEC and the U.S. attorney’s office.

Over the years, the two agencies had become competitors more than collaborators--a situation Sorkin, who had worked for the U.S. attorney before joining the SEC in 1984, considered partly responsible for the SEC’s enforcement failures.

As long as a fine and lost profits were the harshest penalties for insider trading, he argued, the SEC’s fight against that white-collar crime would never go beyond lip service. Only the threat of prison would be effective in this fight, he repeatedly told Lynch, and only the U.S. attorney’s office had that weapon in its arsenal.

“The investigation may well not have happened without the tip” from Merrill Lynch, one SEC investigator says. And it almost certainly would not have netted Levine and Boesky, he said, without teamwork between the SEC and the U.S. attorney’s office.

Bank Targeted

Lynch moved swiftly. Five days after Romano outlined his suspicions to the SEC, the agency launched a formal investigation. Its target: Bank Leu.

With the help of a new computer monitoring system installed at the New York Stock Exchange, SEC investigators quickly honed in on 27 securities traded between Oct. 1, 1983, and June of 1985. Armed with that evidence, the agency wrote to the Bahamian branch of Bank Leu, seeking its cooperation.

The bank balked. As a branch of a Swiss bank, it was protected by Swiss secrecy laws and was under no obligation to cooperate, even though Swiss officials had reluctantly been negotiating an end to that enforcement barrier with U.S. authorities.

What SEC officials did not know at that time was that officials of the Bahamian branch had another reason for refusing to cooperate: They were in on one of the biggest insider trading schemes in U.S. history.

As the scheme is detailed in court documents, bank officials had slowly been drawn in by a man most of them knew only as Mr. Diamond.

This man had opened his first account at the branch on May 27, 1980, depositing $125,000 and leaving instructions that he would initiate all trades by phone using the secret code word “diamond.” His real name, however, was recorded on the signature card he was required to fill out: Dennis B. Levine, then a 27-year-old mergers and acquisitions specialist at the New York investment firm Smith Barney.

Levine, whose mother’s maiden name is Diamond, soon drew attention to himself at the offshore bank--both for his habit of always calling collect at lunchtime from a pay phone and for his phenomenal stock trading skills. He also frequently bragged in conversations with Bank Leu employees that his trades were based on corporate secrets to which he had access.

So good was he at buying stocks just before a public announcement of a takeover sent the price soaring that some bank employees began following his lead. He bought; they bought. He sold and so did they.

Collected Information

They did not ask how he happened upon these corporate secrets and he did not tell. But first at Smith Barney, then at the predecessor to Shearson Lehman Bros. and briefly at Drexel Burnham Lambert--the last investment firm Levine will ever work for--Levine’s job was to dig up intelligence on companies in order to land mergers and acquisitions work. He collected much of this intelligence from the stock-market speculators known as risk arbitrageurs, with whom he would trade information.

There is nothing illegal about that. But what the SEC would later allege is that he was also selling secret corporate information he unearthed on the job, as well as using this secret information to make money on the side--in his account in the Bahamas. He was breaking the law.

For example, in late 1982, Levine came up with the idea for LTV Corp. to acquire Sierra Research Corp. and was put on the team structuring the deal. Since he had access to all the latest non-public information about the impending deal, he knew when the merger was imminent and bought 9,700 shares of Sierra on April 7 and 8 in 1983. Two weeks later, the merger was publicly announced and he sold his stock, making a profit of $66,498.

Number of Deals

In all, the SEC would later claim, Levine did nine insider deals in 1981, 11 in 1982, nine in 1983 and 13 in 1984.

His account in the Bahamas explains his motive. Over the years, he deposited all of $165,000 in that account. When the SEC finally caught up with him six months ago, his trading activity had increased the account to a bulging $10.3 million. That did not include the $1.9 million he had withdrawn--mostly in $100 bills, which he occasionally carried away in plastic bags--during frequent visits to the Bahamas that not even his wife knew about.

Levine lived well, too. He rented a summer house in New York’s fashionable Hamptons, bought a lavish $500,000 Park Avenue apartment and drove a red Ferrari Testarosa, for which he paid $90,000.

So it is not surprising that when the SEC asked for Bank Leu’s cooperation with its investigation in 1985, Levine not only kept up his illicit trading activities, but also invited the branch officials to join him in an elaborate cover-up of his scheme.

The SEC had not mentioned any customer names when it alerted Bank Leu to the U.S. government’s investigation. But Levine’s portfolio manager in the Bahamas, Bernhard Meier, knew immediately that Levine was their man.

Bank Meets With Levine

Meier, who was piggybacking on Levine trades to earn a little extra on the side for himself, notified Levine. And on Sept. 2, 1985, Bank Leu officials met with Levine in Nassau.

The SEC was just fishing, Levine insisted, noting that his trades showed no pattern.

“Mr. Levine apparently was an avid watcher of the SEC,” an agency investigator would later testify in court. So, he knew that his chances of escaping detection were better if he mixed things up--making sure that not all of his trades of takeover stocks were connected with information gleaned from his job.

Even if a pattern was detected, Levine was later quoted as telling a bank official, he had lied to the SEC before and he would do it again.

But he needed the bank’s help. He would compile packages of publicly available information and detailed scenarios so the bank could justify the past trading in the 27 stocks the SEC had targeted. And when the SEC asked, they were to say that bank employees had directed the trading in the “Diamond” account, not Levine.

Cover-Up Widens

Three weeks later, a Bank Leu employee would later testify, the cover-up widened. Levine ordered bank officials to destroy all documents that could implicate him--especially the withdrawal receipts bearing his real name.

All the while, Levine insisted that he keep trading to avoid any further suspicions.

For a time, the ploy succeeded in frustrating the SEC’s investigation. But, when SEC officials began to threaten action against Bank Leu’s New York office, the Bahamian branch officials began to sweat.

They had alerted their parent company in Switzerland to the SEC probe shortly after being notified themselves. And in a meeting on Oct. 1, 1985, they had warned the bank’s chairman that they might have to lie to the SEC or risk paying a multimillion-dollar fine for aiding an insider trading scheme.

The bank chairman “almost jumped from his chair,” a bank employee testified later. “And he said, ‘Mr. Meier, under no circumstances can you go to an authority and lie.’ ”

But, this employee testified, that is just what happened next. They lied to the SEC; they lied to bank officials in Zurich, and they even lied to the outside lawyers from Washington whose help they had enlisted when they began to get cold feet.

Lawyer Hired

Levine at first had ridiculed their squeamish behavior but eventually gave them a recommendation: Hire Harvey L. Pitt, a former SEC general counsel who had gone to work for one of the most sophisticated securities law firms in America: Fried, Frank, Harris, Shriver & Jacobson.

“With Fried, Frank,” a Bank Leu official later quoted Levine as saying, “you will get the SEC off your back.”

Levine did not know how prescient he was. Pitt would later negotiate a deal that won Bank Leu immunity from prosecution in exchange for ratting on Levine. SEC investigators often talk about luck’s role in cracking difficult cases. And over the next few months, it was as much luck as skill that led Levine to the SEC’s door.

Bank Leu officials simply did not share Levine’s will of steel. And one day in early December of last year, they decided it was time to talk.

Over the objections of Meier, Levine’s portfolio manager, Bank Leu’s Bahamian branch manager, Brunno Pletscher, summoned the bank’s Swiss lawyers to Nassau.

Pletscher told all. And then he told it again to Pitt, his own lawyer.

Levine Furious

Levine was not immediately let in on this turn of events. But when he was, Pletscher would later testify, he was furious.

“Mr. X said that was the most stupid thing that we could have done,” Pletscher testified. “You should control your lawyers and not let them control you, he said.”

(Disclosing bank customer names is a breach of Bahamian secrecy law. So for several months after bank officials decided to cooperate, they referred to Levine as “Mr. X.”)

Activities Continue

Even after learning that the SEC was hot on his trail, Levine could not bring himself to wind down his illicit investment activities. Instead of closing out his stock positions as the bank had asked, he actually expanded the list of stocks. And he repeatedly needled bank officials to let him trade a new stock, which he said could have earned him another $15 million.

Levine also began devising a new scheme. Bank officials learned little about this plan except that Levine called it his “genius plan” and said it involved mutual funds. And he offered to let some bank employees in on it, provided that they stopped cooperating with the SEC.

Levine also told bank officials that he had an emergency plan. If the SEC discovered his identity, he had lined up a non-American citizen to claim ownership of the account and planned to also involve a Liechtenstein entity in a role he never disclosed to Bank Leu.

Once the lawyers knew the real story, the dominoes began falling quickly. Meier left the bank and fled to Switzerland. Securities lawyer Pitt began bargaining with the SEC. And the U.S. attorney’s office, which upon Sorkin’s advice had been on the investigative team far earlier than in the past, used its power of granting immunity as leverage to win Bank Leu’s help in cracking the case.

Unknown to Levine, his fate was all but sealed on March 19 of this year. That day, the bank signed an agreement with the SEC, promising the agency documents and testimony about a customer who the bank said had traded in the securities being tracked by the SEC. In exchange, the bank won immunity from U.S. prosecution.

Over the next six weeks, the SEC finally got to see the documents it had been trying to obtain for seven months. But because of Bahamian secrecy laws, those documents had to be doctored to hide the account owner’s identity.

Name Revealed

More negotiations followed. And in the first week of May, the attorney general of the Bahamas concluded that Levine’s activities were not “banking transactions.” Bank Leu could legally hand over his name. And it did.

Two days after SEC officials learned the customer’s identity, Levine took steps to transfer $10 million from the Bahamian bank to a secret account in a bank in the Cayman Islands. The SEC decided it had to move fast.

For the next two days, a weekend, investigators worked around the clock, preparing the case they would make to a U.S. court to stop Levine.

On May 12, a full year after Merrill Lynch was tipped off to the scheme, the SEC accused Levine--by then one of Drexel Burnham Lambert’s chief takeover strategists--with making $12.6 million illegally. As the SEC outlined the case that day, Levine made his money with the help of confidential inside information about 54 companies.

That night, Levine was arrested, handcuffed and hauled off to a jail in lower Manhattan, where he was forced to spend the night. The charge: obstructing justice by trying to block the SEC’s investigation and destroying critical evidence.

But the SEC’s case was hastily put together, and Levine and his attorneys knew it. After he was released on $5-million bail, Levine continued to frustrate the agency. He repeatedly asserted his Fifth Amendment right against self-incrimination and refused to provide a court-ordered accounting of his assets.

But over the next few days, the SEC put together a solid case: dates, trades, takeover deals Levine had worked on, withdrawal receipts. All of it was laid out in the agency’s request for a court injunction.

It was the end of the road for Levine. On June 5, he pleaded guilty to four felony charges--on which he still awaits sentencing--agreed to pay the government $11.6 million and promised to cooperate with the SEC’s continuing investigation into insider trading.

The government’s most pressing question: Where did he get the information about takeover deals in which neither he nor his employer was involved?

Almost immediately, Levine started singing. “He loves to talk and we let him,” one SEC investigator said.

Accomplices Named

In less than a month, Levine had named his accomplices and the government had bagged former investment bankers Ira Sokolow, Robert Wilkis and David Brown and takeover lawyer Ilan Reich. All would eventually settle SEC charges that they had been Levine informants and agree to cooperate with the government’s investigation. They also face prison terms.

But as summer turned to fall, the investigation seemed to wind down. At first, rumors were flying that the really big names in corporate takeover circles would be trapped in the government’s web--arbitrageur Boesky, raiders T. Boone Pickens and Carl Icahn, junk bond specialist Drexel Burnham and takeover advisers First Boston, Morgan Stanley and Goldman Sachs were all mentioned.

But, when no new evidence surfaced for months, critics began scoffing at the SEC’s promise that there was more to come.

All SEC officials could do was bite their tongues. They had Boesky, but they could not yet disclose it.

Smoking Gun

In fact, the SEC had been assembling circumstantial evidence about Boesky’s trading patterns for years. But he was such a major player in the takeover game, with access to such powerful legal counsel, that investigators were scared to try to make a case without a smoking gun.

They also knew too well that circumstantial evidence has not been enough to win insider trading convictions in some recent cases.

But within three months of catching Levine, they had their smoking gun. Levine and Boesky had a contract. Boesky had promised to pay Levine for confidential information on takeover deals before the public learned about them through legal channels.

The chase was over. Boesky gave himself up.

And then he did something even more remarkable. Besides agreeing to turn over a phenomenal sum of money--$100 million--Boesky agreed to let the government eavesdrop on his business conversations.

For more than a month, government investigators listened to every conversation he had, accumulating still more evidence against still more participants in the ever-more-daring business of corporate takeovers.

All of this came to light two weeks ago, when the government, discovering that its eavesdropping had been found out, called a press conference on a Friday afternoon to announce Boesky’s role in the biggest business scandal of the century.

With those tapes, no one doubts the SEC any longer when it says that there will be more disclosures, more big names and at least another year before the investigation runs its course. Already, more than a dozen people have been subpoenaed, but it is still anybody’s guess who will actually be charged with wrongdoing.

Difficult Cases

“We don’t all sit down in government and say, OK, who are we going to get today?” a former SEC investigator said. “And, even when you have what looks like solid evidence, you soon learn that these insider trading cases are very hard to make.

“It’s something akin to spotting a pregnant woman. It’s easy to see she’s pregnant but it’s quite another matter to figure out who the father is.”

What lawyers and investigators close to the case will say is that the names to follow will be recognizable.

“Will Boesky be the biggest name?” said one lawyer, repeating a reporter’s question. “The biggest arb, yes. But the biggest investment banker? The biggest takeover lawyer? The biggest raider? Stay tuned.”