Eagle on the Street

  Fedders had surfaced in a typical way. A partner at the large and prestigious Washington law firm of Arnold & Potter, he had been active in raising money for the Reagan campaign from fellow conservative lawyers. When the election was won, he let it be known that he was interested in a job in government. His chances of attracting at least some offer were good, since unlike many of the Republican activists who flocked to Washington on Reagan’s coattails, Fedders had distinguished himself in his profession. Though relatively young, he had earned a reputation as one of the best corporate lawyers in the capital. After reviewing his résumé, Schneiderman flew to Washington and talked with Fedders over a bowl of soup in a restaurant near Arnold & Porter’s plush downtown offices. Schneiderman was impressed. Fedders was articulate, smart, and forceful in his views about how the SEC should change its approach to law enforcement. Schneiderman suggested that Shad set up a meeting.

  They were both busy and the only time they could find was a Saturday morning. Shad suggested a doughnut shop near his Georgetown hotel and Fedders drove in from his home in the Maryland suburbs. Once they started talking they found they couldn’t stop, and they wandered through the cobblestone streets for hours. They talked about Stanley Sporkin, the history of the enforcement division, and about their own careers and ambitions. Shad was immediately taken by Fedders’s self-confidence, his apparent leadership qualities. And Fedders made it clear that he shared Shad’s ideological approach. He wanted to stop the enforcement division from harassing corporations over infractions such as overseas bribery or political payoffs—these were crimes beyond the jurisdiction of the SEC, Fedders said. He wanted to make the commission’s prosecutions more orderly, more systematic, less dependent on the whims of a single chief such as Sporkin. And he wanted to create new priorities for division investigators, focusing their attention more on outright fraud in the financial markets and less on moral goose-chasing aimed at big corporations. All this accorded perfectly with Shad’s ideas. And Fedders was articulate, deeply knowledgeable, able to muster specific cases and facts to make his points. Shad didn’t know securities law in such detail. He needed someone on his team who did.

  Can you afford to give up your private law practice? Shad asked finally. He had this way of getting to the bottom line. It was blunt, but effective.

  Fedders said he could. It would be a big pay cut—more than 50 percent—but he could supplement his new government salary with real estate and other outside income. Moreover, he and Shad both knew that a stint as SEC enforcement chief was itself a kind of economic investment, since it would raise dramatically Fedders’s value as a corporate lawyer when he eventually returned to private practice.

  Shad engineered the hiring with the finesse of an experienced Wall Street investment banker. He provided Ted Levine, Sporkin’s protégé, with a long and fair hearing. Shad was impressed by Levine’s intelligence, and he made it clear that his inclination to hire from outside the commission was not a reflection on Levine’s ability. He wanted Levine to stay—under Fedders. And to be sure that he did not ruffle feathers among his politically appointed colleagues on the commission—by law, two of them were Democrats—Shad sent Fedders to meet with every commissioner before any appointment was announced. Only when his colleagues expressed their approval did Shad go public with his choice.

  Shad persuaded Sporkin to appear at the press conference where Fedders’s appointment was announced, even though Sporkin had been working for weeks at his new job at the CIA. The appearance was meant to symbolize to commission staff and the public a smooth handoff of the SEC’s most important staff job. Fedders said all the right words. He talked of Sporkin as a “legendary public servant.” He pledged to avoid conflicts of interest involving clients of his old law firm and to pursue white-collar crooks with vigor and enthusiasm.

  Away from the public spotlight, Fedders moved swiftly and decisively to implement changes in the enforcement division. There were superficial matters, reflecting his obsession with orderliness and detail. He insisted, for example, that all enforcement division attorneys fasten their ties and put on their suitcoats for meetings with outsiders. He banned enforcement employees from putting posters on their office walls. General Patton was one of his heroes, Fedders let it be known. Fedders viewed these edicts as part of a general campaign to make the enforcement division’s investigative work more systematic and professional. During the 1970s, reflecting the looseness of Sporkin’s leadership, the SEC sometimes let cases linger unresolved for years, never telling the targets of a probe whether they had been exonerated or not. Fedders said there had to be strict time limits on investigations and that potential defendants should be informed of a case’s outcome within a reasonable period. Some of the staff welcomed these changes; others saw them as the arbitrary campaign of a tightly wound neurotic.

  The enforcement staff received their first clear picture of Fedders’s prosecutorial priorities during a three-day conference late in September 1981, to which all of the SEC’s regional administrators were invited. The SEC had a centralized headquarters staff in Washington, where the division directors and the five appointed commissioners worked. But thousands of its employees were scattered about the country in the commissions’ regional offices. There were offices in New York, Los Angeles, Atlanta, Dallas, Denver, and even a “Washington Regional Office” across the Potomac in Virginia, with responsibility for detecting fraud and inspecting investment firms in the immediate Washington, D.C., area. Some of the regional offices were crucially important. The New York office, for example, had primary responsibility for inspecting brokerage firms on Wall Street, where there were thousands of investment firms, large and small. Each SEC regional office was headed by a semiautonomous regional administrator. Policy was made in Washington, but new policies such as those being devised by Fedders and Shad would only be effective if they were adopted in the regional offices.

  On September 19, the day before the conference began, Fedders drafted a “confidential discussion memorandum” to all the regional administrators. The enforcement program “should remain active and effective—not splashy,” Fedders wrote. Staff attorneys should “avoid peripheral parties and exotic theories—they slow us down.… We cannot be all things to all men.”

  As for “what should the enforcement program look like; what should be emphasized,” Fedders provided a list of priorities enumerated from the letter A to the letter U. Fedders later said that the list was in no particular order, but to the regional administrators it communicated an unmistakable shift of priorities. The hallmark of the 1970s—what the SEC had become famous for—was corporate bribery cases, particularly ones that ran afoul of the Foreign Corrupt Practices Act. But Fedders relegated such cases to near the bottom of his list, in between such irrelevancies as “the delinquent reports program” and a “program for processing applications for relief from disqualification.”

  At the top of the list Fedders distributed was “trading on the basis of nonpublic information,” a crime popularly known as insider trading, a term to which Fedders mildly objected because it didn’t distinguish between permissible stock trading by top corporate executives known as insiders and the use of confidential, inside information about corporate takeovers to make illegal stock trading profits.

  Insider trading was a hot topic with Fedders that September. In part, he was responding to Shad. Fortune magazine, one of Shad’s favorite publications, had published in August a long and persuasive cover story called “The Unwinnable War Against Insider Trading.” The magazine argued that theft of confidential information on Wall Street was becoming almost endemic and that there was virtually nothing the SEC could do about it—the crime was too hard to detect and prove. The article riled Shad. Though he didn’t know the extent of illegal trading, he disagreed with both its premises: that there was a major wave of dishonest dealing on Wall Street and that the SEC couldn’t stop insider trading. Shad supported Fedders’s efforts to make prosecution of such cases a priority.


  A few months later, when what came to be known as the SEC’s war on insider trading spilled into the newspapers, some former SEC lawyers described the new campaign as an effort to ease up on big business. Rather than pressuring large corporations and Wall Street firms, Shad and Fedders were proposing to spend their time chasing individual thieves. In truth, unlike some other area’s of the SEC’s franchise, prosecuting insider trading was a part of the commission’s work about which John Shad felt no ambivalence. He was an avid Reagan man and a committed deregulator, but in his abhorrence of insider trading Shad dissented from the radical conservative precepts of some economists. Some disciples of the Chicago School of economic theory argued vocally in 1981 that insider trading should be made legal because the stock market would work better if there were no restrictions on the flow of information, however it was obtained. Though he valued efficiency in the stock market, that argument never registered with Shad—or with Fedders. What was wrong was wrong, they both said. And insider trading was wrong.

  Fedders had put insider trading on the top of his list in part because he was looking for a chance to make his mark quickly in the way his predecessors at enforcement had done: by cracking a big fraud case in dramatic fashion. What Fedders needed was for some exceptionally greedy transgressor on Wall Street to provide him an opportunity.

  As it happened, just weeks after Fedders handed out his confidential list to SEC regional administrators, Wall Street obliged.

  “Maybe this is all a fluke,” Gary Sampson had told himself on Friday, when word spread on the boisterous floor of the Pacific Stock Exchange that trading in Santa Fe International stock would be suspended until the following week. “Maybe this will all blow over.” He tried to put it out of his mind over the weekend. But by Monday, October 5, 1981, he was beginning to feel the grip of panic.

  There was talk of a possible takeover announcement, but Sampson, Steven Mitchell, and the other traders in the options pit could scarcely believe it. They were all self-employed market makers at the dingy Pacific Stock Exchange in San Francisco, one of the lesser financial markets overseen by the Securities and Exchange Commission in Washington. They spent their days in clusters often or fifteen, screaming madly at one another and waving hand signals like crazed sign-language interpreters. If you were young and gutsy and had a head for numbers, it was a pretty good business. Sampson had been at it four years. He had made a little, lost a little, accumulated some savings.

  He did not imagine that it was possible to lose $2 million in a single day.

  As market makers on the Pacific exchange floor, Gary Sampson and his brethren enjoyed monopoly privileges: They had exclusive rights to handle the purchase and sale of certain stock options. They also had an obligation to help maintain what the regulators in Washington called a “fair and orderly market.” That meant, at any given moment on any given day, if the public wanted to buy stock options, Sampson and the others were required to sell. If the public wanted to sell, they had to buy.

  Santa Fe International’s stock options traded at the post where Sampson worked. The company was an industrial and natural resources behemoth headquartered in southern California. Not much appeared to be happening at Santa Fe that fall of 1981. Its stock price had been stuck between $21 and $23 per share for months, and it didn’t move up or down very often. The stock options Sampson bought and sold were tied directly to Santa Fe’s stock price. Unlike a share of stock, though, an option didn’t last forever—every “call option” gave its owner the right to buy one hundred shares of stock at an agreed upon price, until the option expired in a particular month and year. Often when an option expired it turned worthless, like a losing lottery ticket after a drawing. Options were popular because they were dirt cheap. By spending a relatively small amount of cash, an investor could load up on Santa Fe options. By owning the options, he could control a big block of Santa Fe stock for a limited period of time. If the stock price advanced during that period, the value of the options would soar.

  Strange things had begun to happen in Gary Sampson’s trading pit during the last days of September. Orders poured in for Santa Fe stock options that were due to expire in just a few weeks. On Thursday, October 1, the number of Santa Fe options sold tripled over the previous day, to 3,993 from 1,153. Chaos reigned. The traders in the Santa Fe pit couldn’t figure out why anyone would want to spend so much money on options that would be valuable for only a short time. They also couldn’t learn who was buying the options. But they didn’t dwell on it too much. It was hard to figure out the public—investors did a lot of stupid things. And the traders in the pit, all of them in their late twenties and early thirties, worked more from instinct than from sophisticated analysis. If somebody wanted to buy, they were willing to sell. Sampson sold hundreds of contracts worth tens of thousands of dollars each. He wasn’t too worried. He could only get burned if Santa Fe’s stock rose suddenly and dramatically in price before the options expired, something that had never happened before.

  On Tuesday it happened. The clacking wire services that carried the news of the outside world to the Pacific exchange floor told the tale: Kuwait Petroleum Corporation, an arm of the Persian Gulf government of Kuwait, had agreed to buy all of Santa Fe’s stock in a corporate takeover for $51 a share—double the current market price. Sampson was shocked. Giant takeovers were relatively rare events in those days and the truth was that he had never thought it was possible. He calculated the damage in a matter of minutes. All of his personal trading capital—$108,000—had been wiped out. He figured he owed about $2 million to the San Francisco firm that provided him with financing. Steven Mitchell made the same calculation and said that he was out about $1.75 million. Among the group the losses exceeded $6 million. It was odd how they reacted, Sampson thought—each according to his personality, some morosely, some with humor. Sampson was pissed off. Whoever bought the stock options he had sold knew there was a takeover announcement coming—that was illegal. The buyers must have had inside information.

  “Shit,” Sampson told his friends in the pit. “I’m going to try to get my money back.”

  He said he was going to call a lawyer. He said he was going to call the Securities and Exchange Commission.

  Sampson’s complaint helped spur the SEC into action. But even before his detailed explanation of unusual trading reached the enforcement division in Washington, the Santa Fe matter had galvanized Fedders’s interest. Market surveillance officials at the Pacific exchange had begun to report unusual activity in the Santa Fe options pit. After the takeover announcement by Kuwait Petroleum, it was obvious to Fedders that someone, or some group of people, had made millions of dollars illegally by purchasing Santa Fe options from Sampson and the rest while knowing that a merger was about to be announced. Working with the Pacific exchange, Fedders quickly obtained trading records to see who had placed the mass of orders during the last week of September and the first days of October.

  And immediately Fedders hit a brick wall.

  The vast bulk of the Santa Fe options suspiciously purchased before the takeover had been ordered through trading accounts at Credit Suisse, one of the largest banks in Switzerland. Swiss banking laws prevented the SEC from finding out who owned the accounts.

  The shroud of Swiss banking secrecy had recently become an enormous frustration at the enforcement division. In March 1981, just before Shad was confirmed in his new position, the SEC’s New York office had filed a major enforcement action in a situation similar to the one involving Santa Fe. Someone using secret Swiss bank accounts had earned millions by purchasing large numbers of stock options in St. Joe Minerals Corporation, shortly before a publicly announced takeover of the company. Robert Blackburn, an SEC attorney in New York, had been fighting in court for months to find out who was behind the Swiss accounts, but to no avail. Now Fedders assembled a team of lawyers in the Washington enforcement office to try to find out the same thing in the Santa Fe matter.

  Quickly, they came up with a novel i
dea. At a closed SEC meeting in October chaired by Shad, Fedders proposed filing a lawsuit against “Certain Unknown Persons” who had bought massive amounts of Santa Fe stock options from Gary Sampson and the other traders in San Francisco, and also against giant Credit Suisse, where the unknown persons had their secret accounts. The idea of filing suit against someone unknown was an unusual and creative legal approach, but neither Shad nor the other commissioners blanched at Fedders’s proposal. They approved the lawsuit. On October 25, Shad flew to New York and met with editors and reporters at the New York Times, declaring over lunch that the SEC was about to “come down with hobnail boots” on illegal insider trading. The next day, the unknown-persons suit was filed in New York federal court and Judge William Conner issued a temporary order freezing millions of dollars held in the suspected Credit Suisse accounts.

  In the meantime Blackburn of the SEC’s New York office, working with Fedders in Washington, had put the final touches on an aggressive strategy in the parallel St. Joe case. Frustrated by his inability to obtain the names of the account holders at Banca Della Svizzera that he suspected of reaping illegal profits on St. Joe stock options, Blackburn had submitted a brief to the judge in his case, a feisty older jurist named Milton Pollack, arguing that the only way to break through the Swiss banking laws was, in effect, to hold a gun to the bank’s head.

  A traditional and compelling defense of Swiss bank secrecy law was that the rules had been established to stop Hitler’s Reich from seizing assets of Jews and others fleeing Nazi Germany. The neutrality of Swiss law cut two ways, the Swiss argued. It might protect crooks who traded on inside information about U.S. corporate takeovers, but it also was a safeguard against tyranny.

  Blackburn had found a way to turn an aspect of this historical defense on its head, and to use it against the Swiss bank he was suing. He had learned that in Switzerland it was a serious crime for anyone to disclose the name of a Swiss-bank-account holder. That was why the banks refused to turn over the names in American courts—they would be breaking Swiss law. But there was an exception in Swiss tradition: If someone was under imminent duress, they could reveal account holders’ names with impunity. Blackburn told his judge that the exception dated from the days following World War II when, behind the newly erected Iron Curtain, guns were literally held to the heads of Swiss bank employees by Russian occupiers who were trying to stop the flight of capital out of Eastern Europe. Lawyers for the Swiss banks said they didn’t think the issue or the history was as clear as Blackburn and the SEC made it seem. In any event, Blackburn tried to hand Judge Pollack a gun to use against the Swiss banks: He proposed the judge levy massive fines against Banca Della Svizzera, fines so large that it would jeopardize the bank’s financial standing. Then, under imminent duress imposed by the American court, the bank would be free to turn over the names of its account holders to the SEC.