Securities and Exchange Commission Historical Society

Wrestling with Reform: Financial Scandals and the Legislation They Inspired

Manipulating Markets, Making Law: ITSFEA of 1988

The Milken Scandal

“We believe, based on the information available to us, that the charges filed by the SEC are wrong.  After an examination of 1.5 million pages of documentation and interviews of scores of Drexel Burnham employees, we continue to believe that neither Drexel Burnham nor any of our employees named in this matter have engaged in any wrongdoing.  We expect to be vindicated.”

September 7, 1998 Drexel Burnham Lambert letter to customers on SEC civil suit

Though based in California, Michael Milken held sway on Wall Street as its “junk bond king.”  Together with Drexel Burnham Lambert he pioneered the use of these poorly-regarded but high-yielding bonds in the 1970s and flourished with them in the 1980s.  In the early 1980s, Milken supplied Ivan Boesky with capital and information, which Boesky used to take advantage of takeover bids and manipulate stocks to the benefit of both men. (34)

Repercussions from Boesky’s fall were big; those from Milken’s were bigger still.  Milken had appeared before Congress in April 1988, when momentum behind both takeover and insider trading legislation was weak.  Two weeks after that testimony, however, Representatives Dingell and Markey produced a new insider trading bill, increasing penalties for insider trading, penalizing firms that failed to police employee behavior, and awarding bounties to informants in securities fraud cases.

In September, the SEC filed a civil complaint against Drexel Burnham Lambert, consisting of 184 pages documenting conspiracies and insider trading episodes.  Representative Markey believed this ensured passage of “a tough, common sense insider-trading bill.”  His measure passed the House unanimously within a week.  This contained the same penalties as the Proxmire bill, retained the bounties provision, and required firms to maintain adequate Chinese walls.  It did not, however, define insider trading. (35)

Senator Riegle believed that the Drexel complaint provided an “impetus” for insider trading legislation, but a staffer gave legislation only “60-40” odds that year, in part because the Senate was still wrestling with combined takeover and insider trading legislation.  Nine months after the market break, Proxmire had reintroduced his takeover bill with little success.  He continued trying to expand insider trading legislation into either a comprehensive banking reform or a takeover bill, delaying Senate efforts to address it.  House leaders urged the Senate to take advantage of “the irresistible momentum” provided by the Drexel case, stick to insider trading, and leave takeover legislation for the next session.  Well after midnight on the last day of the session, the Senate relented and approved the Insider Trading and Securities Fraud Enforcement Act (ITSFEA).  President Reagan signed it into law. (36)

The Ivan Boesky and Michael Milken scandals provided a strong push.  Nevertheless, disparate legislative goals and disputes about insider trading stretched the legislative process out for nearly two years.  ITSFEA imposed severe penalties on those convicted of insider trading.  But insider trading theory remained contentious until the Supreme Court ruled in U.S. v. O’Hagan in 1997.  Corporate takeovers also remained unaddressed by Congress.  The legislative response to great insider trading scandals of the 1980s produced a powerful piece of deterrent legislation that made few sweeping reforms. 


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Footnotes:

(34) Charles R. Geist.  Wall Street (New York: Oxford University Press, 1997), 336-337.  Stewart, Den of Thieves, 114-118, 122-125, 210-217, 234-241.

(35) New York Times, “Bill That Lifts Insider Fines Is Introduced,” August 4, 1988.  New York Times, “Proposed Insider-Trading Bill Worries Wall St. Lobbyists,” May 12, 1988.  Stewart, Den of Thieves, 461.  New York Times, “Drexel Burnham Charged by SEC With Stock Fraud,” September 8, 1988.  Bill Summary and Status, 100th Congress (1987-1988), H.R. 5133 All Congressional Actions http://thomas.loc.gov/cgi-bin/bdquery/z?d100:HR05133:@@@XLos Angeles Times, “Stiffer Insider-Trading Penalties Clear House But Face Uncertain Fate in Senate,” September 15, 1988.

(36) Wall Street Journal, “The SEC’s Case Against Drexel,” September 9, 1988.  New York Times, “Chances of a New Insider Law Look Better,” September 9, 1988.  New York Times, “House Passes Bill to Raise Insider Fines,” September 15, 1988.  Los Angeles Times, “Stiffer Insider-Trading Penalties Clear House But Face Uncertain Fate in Senate,” September 15, 1988.  Washington Post, “Senate’s Chance to Reassure Investors Was All But Lost in Preadjournment Politicking,” October 25, 1988.

Related Museum Resources

Papers

1988
document pdf (Government Records)
February 17, 1988
image pdf (Anonymous)
September 7, 1988
transcript pdf (Courtesy of the National Archives and Records Administration)
September 9, 1988
image pdf (Courtesy of Stuart J. Kaswell)

Programs

01 November 2011

Silver Screen: How Films Shape Public Perception of Financial Regulation

Moderator: David Lipton

Presenter(s): J. Bradley Bennett and John Reed Stark

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