SEC Probes Firms That Gather Data on Who Owns What Shares

<http://online.wsj.com/article_print/0,,SB110247556985994158,00.html> The Wall Street Journal December 8, 2004 PAGE ONE Tracking Stocks SEC Probes Firms That Gather Data on Who Owns What Shares Its Question: Have They Paid Custodian Banks' Staffers To Give Up Information? Free Steaks and Game Tickets By SUSAN PULLIAM Staff Reporter of THE WALL STREET JOURNAL December 8, 2004; Page A1 A back-office clerk at CIBC Mellon Trust Co. was filling in for a colleague this summer when she got an unusual e-mail. The sender wanted data about which of the big investors the company dealt with owned a particular stock -- information the clerk knew was supposed to be top secret. The employee refused to provide the data. An internal probe concluded that the clerk she was filling in for had for years been giving out data on stockholdings, according to people close to the situation. They say the probe found that in return, this clerk got baseball and hockey tickets and cash payments of $50 to $100 per tip. The people add that a separate internal probe found that four employees of Mellon Financial Corp. had received Pittsburgh Pirates tickets, $50 American Express gift certificates and boxes of steaks for such data. The incident offers a window into a secret Wall Street world of gathering and selling real-time data about big investors' stock trading. This information, which is generally confidential, is so valuable that a whole industry has sprung up around finding it out. Businesses known as stock-surveillance firms gather trading data as best they can and market it to corporations that are curious about who is buying and selling their shares. Because small bits of trading data can be gleaned through legitimate sources, the business model is perfectly legal. But there's the potential for stock-surveillance firms to veer off the legal track if they use improper means to find out who is buying or selling what. There's also the potential for illegal insider trading if the information falls into the hands of investors who use it in their trading. Now the Securities and Exchange Commission is investigating the stock-surveillance business, sending out subpoenas to several data firms, according to people close to the situation. Among issues the SEC is looking into: Whether, at banks that act as custodians of stock during the trading process, some back-office workers systematically received gratuities for leaking data. The SEC also wants to know whether any trading data may have been turned over to investors and led to insider trading. SEC enforcement chief Stephen Cutler said, "As a general matter, we are interested in whether confidential portfolio information has been leaked at any point along the chain." A person close to the situation said the SEC probe focuses on possible data leaks as far back as 2000. The CIBC Mellon Trust case helped spur the SEC's enforcement division to action, people familiar with the matter say. The trust, based in Toronto, is a joint venture of Canadian Imperial Bank of Commerce and Pittsburgh's Mellon Financial. A spokeswoman for CIBC Mellon said it has taken steps to correct the problem uncovered by the joint venture's internal investigation. A spokesman for Mellon Financial said that regulators were notified quickly after the problem emerged, adding that Mellon "regrets the unauthorized disclosure of custodial information" and was "very proactive" in informing clients. A spokesman for CIBC said it doesn't carry out custodial activities in the U.S. but declined to comment further. The joint-venture employee who the probe concluded had been giving out data for years was Yvonne Williams, say people close to the situation. She was fired in July after the venture's internal investigation. Ms. Williams couldn't be reached for comment. Three of the four Mellon Financial employees cited in a Mellon probe also have been dismissed. No employees have been charged with anything. Among firms subpoenaed in the SEC's investigation, say people familiar with the matter, is Thomson Financial, a unit of Thomson Corp. of Toronto. Thomson Financial's Capital Markets Intelligence unit is one of the largest stock-surveillance firms. The unit told its employees this week that one CMI executive had left after an internal probe found business practices conflicting with its code of conduct, say people close to the situation. They add that at least two other employees are expected to depart. Thomson wouldn't comment on the probe but said it has taken steps to correct problems. "We take any allegation of impropriety or wrongdoing seriously and will not tolerate any such behavior," said a spokesman. He added that Thomson provides the trading data it gathers only to its corporate clients and their agents. Also receiving subpoenas, according to people familiar with the SEC probe, are Ilios Partners; the Georgeson Shareholder Communications Inc. unit of Computershare Ltd.; and Miller Tabak & Co., an institutional trading firm that has a unit called Strategic Stock Surveillance. Corporations pay fees to stock-surveillance firms in order to know who is buying and selling their shares. They have various motives for wanting to know, such as to gauge the effectiveness of their investor-relations efforts and, in rare cases, to find out if a potential hostile bidder is accumulating their shares. Some stock traders covet information about big investors' buying and selling for a different reason: It gives a sense of which way a stock is likely to move. For just that reason, those big investors like to keep their moves secret. When a mutual-fund family has a large chunk of stock it wants to buy or sell, it often does the trading in pieces over several days. A key reason is to disguise its intentions, so others can't jump in and buy or sell the stock first -- driving up the fund's cost of buying or reducing what it gets from selling. But if a trader knew a big fund had begun buying, he could assume there was more buying to come, and that the stock would tend to rise. "If speculators know in real time what you were doing they can jump aboard and piggyback you or work against you," says Samuel Hayes, a Harvard Business School professor. If a mutual fund's performance suffered as a result, among those hurt would be fund shareholders, he adds. Mutual funds typically disclose changes in their holdings only four times a year, after the end of each quarter. The business of ferreting out data about big investors' holdings has its roots in takeover battles. There, warring camps want to know the identities of shareholders so they can appeal to them for their votes. The camps hire proxy-solicitation firms, whose job includes identifying shareholders and lobbying them. The business shifted when hostile takeovers started to wane in the early 1990s. Some proxy-solicitation firms began building a business in stock surveillance, hoping to make customers of corporations that simply want to know who their shareholders are. Stock-surveillance firms developed an ability to tap into the arcane processing world that exists behind the scenes as investors buy and sell. For instance, when a pension or mutual fund buys shares, it places the order with a broker, who goes to a stock marketplace to have the order matched with a seller. After the order is filled, the fund sends instructions to the broker about where to deliver the shares and which "custodian bank" will make payment for them. The fund also sends instructions to that custodian bank, telling it to receive the shares and pay the broker. Both the broker and the custodian bank send instructions about the trade to the Depository Trust & Clearing, or "the DTC." It is part of a private organization set up in the 1970s to formally process and make final the trades -- steps known as "settlement" and "clearing," respectively -- for the bulk of the U.S. stock trading. The DTC formally moves ownership of the shares to the buyer and sends payment for the trade through one of the Federal Reserve banks. This is the final step in a process that can take up to three days to complete. Stock-surveillance firms rely partly on their access to reports from the DTC. This access is legitimate, explains Larry Thompson, senior deputy counsel of DTCC, holding company for the DTC. That's because SEC rules require the DTC to provide, at a company's request, daily reports of where its shares are held in custody once settlement is completed. And with a company's permission, the DTC can also turn over such reports to "agents" -- such as proxy solicitors and stock-surveillance firms. Mr. Thompson says that the DTC lists give only the total number of a company's shares held at each custodian bank. They don't provide data about specific investors' holdings or other sensitive trading information. But stock-surveillance firms combine these DTC listings with their own database of information about where big investors keep their shares -- such as what banks they use as custodians. Sometimes, these two bits of data -- combined with regulatory filings and information about the investment strategies of mutual funds -- are enough to get to the bottom of who is buying or selling shares, says Kevin Marcus, head of the part of Thomson that includes Capital Markets Intelligence. "It is to some extent a process of deduction," he says. Since DTC listings don't provide the up-to-the-minute information that some corporations want about who is buying and selling their shares, stock-surveillance firms turn to various market contacts to try to provide this. Among them are stock-exchange "specialists" -- the traders on the New York Stock Exchange floor whose job is to match buy orders with sell orders. Employees of stock-surveillance firms say they sometimes even turn to employees at the mutual funds themselves in hopes of getting such information. And they sometimes ask employees at the custodian banks -- a particular focus of the SEC probe. These employees are continually receiving up-to-the-minute information from mutual funds, pension funds and other institutional investors about what they're buying and selling. Companies use stock-surveillance services for a variety of legitimate business purposes. Ralph Poltermann, treasurer of AptarGroup Inc., a maker of packages such as flip-tops for ketchup bottles, says his company hired Thomson to help it track trading in its own shares after meetings with investors. For instance, AptarGroup met with big investors at a Credit Suisse First Boston conference in San Francisco on Sept. 28. Within a week, Mr. Poltermann says, an analyst at Thomson told him that at least one of those big investors was trading in AptarGroup shares. "It's magic to me," Mr. Poltermann says. "They have insights and contacts we don't have." Big investors, on the other hand, are annoyed that a business has sprung up to try to find out about their trading. John Wheeler, head trader at the American Century mutual-fund family, recalls having an eerie feeling a few years back when he was told that Sprint Corp.'s chief executive had called his firm. American Century had bought Sprint shares just the day before. But William Esrey, then Sprint's CEO, already had called to thank the fund family for its purchase. "Appreciate your support," Mr. Wheeler recalls Mr. Esrey telling an American Century executive. Mr. Esrey says through a Sprint spokesman that he doesn't recall the conversation but that it wasn't unusual for him to make such a call to investors. The trade hadn't even "settled" yet. The fund hadn't paid for the Sprint stock. So normally only American Century, its broker, custodian bank and others in the custody chain would have known who was buying the shares. Sprint, it turned out, had legitimately gotten its information from Thomson's stock-surveillance unit, a Sprint spokesman says. Many large companies use such services, getting daily updates and glossy monthly and quarterly summaries about activity in their shares. Dow Jones & Co., publisher of The Wall Street Journal, once used stock-surveillance services but no longer does. Thomson says its CMI unit has about 800 corporate clients, which pay $40,000 to $60,000 a year each for the service. The stock-surveillance unit had about $33 million in revenue last year, a tiny sliver of Thomson Corp.'s $7.44 billion revenue. Andrew Brooks, head trader at mutual-fund giant T. Rowe Price, says his trading desk often receives mysterious calls asking about changes in its holdings. Often, he says, the callers say they are "just checking your ownership on behalf of the company." He says callers typically hang up when pressed for more information on why they're calling. Mr. Brooks and a few other mutual-fund managers, including American Century officials, discussed their concerns about trading leaks 18 months ago with Lori Richards, head of the SEC's office of compliance and inspection, after she contacted them. In the case of CIBC Mellon Trust, the joint venture notified regulators of the incident involving Ms. Williams, the back-office clerk, this summer. Officials of the trust learned of the problem after Ms. Williams's fill-in told a supervisor of a surveillance firm's request for data, say people close to the matter. Ms. Williams's knowledge of stockholdings was broad. It wasn't limited to the names of shareholders who had permitted the custodian bank to release data about their holdings -- so-called Non-Objecting Beneficial Owners, or "nobos." Her knowledge would have included all shareholders of companies. Mellon Financial scoured e-mails, faxes and phone records to find out whether others might have accepted payments for data. It determined that the leaks had occurred in the area of the bank that handles communications with shareholders on matters like stock splits and dividends, the people familiar with the matter say. They say Mellon concluded that four employees had provided data about specific stockholdings of big investors, including Fidelity Investments. A spokeswoman for Fidelity says it has "always been concerned about disclosure of this information outside of required regulatory filings." The Mellon employees had access to a full list of investors for each stock. The bank's probe concluded, according to people close to the situation, that they released data about the holdings of shareholders who hadn't given the custodian bank such permission. In return, it concluded, they got sports tickets, steaks and gift certificates. Mellon Financial and its joint venture with CIBC notified hundreds of customers of the problem this summer through calls and e-mails. -- ----------------- R. A. Hettinga <mailto: rah@ibuc.com> The Internet Bearer Underwriting Corporation <http://www.ibuc.com/> 44 Farquhar Street, Boston, MA 02131 USA "... however it may deserve respect for its usefulness and antiquity, [predicting the end of the world] has not been found agreeable to experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire'