SEC Probes Firms That Gather Data on Who Owns What Shares

[R.A. Hettinga]

<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.


-- 
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R. A. Hettinga <mailto: rah at ibuc.com>
The Internet Bearer Underwriting Corporation <http://www.ibuc.com/>
44 Farquhar Street, Boston, MA 02131 USA
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