NEW YORK — The Securities and Exchange Commission has begun an informal inquiry into complaints of widespread insider trading in high-yield, high-risk junk bonds, sources confirmed Wednesday.
The inquiry was sparked by sharp price movements of junk bonds before corporate announcements affecting the value of the bonds, such as a company's offer to buy back its bonds at a premium.
The sources said the inquiry focuses heavily on individuals who serve on creditors committees of troubled companies, including those in bankruptcy proceedings. These individuals often have advance knowledge of the plans of a troubled company.
But creditors committee members often also are executives of securities firms that own a company's bonds or make markets in them and therefore may be tempted to use their advance knowledge.
Big run-ups in junk bond prices have occurred before public announcements by several troubled companies, including Ft. Howard Corp. and Harcourt Brace Jovanovich. Using such advance information could yield big profits, because junk bond prices have become extremely volatile since the market for them collapsed last year.
The SEC, however, hasn't authorized a formal investigation. Senior SEC officials said in interviews that there are significant legal questions about how far insider trading laws can be applied to junk bonds as opposed to stocks. The spate of insider trading prosecutions thus far centered on trading in stocks and related instruments such as warrants and options.
SEC Commissioner Edward H. Fleischman said that under current law corporate insiders have responsibilities to stockholders that they don't have to bondholders.
"The traditional notions of insider trading are grounded in a relationship between the company and its shareholders that has frequently been characterized as a fiduciary relationship," he said. "There is no parallel body of theory that makes the company or the company's officers fiduciaries with respect to debt holders."
William McLucas, the SEC's director of enforcement, also said the law isn't clear with respect to junk bonds. But he said the SEC probably could make a case based on the theory of misappropriation of information, a theory that has been upheld by the Supreme Court.
One individual who has advised many creditors committees, Wilbur L. Ross Jr., of the investment banking firm Rothschild Inc., said a number of individuals or firms may have exploited the uncertainty about the law.
"Since everybody has known that there was at least a lack of clarity, my guess is that there probably have been some abuses," he said.
Ross said he favors eliminating the uncertainty by having the SEC and Congress expand the insider trading laws so that they clearly apply equally to stocks and bonds.