Wall Street: Where It Really Hurts

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WALL Street for years has escaped what it dreads most: a serious attack on its integrity. Last week, when just such a blow fell, it landed where it really hurt. The staff of the Securities and Exchange Commission accused Merrill Lynch, Pierce, Fenner & Smith, Inc., the world's largest and best-known brokerage house, of practicing fraud and deceit by misusing inside information. Even though Merrill Lynch immediately protested its innocence, the charges by their very nature can only tarnish Wall Street's zealously nurtured image. That image is of a market where 24 million investors can trade with confidence that they are not being cheated.

The commission ordered public hearings into charges that Merrill Lynch illegally fed corporate secrets to 15 of its largest customers—even while withholding the same information from thousands of little investors. The tipoffs, according to the SEC staff, led the 15 big outfits to unload shares of Douglas Aircraft Co. stock just before it plunged in value during June 1966. At the same time, said the SEC, Merrill Lynch kept on buying Douglas stock for less favored customers without telling them it had inside knowledge that Douglas' earnings were falling sharply.

That charge struck at the heart of the brokerage firm's cherished reputation for encouraging and instructing small investors. In essence, it accused Merrill Lynch of doing the very opposite: favoring big institutions at the expense of the rank and file.

Before the Public. The SEC filed fraud charges against Merrill Lynch and 14 of its officers and salesmen, including Executive Vice President Winthrop C. Lenz. For the first time, the agency also brought fraud charges against the recipients of the information. All are large institutional investors, including the Dreyfus Corp., the Madison Fund and Investors Management Co. All were accused of violating SEC regulations, issued under the 1933 Securities Act and the 1934 Securities Exchange Act, that prohibit insiders from acting on information before it becomes public knowledge.

According to the SEC staff, Merrill Lynch learned of Douglas' financial troubles while underwriting a $75 million offering of the company's convertible debentures. On June 7, 1966, the planemaker reported profits of 85¢ a share for the five months that ended the previous April 30. But by then Douglas, now a part of the McDonnell Douglas Corp., was running into production snags and unexpected cost increases. In its underwriter's role, said the SEC, Merrill Lynch discovered that the aircraft company's earnings outlook had worsened, and passed that fact on to some of its big institutional customers. On June 24, the company publicly disclosed that its profits for the six months through May 31 had fallen to a mere 12¢ a share, and predicted that its earnings for the entire year would be paltry at best. The bad news caused Douglas shares to plummet in a week from 90½ to 64⅜ on the New York Stock Exchange. Forewarned by Merrill Lynch, said the SEC staff, the big traders lightened their holdings in time to save an estimated $4,500,000.