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There's a Reason They Call it "Insider" Trading

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August 14, 2014 | Jennifer Namazi

There's a Reason They Call it "Insider" Trading

This is a topic I've covered in the past: blatant insider trading; colorful schemes to profit from material, non-public information; even the SEC's recent and ongoing crackdown in this area. This week I was hit with two stories and it was a sign that I had to, once again, share.  Even if you've read other blogs on insider trading, you'll want to stick with this one. Today's has all the makings of a James Bond movie: pre-paid disposable cell phones and cash traveling in unmarked envelopes. I almost have to wonder what the bigger draw is for those who engage in insider trading: the possibility of illegally making a lot of money and getting away with it or the (albeit short) thrill of taking covert spy-like steps in an attempt to conceal your trail?

It's an Inside Job

First, let's get to topic du jour number one: a study that is being published this month that seems to conclude that a significant number of information leaks that lead to insider trading come from, well, insiders.  Okay, okay. That's not a story, I know. We all know that. What the study actually pointed to was the seemingly high number of information leaks that appear to be coming from state and regulatory agencies—those who should be protecting the sensitive information in their care. An article on the study quotes one of the researchers:

"Our findings are somewhat controversial in that we're saying the presumed protectors of the shareholders and general public interests appear to be using their positions to their advantage," Zhao said. "The evidence shows it is happening. There is more insider trading within regulated firms than within unregulated firms. There is very, very strong indirect evidence that this is due to people involved in the regulatory agencies."

The best way to articulate this is to use an example. Let's say there's a pharmaceutical company seeking FDA approval for a new drug. In theory, nobody at this point knows if the drug will be approved or not. But a couple of days before the decision is announced, there is a spike in trading of the company's stock. It appears that somebody did know the outcome and leaked the information. In this hypothetical, the leak is likely from the regulatory agency that was tasked with approving the drug, not from the company itself.

Numerous factors were looked at to reach these conclusions. Researchers say they evaluated factors like cumulative abnormal return and short sale data.

Let's face it, nobody wants to be in the middle of an insider trading investigation. Regardless of who acted on the information, how they got it, and why it happened, it's still cumbersome to participate in an investigation, it diverts time and attention away from the normal course of business, and creates lots of publicity that the company would probably prefer to avoid. If it's beyond our control, how do we mitigate against the possibility of an investigation? That's the big question.

Insider Trading—James Bond Style

Sometimes smart people do bad things. They just do. And the insider trading case in the media this week falls into that category. I can't do the full story justice in today's blog, but it's worth a read. Seriously, I could see a made for TV movie coming out of this one. A Microsoft employee, dad of four kids, making $130K a year, is struggling to pay his kids' private school tuition. So what does he do? He concocts an insider trading scheme in which he passes along information to a day trading former colleague who then trades on their behalf to the tune of $400,000 over time. Using prepaid cell phones, plain envelopes to deliver cash profits, and other covert tactics, the plan unfolds. The first trade goes off without a hitch. Later there is a second, then a third. They get so excited they even talk about starting their own hedge fund using their newfound fortune. Eventually (and can I say predictably—after all, there is an insider trading crackdown going on), he gets caught by the SEC. Yes, it can happen to you. Long story short, all the painstaking steps taken to hide the scheme didn't work. He got caught, his partner got caught, and both are going to jail. The Microsoft employee was sentenced to two years in jail. His partner got 18 months. One thing that stood out to me: the former Microsoft employee was very candid in saying that yes, he knew this was wrong. He even described his struggle with the scheme and how he rationalized it to himself saying that if members of Congress could do it, he could too. It's not often you get to hear a full admission in these cases, nor the thought process behind it.

Many of us come into contact with material, non public information routinely. It's the nature of our work. While it's clear we can't control others—our colleagues or even the regulators who engage with some of our firms—we can control ourselves. It's never going to be worth it. I've covered the gamete of insider trading cases in this blog, mostly because it seems there is a new angle every time. The people getting caught doing this are not just CEOs and heavy hitters. Husbands have gleaned inside information from their unknowing wives. In a prior blog, I noted how the U.S. Government tracked an insider trading suspect to Hong Kong and extradited him back to face the music in the U.S.—all over a $7,900 trade. I continue to cover this topic because smart, ordinary people with decent jobs, families and seemingly good upwardly mobile career prospects keep getting entangled in these schemes. So I will beat the drum a little bit more. Insider trading is never going to be worth it. We must be vigilant about the information in our care: the data we hold, the information we receive. The vast majority of us are too ethical to deliberately trade on inside information, but as I've highlighted before, tipping can often be unintentional. I leave you with a phrase of the day to consider: "persistent vigilance."

-Jennifer

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