It would seem to me that insider trading goes on quite a lot. It seems almost too easy. Of course the penaly if caught is HUGE, but what are the realistic chances of being caught?
I am reminded of this by Martha Stewart and the Major League Baseball steroids scandal. Other ballplayers say, sure, people use steroids all the time. Just not me.
Is this the case with insider trading? Is it going on all the time?
To some extent, I’m sure it is. Martha Stewart just so happens to be a fairly well-known (evil) figure, so her actions are often viewed with some scrutiny.
It’s occurs, but isn’t common. The SEC comes down on you hard if there are any allegations. Very hard (I was involved in a wholly unfounded charge of using insider information, and it was not a pleasant experience). They aggressively investigate any allegations. This makes it very difficult to get away with it.
Corporation executives can’t really do it, since they are required to report all their stock transactions, and are also prohibited from buying or selling stock at the times when it would be most profitable to know inside information (i.e., when quarterly earnings are about to be announced). I believe their families are included in this prohibition. It is very easy to see if a corporation executive made a sudden sell-off of stock just before bad news was announced. Any sign of that, and you’re toast.
Martha Stewart is a special case. Normally, corporation executives don’t call their friends with inside information; it puts them at a double disadvantage – allowing someone to take profits while they don’t benefit themselves. In effect, they can go to jail while not even making money on the deal. Note that the president of ImClone is already heading to jail for this.
Stewart’s problem is compounded not by the insider trading, but because she told her broker to lie about it. If she had said in the beginning, “I thought the information was public and acted on it,” she could have gotten off with far fewer problems.
I’m not really thinking of corporate executives trading on their own insider info. I’m thinking more of the “golf game” effect, where you scratch my back and at a later and unconnected date, I will scratch yours. A loose network of informants could do very well for themselves without ever trading their own company’s stock.
Its not that hard to notice insider trading, either. Martha Stewart came under immediate suspicion when she dumped a bunch of stock in a biotech corp. Right after this, the company announced some majorly negative news, which sent their stock dropping.
Any large trades made immediately before either “bad” or “good” news would be subject to scrutiny, I’d warrant. If you’re a well-known public figure, probably more so. If you did small-scale insider trading, you could probably get away with it, but those who do large trades are the ones who get caught.
The stock exchanges keep track of trades. The exchanges, NASD, SEC and brokers/investors use this trading data for lots of things. Brokers and investors build statistical charts (showing daily volume, trading price ranges, etc.) because they think that if they can predict market trends, they will make money. The exchanges and indexes track key stock volume and prices for their own prestige (the NYSE trades more shares of X than any other exchange–make all your trades with the NYSE for the most efficient pricing) or to best track the economy (X isn’t a stock with a lot of interest or a big following so it may not have efficient pricing and therefore is not a good component of a stock basket that attempts to track economic activity in X’s region of operations).
The SEC and the NASD (Regulation part) have access to these statistics for enforcement purposes too.
If a stock has “suspicious activity,” that means that there is a pattern of trading (volume or timing) which is statistically out of the norm. If such activity is followed closely by either good or bad news about the stock, the NASD will go back and figure out who traded, and will send a questionairre to the company and its advisers asking whether they have any connections with any of the people trading during the unusual activity period.
Also, consider that many people are not active traders. If a portfolio that was a “buy and hold” suddenly trades a huge block of stock that the investor never bought before, that is a red flag. Then too you often have to trade a very large amount of stock (or use derivative instruments like options or short sellling) to capture a big enough return to make trading on a short term basis (with broker commissions, etc.) worthwhile. If the investor is not an active trader, has never before traded options, doesn’t typically take large positions in individual stocks, a big score around the time of good or bad news will look suspicious and may be questioned because of the statistical checking that goes on.
Insider trading would be easier for market professionals (brokers, advisers, fund managers, etc.) who typically do trade actively, but they are hit with additional regulations (requirements to report all trades to their in-house compliance people, routine recording of phone calls, etc.) designed to specially address their issues.
Don’t forget that Stewart is a former successful stockbroker herself, as well as all the other good and nasty things attributed to her. She should have known better.
What ironic is that the FDA may really be the ultimate villian in this. Apparently the FDA leaked the information about denying FDA approval for the drug before their official announcement. Stewart and friends allegedly acted on insider information provided by the very same government that is now prosecuting her.
I don’t think it was the FDA as an agency that leaked the information; rather it was someone at the agency with access to the report. If that person’s name comes out, there’s a chance he’ll be in legal hot water (and probably lose his job).
In addition, it’s very difficult to hide their trades by going to another brokerage. You need special approval, and since you get free trades at your own broker, but have to pay elsewhere, that immediately raises questions.
It happens all the time, usually by people who buy or sell quantities of stock that are insignificant relative to the total volume. People talk.
Kind of off topic but Rampant was one of my favorite words as a kid (I think I got it from watching Dr Who) and I was surprised once when I found that my Webster’s dictionary didn’t have a definition for it. I see now that current versions do include it.
From what I have read, insider trading is a pretty common practice at the big brokerage houses, but it comes in more subtle forms than an IMClone type “tip.” Most often it comes in the form of big brokers giving favored clients a shot at getting in on a hot IPO that most of their other clients never hear about.
If Stewart’s 3000-share dump is indictment-worthy, there are a LOT of Wall Street brokers who should be indicted. But somehow I don’t think fairness is the object here. It seems more like an attempt to give cover to the middle-aged suits who are committing major crimes. The glare of the spotlight on Stewart will hide a lot of scurrying in the dark.
Keep in mind that this is secret information. If it gets out, it might be traceable back to you. So you can trade it on the golf course, but it could come back to bite you.
“Hot IPO” share allocations are indeed a recognized problem (or at least they were when there were hot IPOs–since the market downturn started this hasn’t been much of an issue: rather, many IPOs have been cancelled for lack of interest), but they are not the same problem as insider trading. If an initial public offering must be offered at a price at which there is excess demand (and one might ask why this should be the case), then shares will have to be allocated in some manner because demand will exceed supply. The “hot IPO” problem is how to make sure the allocation is fair: it is not a question of knowing more infomation about a stock. As Evil Captor implies, it is a question of who you know. But it is a different problem with different solutions.
There are always lots of rumors about stocks. Some of these will be based on the research ideas of industry students (gee, if Citigroup could acquire Wells Fargo, it would have a dominant market position nationwide–this is such a great idea that Citigroup must have noticed this already–Citigroup has said that it is looking for acquisition candidates–ergo, “have you heard anything about Citigroup taking over Wells Fargo?”), some will be based on unscrupulous investors or brokers trying to pump up the price of a stock they own (we have a target price on this stock of 50x earnings!) and some will be based on public but slightly obscure information (say Ford just published a quarterly report indicating that inventories are up 10%; it may cut back orders to its glass window supplier; its glass window supplier has a contract with a sub supplier for its excess orders but now repudiates the contract because it no longer has excess orders; the sub-supplier therefore consolidates its space and repudiates its huge warehouse lease in Indianapolis, leaving the REIT that owns the warehouse without a tenant–the REIT’s stock price may fall and you may avoid a loss in the REIT if your research is good enough to make the connection in advance of other people).
(There is some legal controversy about what information should be regarded as publically available and what should be regarded as “inside.” The idea for a while was that you could trade on any information as long as you didn’t “have a duty” to keep it confidential. Thus, an employee couldn’t trade on news that the FDA had rejected a drug (he owes a duty to his employer), and his shrink couldn’t trade on that news if revealed in a session (shrink owes a duty of confidentiality to his patient), but if the employee told the same tale to his bartender, the bartender didn’t owe him any duty and could trade on the info. Another formulation asks whether the tippee “should have known” that the information was confidential and not public. If you are chatting with your doctor golf partner about the planned layoffs at the local bank, “should” you know that he got that information from his patient, the CEO of the bank? Probably not, unless he tells you.)
I know people who are working on this. Currently, all the stock data is fed thgouh massive computer analysis looking for red flags. A lot of research is going into finding better ways of trawling through this huge glut of data looking for instances of something suspicious.
For what it’s worth, my professor in Mergers and Acquisitions told the class that an average, there is a significant rise in the share price of target companies in the days before a takeover bid is announced. This is strong evidence that inside information leaks out on a regular basis and people trade on it.
My Corporations prof warned us about insider trading – he said that the SEC has a database of who went to school together etc.
Based upon my knowledge of human nature, I believe that insider trading is fairly rampant. I believe that a lot of people get tipped off and are smart enough to make small, ambiguous trades that could be defended if called into question.