An Introduction to Insider Trading
You’ve seen it glamourised in the Wolf of Wall Street, you know Gordon Gecko’s ‘greed is good’ speech word for word, and you’ve applauded the tireless work of the FCA when prosecuting rogue city boys… But what exactly is the deal with insider trading?
So what is it?
In short, insider trading is when you act on information that has not been released to the general public, giving yourself a huge advantage against others in the market. For example, say after a few jagerbombs your corporate lawyer buddy told you that a company he represents is about to announce a huge merger, and then you proceed to buy corresponding shares in order to capitalise on said merger, you have just acted on inside information, and if caught, could be sent up the proverbial creek without a paddle.
They’ll never catch me though, right?
The key to convicting insider traders is, like most prosecutions, evidence — so piecing together phone recordings, email chains, text messages etc. are all key to proving that information was relayed and then acted upon in order to cheat the market. Easy to get around, right? Just talk in code? Use carrier pigeons instead of iMessage? Wrong! The regulators know you aren’t that stupid, (well, most of you) so there are more sophisticated ways that the agencies attempt to monitor insider trading. One of the most common is to look for trading patterns before any major announcement, such as those related to earnings or M&A, leveraging new tech such as AI and Big Data to flag those that look suspicious (the SEC uses Palantir — be afraid).
Is the risk worth it?
Penalties for insider trading vary by region, and to put it a different way, they depend on how feisty the local regulator actually is. The US has traditionally been a lot harder on those caught than the UK, with high profile penalties for firms such as SAC Capital (Steve Cohen’s old fund — fined nearly $2bn in 2013), and equally high penalties for individuals. Just 2 weeks ago an executive was sentenced to over 2 years jail time for sharing unreleased details of a new cancer drug, but there have been two notable sentences that have reached double digits and eye watering fines (Zvi Goffer — 10 years, $10m & Raj Rajaratnam — 11 years, $92.8m).
As I alluded to in my opening paragraph, the FCA has not been as successful with our market delinquents, having only prosecuted 10 cases in the last 6 years, compared with 86 in the last 2 years for the SEC. However, the good news is they have been kick starting their operations as of late, employing new surveillance tactics and bringing in some help from across the pond to teach them more on defending against the dark arts.
So, it’s all bad?
Not quite, there are legitimate forms of insider trading (in the US at least), such as company officers and directors trading the stock of the company they work for, however any and all trades must be filed with the SEC to ensure there is no foul play. The legal side of insider trading is all a bit murky though, so I’m not going to go into any more detail on this.
TL;DR If you suspect a tip you’ve got is too good to be true, don’t trade on it. If you’re the one on the inside, make sure you don’t drink too much when you’re around someone with a trading app!
