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How to Get Away with Insider Trading

Insider trading has been going on ever since the stock market existed. Everyone is looking for an edge and no one is willing to play fair. Martha Stewart did it and was treated to several months in one of our nation’s fine institutions. Raj Rajaratnam did it and was sentenced to 11 years in prison and penalties of over $150 million. Heck, someone you know has probably done it.

Some are brazen about it, others are a little more secretive. I first realized how prevalent it was when I read Trading with the Enemy [3], an anecdotal book written by Nicholas Maier as he worked at Jim Cramer’s hedge fund. The story that struck me most was how they’d get news stories before they hit print and used it to their advantage. It’s not necessarily insider knowledge about a company but getting it a few minutes before the rest of the world, even if it was a third party, is a big advantage.

So, as for insider trading, if you want to learn how to do it, this is what you need to do to get away with it.

Don’t try this at home. Or anywhere. Insider trading is illegal, you will get caught no matter what, and you’ll have to pay everything back. Don’t be stupid, just stick your money in an index fund and enjoy life.

1. Don’t Be Greedy

We can thank Gordon Gekko for what many believe is the driving credo of Wall Street – “Greed is good.” It’s not, however, good when it comes to insider trading because that’s why so many people get caught! We’ll go into many of the reasons below but stock brokers have programs designed to find unusual activity and notifying the authorities. If you’ve never traded options before and then you suddenly start trading them in large quantities, you’ll get investigated. Even if you just sell a stock before an announcement, you might get investigated too.

Then, the next time you do it, since they are monitoring you now, you’ll get caught. You’ll be fined, sent to jail, boom goes the dynamite. They see you handing some guy a bag of cash, a watch, and everyone goes to jail [4]. You rarely hear about someone having to disgorge $500 in illicit trading profits.

2. Know Your Insider Really Well

Who is giving you your information and who else is he or she giving it to? Raj Rajaratnam of Galleon Group was convicted of 14 counts of securities fraud and conspiracy [5] and it started because prosecutors were investigating David Loeb, a managing director of Goldman Sachs. In wiretaps, they learned of Rajaratnam and then the whole thing came crumbling down. (The crazy part is that 9 years earlier [6] an Intel employee that passed information to Galleon was prosecuted but they didn’t go after Galleon).

Insiders rarely just tell you all that juicy sensitive information. Why get a bag of cash from one person when you can get multiple bags from multiple people? Martha Stewart’s insider was Peter Bacanovic of Merrill Lynch, who was tipped off by ImClone’s founder Samuel Waksal. Waksal told friends and family (and even tried to sell his own shares) and everyone got in exactly as much trouble as you’d expect. It was pretty brazen actually when you read about it.

3. Don’t Be Famous

When Martha Stewart was caught insider trading (when the assistant to her insider disclosed it to investigators), she sold her $230,000 stake in ImClone. She was not even close to the top of the list in terms of ownership size. There were Waksal family members who had in the millions, other executives, but everyone focused on Stewart because she was the most famous. They made an example of her by sentencing her to five months of prison, five months of home confinement, and two years probation.

The lesson here is that you don’t want to be so famous or so public that they want to put your head on a proverbial pike and walk around the town square with it.

4. Don’t Trade Options

The reason why a lot of insider traders get caught has to do with options. You can get a lot of leverage using options (which is a contract to buy or sell shares) and many times traders will use options because they can get the most bang for their buck. A call option is the right to purchase a hundred shares of stock at a specified price. I pay a small premium for this right but if the stock jumps up beyond the strike price, then I start making a lot of money because I can exercise the option, pay less than market value, and then sell the shares.

The tricky thing is that you look suspicious if you:

  1. Never trade options, or do so sparingly, then make a relatively large bet on a stock a few days before it pops.
  2. You trade a lot of options but there isn’t much volume on the stock you have insider information on.

And to make matters even harder, the SEC is already monitoring this [7]. They will see higher options volume ahead of major announcements and they’ll just start investigating everything. And if you do make a big bet, expect to see the assets frozen.

5. Be a Rich Hedge Fund

Last, but certainly not the least, make sure you’re a very large, very rich hedge fund. You will want to be as big as SAC Capital Advisors, who recently settled a lawsuit to the tune of $602 million [8] and let a few (former) heads roll. $602 million can buy you a lot of indulgences. 🙂

A year ago, I would’ve just suggested that you work in Congress because they were not subject to insider trading laws but that was changed when President Obama signed into law the Stop Trading on Congressional Knowledge Act [9].

Just as a warning and a disclaimer, in case it wasn’t clear in the bright yellow box above, this post was written in jest. We do not advocate insider trading, or breaking the law in any way, and we don’t promise that you’ll get away with insider trading if you follow these tips. We have also never tested these tips personally and I’ve never insider traded a share of anything in my life (nor do I plan on it… I value my freedom way too much!).

A tip of the cap to Prince for this great post idea!

( Credit: Art Comments [10])