The line can be blurry, to say the least (unless you’re Chris Collins, in which case, holy cow that was illegal)
Prosecutors say Collins — who was on the board of the clumsily-named Innate Immunotherapeutics Unlimited — was told in June 2017, via an email from the CEO, that the Food and Drug Administration was planning not to approve the company’s flagship drug. The next morning — in what must surely have been a total coincidence! — Collins’ son began selling more than 16,500 shares several days before the public knew the FDA’s decision, after which time Innate’s stock price crashed more than 90 percent. It saved the son more than half a million dollars in losses, but also possibly earned him and his congressman father a stay in Club Fed.
Now, to appearances, this is one of the most obvious — and come on, guys! — unsophisticated cases of insider trading. But it isn’t always this straightforward, because really, what’s the practical difference between having good intel (i.e., the thing you pay a broker to have and base their decisions on) and having illegal information? With help from Eugene Soltes, a professor at Harvard Business School whose book, Why They Do It: Inside the Mind of the White Collar Criminal, explores the ins and outs of insider trading, we’re going to try and chart these extremely murky waters.
So what exactly is insider trading?
“The way I like to think about it, it’s stealing,” Soltes says. “The crime itself isn’t trading on information that others don’t have. But rather it’s stealing information and misappropriating it for one’s own use. That’s actually what makes it criminal.”
In other words, there are plenty of ways to get what’s called “material information” — that is, useful information — that’s not exactly considered public knowledge. For example, hedge funds buy huge data sets costing hundreds of thousands of dollars. Maybe it’s a complex algorithm, or satellite images of every parking lot of a retail chain around the holiday season. These are clearly not things available to the general public, but possessing them and acting on them isn’t insider trading. However, say you work at a printing company: You have a duty to protect the confidentiality of the documents you see, yet you use some of that information you saw to trade on yourself — that’s insider trading. Likewise, if a friend passes on confidential information from his company and you trade on that information — as Collins allegedly did — that’s also insider trading.
What are some more legal ways to acquire non-public information?
Most of them require the labor force and budgets of large banks or hedge funds. One of Soltes’ favorite examples involves Capital One: Some analysts in the bank division started diving into the customer transactions of the company’s credit card division, looking for burrito purchases at Chipotle. They figured that if they could see that more people were buying burritos, they could predict Chipotle’s quarterly earnings ahead of their actual release — and of course act on this information. So they invented a sophisticated algorithm to mine the data, liked what they saw, bought options in Chipotle and made a pile of money. This, it was decided, was insider trading.
Here’s where it gets strange: Soltes says that, had the bank division simply bought the data set from an outside company, it would have all been legal. The fact that Capital One was misappropriating internal information and using it for capital gain is what made it illegal.
Confused yet? You’re not alone.
In any case, this isn’t the sort of data that you or I could easily (or even with great difficulty, in fact!) obtain. “The notion that insider trading is just about making the markets more fair so that we’re on a level playing field isn’t quite the right way of looking at it,” Soltes says. (Oh, and by the way, credit card companies sell this kind of information about us all the time, according to Soltes. How comforting is it knowing that these Wall Street types are getting filthy rich based on your choice of burrito?)
How does the SEC catch insider trading?
They have pretty sophisticated analytic tools, says Soltes. They know when big, market-swinging news comes up, and they can see who makes major transactions, which is why Collins didn’t stand a chance of getting away with this. “This isn’t particularly good white-collar crime,” Soltes explains. “This isn’t the sophisticated kind with some elaborate scheme. This is, in some ways, pretty amateur. It’s going to be detected, and anyone who doesn’t think that is being foolish.”
Is this along the same lines as Martha Stewart’s insider-trading thing?
Kind of! For one thing, they both involved selling off shares in a pharma company ahead of an announcement by the FDA. And Stewart reportedly told her broker (who was also broker to the pharma company’s CEO) to sell after he told her the FDA results ahead of time. But it’s important to note that Martha Stewart didn’t get convicted of conspiracy — she was convicted of obstructing justice (basically, lying about why she dumped her stock). It was one of those “the cover-up is worse than the crime” situations.
How rampant is insider trading, really?
Soltes says the SEC is pretty adept at monitoring the egregious stuff. But what Soltes works on himself is the more subtle kind — the meetings that go on between executives and investors, of which there are literally hundreds every day. It may not be clear insider trading per se, but a much more subtle instance of acquiring information that others don’t have.
Under both insider trading rules and another set of rules called Regulation Fair Disclosure, companies have to publicly disclose all material information to all their investors. “But simultaneously, every day we see investors flying from San Francisco to New York to spend a half-hour of face time with the CEO,” Soltes says. “Now, if the CEO can’t disclose anything material, what exactly are they disclosing? Much of my work explores looking at records and finding out — not surprisingly — that people who are doing these meetings seem to make better trading decisions.”
People try and explain them away, Soltes says, by saying you can put the information from such a meeting together with other pieces of information you received elsewhere to form a decision — more of a big-picture approach. Maybe, even, people are just reading body language and gestures. But, one way or another, people are getting access to information that others don’t have just because of their position. These situations are tough for regulators to monitor because they’re private meetings by definition. “This is the kind of thing that’s happening all the time,” Soltes says.
So what should Collins — or someone in his situation — have done? Just take the hit while his family’s stock value plummets?
In short: Yes, that’s exactly what he should have done. Also, keep in mind that Collins is said to be worth $44 million. He’s essentially sentenced himself and his son to prison over an amount that, to you or I, would be the equivalent of maybe a grand.
What’s the role of the stockbroker in all this? I mean, they’re supposed to provide value, right? What good are they if they don’t have some kind of, well, insider information?
Technically, stockbrokers are just intermediaries in the system, and they have a fiduciary duty not to, you know, get their own brokerage firm in legal trouble. So, according to Soltes, brokerages have institutional systems in place, and if a broker becomes aware that their client wants to engage in insider trading, they’d put a hold on that trade and not make it. In any case, your typical brokers are way less informed than more sophisticated market participants, like giant hedge fund operators and data analytics firms — to get the kind of intel they do takes ungodly amounts of cash.
Depressingly (but in no way surprisingly), while the spirit of insider trading laws are meant to create a level playing field, in the end the only thing that matters — especially on Wall Street — is who has the big money.
Adam Elder is a freelance writer in San Diego. He last investigated whether we should all workout naked.
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