by Bruce Carton
If you want a glimpse into just how weird complaints, schemes, and allegations of insider trading can be, consider the following. In 2003, the Securities and Exchange Commission actually published the Q&A guidance below on its Website:
Question: Is the Andrew Carlssin case for real?
Answer: Many investors and other members of the public have asked us about news reports concerning Andrew Carlssin, an alleged “time-traveler” who supposedly made a fortune in the stock market by trading in the year 2003 based on information gleaned from his travels to the future. The reports appear to be a hoax. The SEC has not, in fact, brought an enforcement action against any such person.
The Andrew Carlssin story originated from no less an authority than the famed Weekly World News, the supermarket tabloid that also broke the stories of Bat Boy and various alien abductions over the years. In March 2003 the News reported that Carlssin used time-travel to turn an initial investment of $800 into $350 million in a period of two weeks. Naturally, the News went on to say, the SEC had launched a probe.
To me, the public’s inquiries to the SEC about this “case” reflect a broader fascination with the idea that someone with access to material, non-public information about a public company can quickly turn that information into virtually unlimited profits through the stock market. The daunting obstacle to such profits, of course, is that access to the key ingredient for the plan—material, non-public information—is, by definition, unavailable to the public.
Other than time travel, then, how can someone interested in such unlimited profits obtain the material, non-public information necessary to produce it? And even if they can get it, is it legal to trade on it?
For some, such as lawyers and investment bankers entrusted to work on corporate mergers, access to inside information arises regularly in the course of their profession. For others, such as corporate executives (and often their family members, friends, neighbors, barbers, and so forth) access to inside information is a one-time opportunity that arises when that executive learns of an upcoming merger or some other key bit of information related to the corporation before it becomes public knowledge. In both types of cases, however, the insider-trading laws are quite clear that it is unlawful to trade on information obtained in this way.
Once you get beyond these common examples of people with access to inside information, and the relatively clear laws that prohibit them from trading on that information, you start to play in the cracks of the insider-trading laws. Inside these cracks is where the most interesting cases arise; uncertainty springs up from the gap between people’s desire to obtain and profit from insider information and the laws that don’t quite address each unique situation.
Over the years we’ve seen numerous efforts and plots to gain insider information through means ranging from theft and bribery to computer hacking and even seduction. Others have gone so far as to “self-generate” market-moving information (which sometimes has actually been true, but usually is false). Let’s take a walk through some of these schemes, and offer a quick verdict on their degrees of success:
- The 30+ people through the years accused of stealing advance copies of BusinessWeek magazine from places like printing plants, distributors, and even post offices to trade ahead of the market-moving recommendations in its “Inside Wall Street” column. Verdict: Failed. Nearly three-dozen people have been sued by the SEC since the 1980s for obtaining and trading on material, non-public information this way. Many of them have gone to prison. The key legal point in these cases is typically that the magazine is stolen by someone with a duty to keep the information confidential, and then passed on to the trader.
- People who, after purchasing or selling securities in advance, created fake news releases and distributed them on the PR news wires to spike trading and make their trades more profitable. Verdict: Failed. These folks are routinely sued by the SEC for violating the antifraud laws and for manipulation. You cannot distribute false information in this fashion.
- People who purchase or sell securities in advance, and then distributed false but apparently material, non-public information via hundreds of thousands of fake voicemail messages, to spike trading and make their trades more profitable. Verdict: Failed. This group was sued by the SEC for violating the antifraud laws and for manipulation, and also pleaded guilty to criminal charges.
- People who recruited strippers to try to coax non-public information out of investment bankers at adult clubs. Verdict: Incomplete. This plan was reportedly in the works as part of David Pajcin and Eugene Plotkin’s much larger insider-trading scheme, which really should be made into a movie someday. The two were apprehended before the stripper scam could be put into motion, so to speak, but the idea sounds a lot like a non-monetary form of bribery to me.
- People who attempt to bribe paralegals at big law firms to provide them with confidential information about upcoming mergers involving the firm’s clients, with the intention of buying stock in the acquisition targets before public announcement of the merger. Verdict: Failed. At least one person alleged to have done this has been sued by the SEC for insider trading and arrested on related criminal charges, to boot.
- People who hack into BusinessWire or corporate computer systems to gain access to material, non-public information before it is announced. Verdict: Hung jury. There is uncertainty right now as to whether “mere thieves” of information commit insider trading or violate the securities laws when they steal, trade on, and profit from that information. In two recent cases (SEC v. Lohmus Haavel & Viisemann and SEC v. Blue Bottle Ltd.), defendants sued by the SEC for variations of this conduct settled or had default judgments against them without a court ruling on the legality of their conduct. In a subsequent contested case (SEC v. Dorozhko), however, the court issued an opinion that stealing or hacking and then trading on that data does not violate Rule 10b-5 of the Securities Exchange Act.
- People who hire investigative journalists to ferret out negative, material, and non-public information; sell short based on that information; and then publish that information, causing the price of the stock in question to drop. Verdict: Allowed (so far). This “business model” was the brainchild of none other than current SEC target Mark Cuban, the famed dot-com billionaire, owner of the Dallas Mavericks, and recipient of an SEC civil complaint in November. Cuban pursued this model in 2006 with a publication called Sharesleuth.com, which still exists but now seems to be dying on the vine. There was considerable discussion on the legality of Sharesleuth.com when it was introduced in 2006; most commentators (including me) agreed that it was probably legal. To date, there has not been any public action against Sharesleuth.com or Cuban for his trading ahead of Sharesleuth.com articles.
Notably, Cuban’s Sharesleuth.com venture was inspired by his now-famous experience as an investor in Mamma.com. The SEC sued Cuban in November over a 2004 stock sale that Cuban allegedly made after being advised confidentially by Mamma.com’s CEO about an upcoming stock offering. Like many of the examples above, this situation seems to fall between the cracks of the insider-trading laws: Cuban’s argument is that although the Mamma.com CEO told Cuban he was receiving confidential information, Cuban never actually agreed to keep anything private.
The connection between Mamma.com and Sharesleuth appears to be that Cuban felt burned by Mamma.com and believed that other “crooked” companies out there could be exposed by investigative journalism. He wrote on his personal blog in March 2005 that although he felt he had done his due diligence on Mamma.com when he bought the business in 2004, the company then proceeded with another round of investment, which Cuban considered “a huge red flag.”
Cuban wrote that he didn’t want to own stock in companies that used this particular method of financing (a PIPE deal, private investment in public equity) because he did not like the idea of a company selling stock in a private placement “for less than the market price, and then to make matters worse, pushing the price lower with the issuance of warrants. So I sold the stock.”
After the SEC filed its case in November, Cuban told the Dallas Morning News that Sharesleuth was founded “with the idea that there were other crooked companies out there like Mamma … I thought that like any other investor, I would trade on the public information we uncovered,” he said. “By also sharing it, future investors could avoid the companies we covered.”
These are just a few of the efforts from people around the world to obtain and profit from inside information. As the outcomes above typically show, it is much easier said than done—unless, of course, you really can travel through time. Then it’s easy.
Originally published in Compliance Week. Reprinted with permission. © 2008 Financial Media Holdings Group, Inc. All Rights Reserved. Compliance Week can be found at http://www.complianceweek.com. Call (888) 519-9200 for more information.