MONEY Markets

The Real Reason You Should Care About Insider Trading

Martha Stewart leaving court after conviction
Businesswoman Martha Stewart, 62 leaves federal court in New York City on March 5, 2004. Stewart was found guilty on all counts over a suspicious stock sale. Jeff Christensen—Reuters

A new study suggests insider trading is even more rampant than anyone thought. But it's not so obvious why individuals should be concerned.

Between Michael Lewis’s takedown of high-frequency traders in Flash Boys and a new study finding that one in four M&A deals are preceded by insider trading, Wall Street’s public image is looking more “sell” than “buy” these days.

But how much does insider trading actually harm the average Joe? Even if Gordon Gekkos are running amok, do cheaters pose a real threat to those who play by the rules? The answer might surprise you.

1. Insider trading won’t hurt you if you don’t trade. Just like front-running high-frequency traders, those who trade on secret information are unlikely to hurt the portfolios of buy-and-hold investors, says Rick Ferri, founder of Portfolio Solutions.

In theory, an individual who frequently trades could be unlucky and end up buying or selling just as market-riggers are doing the opposite. But holding a diversified portfolio of stocks over long periods of time dilutes that damage; if you hold an index fund for a decade, you’d likely lose no more than pennies from trading inequities, says Ferri. “Getting upset about insider trading is like getting upset about the NFL draft,” says Ferri. “It makes for juicy headlines, but unless you’re a professional, it’s not really going to affect you.”

2. Insider trading could even help you. The presence of cheaters in the market could, coincidentally, benefit uninformed investors who just happen to land on the right side of a trade, says Santa Clara University finance professor Meir Statman, who has studied investor perceptions of insider trading. Let’s say you need to sell a stock in a company to free up cash, says Statman: If that happens to coincide with an insider trading-driven run-up before the company announces a merger or acquisition, you could actually win out.

3. Nevertheless, these cheaters are destroying the American Dream. Pundits have used the points above to argue that insider trading should be legalized. But the so-called “victimless crime” claims at least one victim, says Statman: confidence in the market. “A belief in fair play is part of good American culture,” says Statman. “The stock market is supposed to be an emblem of the American Dream: the belief that if you work hard and do your research, you’ll be rewarded. It’s not supposed to feel like the lottery.”

In his research, Statman has found that people living in economies riddled with more corruption, like India and Italy, are twice as likely as Americans to deem insider trading acceptable.

insider
Meir Statman, “Is It Fair? Perceptions of Fair Investment Behavior across Countries,” Journal of Investment Consulting, 2011.

There are a few key takeaways: If we want to keep our markets fair, it’s important that cheaters are caught and punished. But news headlines shouldn’t prevent you from investing, as long as you do it wisely — with diversified index funds and minimal trading. “Trading is like going into the jungle,” says Statman.

“There will always be beasts who are larger than you and thus able to devour you,” he says. “So go in as rarely as possible.”

TIME insider trading

Hedge Fund Manager Gets 3 Year Sentence for Insider Trading

Michael Steinberg SAC
Michael Steinberg, former SAC Capital portfolio manager, leaves Federal Court after sentencing in New York City on May 16, 2014. Andrew Gombert—EPA

Michael Steinberg was sentenced to 3 1/2 years in prison for insider trading on Friday. His prosecution was part of a decade-long federal investigation into former hedge fund giant SAC Capital and its billionaire founder Steven A. Cohen

Michael Steinberg, a top lieutenant to billionaire hedge fund mogul Steven A. Cohen, was sentenced to 3 1/2 years in prison for insider trading on Friday after being found guilty last year of securities fraud and conspiracy charges.

Steinberg’s sentencing is the latest black mark on Cohen’s former hedge fund, SAC Capital, which last fall pleaded guilty to securities fraud and agreed to pay $1.8 billion in the largest insider trading fine in U.S. history.

“Michael Steinberg traded on information from company insiders at Dell and NVIDIA to reap nearly $2 million in illegal profits,” Manhattan U.S. Attorney Preet Bharara said in a statement emailed to TIME late Friday. “Today he has learned the steep cost of those transactions.”

Steinberg, 42, was found guilty last December of conspiracy to commit securities fraud and four counts of securities fraud for insider trading involving two tech stocks, Dell and NVIDIA, that reaped $1.8 million.

“For most people on the planet, $1.8 million of gain is a lifetime of accumulated wealth,” U.S. District Judge Richard Sullivan said before he sentenced Steinberg to prison, according to Bloomberg. “Maybe in a hedge fund it’s no big deal but it’s a lot of money to most people.”

Prosecutors had urged Judge Sullivan to sentence Steinberg to more than six years in prison.

Steinberg’s prosecution was part of a decade-long federal investigation into SAC Capital. Last year, SAC was charged with securities and wire fraud for a scheme in which the fund engaged in a pattern of “systematic insider trading” that allowed it to reap hundreds of millions of dollars in illegal profits.

In April, a federal judge in New York accepted SAC’s guilty plea and approved a landmark $1.8 billion settlement with the government, effectively concluding a decade-long criminal investigation. SAC agreed to shut down its investment advisory business, but was allowed to continue to do business under a new name as a so-called “family office” managing Cohen’s $9 billion fortune.

Federal authorities have been investigating SAC for a decade — rumors of insider trading have been swirling around the hedge fund for years — and have secured guilty pleas or convictions from eight of its former employees. Cohen, who remains under investigation by the FBI, has never been charged with a crime.

It appears unlikely that Cohen will ever be personally indicted for his role leading a firm that was “riddled with criminal conduct,” according to federal prosecutors. Cohen does face civil charges from the Securities and Exchange Commission alleging that he failed to supervise his employees, and could ultimately be banned from the securities industry for life.

Steinberg has been granted bail, pending an appeal, according to Reuters.

TIME insider trading

SAC Capital Plea Deal Ends Long Wall Street Saga

Hedge fund manager Cohen, founder and chairman of SAC Capital Advisors, listens to a question during an interview at the SALT Conference in Las Vegas
Hedge fund manager Steven A. Cohen, founder and chairman of SAC Capital Advisors, listens to a question during a one-on-one interview session at the SkyBridge Alternatives (SALT) Conference in Las Vegas, Nevada May 11, 2011. Steve Marcus / REUTERS

Federal prosecutors called the settlement a "day of reckoning" for a hedge fund "riddled with criminal conduct," but SAC founder Steven A. Cohen is likely to avoid prosecution

Multibillion-dollar hedge fund SAC Capital was sentenced on Thursday for its central role in one of the most wide-ranging insider trading schemes in U.S. history. A federal judge in New York accepted the firm’s guilty plea and approved a landmark $1.8 billion settlement with the government, effectively concluding a decade-long criminal investigation.

In approving the settlement, U.S. District Judge Laura Taylor Swain paved the way for SAC Capital to continue to do business under a new name as a so-called “family office” managing the $9 billion fortune of Steven A. Cohen, the hedge fund’s secretive founder. Earlier this week, SAC Capital formally changed its name to Point72 Asset Management, an apparent nod to the address of the firm’s sprawling trading floor at 72 Cummings Point Road in Stamford, Conn., near Cohen’s 35,000 square-foot mansion.

Cohen, one of the most enigmatic figures in Wall Street history, was long thought to be the ultimate target of the investigation, but he was never charged with a crime. Now that his hedge fund’s guilty plea has been accepted, it appears unlikely that Cohen will ever be personally indicted for his role leading a firm that was “riddled with criminal conduct,” according to federal prosecutors. Cohen does face civil charges from the Securities and Exchange Commission alleging that he failed to supervise his employees, and could ultimately be banned from the securities industry for life.

The SAC Capital investigation was the most high-profile probe in a sweeping insider trading crackdown led by Preet Bharara, the U.S. Attorney for the Southern District of New York, who has made insider trading one of his signature law enforcement missions. Bharara has secured 79 insider trading convictions or guilty pleas — including eight former SAC employees — without losing a single case. Earlier this year, Mathew Martoma, a former SAC manager, was found guilty in what federal prosecutors called the most lucrative insider trading scheme in U.S. history.

(MORE: ‘Guilty’ Verdict in Biggest U.S. Insider Trading Case)

Martoma faces more than a decade in federal prison after he was convicted of trading illegally on inside information he obtained from doctors involved in a 2008 pharmaceutical trial for an Alzheimer’s drug. Martoma’s scheme, which allowed SAC to make gains and avoid losses of $276 million, occurred “on a scale that has no historical precedent,” Bharara said.

In court proceedings, prosecutors said that Martoma “corrupted” two doctors involved in the drug trial in order to obtain advance notice of its results. Martoma, a 39-year-old portfolio manager who changed his name after being expelled from Harvard Law School for fabricating his academic transcript, is appealing the verdict. Martoma later graduated from Stanford’s Graduate School of Business, but last month Stanford stripped Martoma of his diploma.

Cohen is a legendary Wall Street figure who amassed his fortune while building a reputation as one of the most successful hedge fund traders of his generation. For years, SAC Capital consistently delivered returns of 30% or more to its clients, even as the hedge fund charged a commission of as much as 50% of the profits. During one seven-year stretch, SAC only had two losing months.

Prosecutors said that the insider trading scheme lasted from 1999 to 2010, a period of time in which a “relentless pursuit of an information ‘edge’ fostered a business culture within SAC in which there was no meaningful commitment to ensure that such ‘edge’ came from legitimate research and not inside information.”

As the SAC Capital investigation unfolded, the hedge fund became a symbol for financial corruption that helped fuel the perception that Wall Street’s wealthy moguls operate under a different set of rules than everyone else. At a time of increasing income inequality in America, Cohen’s lavish lifestyle — his gargantuan Greenwich estate contains an indoor swimming pool, a basketball court, a two-hole golf course and a 6,700-square-foot ice skating rink — seemed outlandish even by the standards of Wall Street’s billion-dollar elite.

(MORE: Inside the Biggest Insider Trading Case in American History)

“Today marks the day of reckoning for a fund that was riddled with criminal conduct,” Bharara said in a statement. “SAC fostered pervasive insider trading and failed, as a company, to question or prevent it.” He added: “When so much criminal conduct takes place within one institution, it is appropriate to impose criminal liability on the institution itself. Today’s sentence affirms that when institutions flout the law in such a colossal way, they will pay a heavy price.”

Although Cohen’s reputation has been severely tarnished and his hedge fund is now barred from accepting outside funds or operating as an investment manager, the reclusive billionaire remains free to invest his multibillion-dollar fortune. Bharara’s failure to secure an indictment against Cohen, who has maintained that he acted appropriately at all times, highlights an increasing trend in which mid-level employees and corporate institutions — but not the executives leading them — are charged with serious crimes.

That, in turn, raises questions about the ultimate deterrent value of such prosecutions for financial executives at the highest echelon of Wall Street. Cohen “goes on much as he did before, buying and selling hundreds of stocks every day as the head of a $9 billion family office rather than an actual hedge fund,” Bloomberg Businessweek national correspondent Sheelah Kolhatkar wrote on Thursday.

“It’s become a familiar pattern at major financial firms, which have been paying billions of dollars in fine of late to settle all manner of civil and criminal cases.” She added: “Is this suitable retribution for what the government says happened at one of the world’s largest hedge funds? And why was Cohen never charged?”

TIME insider trading

Justice Department To Probe High-Frequency Trading

U.S. Attorney General Eric Holder testifies before a House Appropriations Committee Commerce, Justice, Science, and Related Agencies Subcommittee hearing on the Justice Department's fiscal year 2015 budget request on Capitol Hill in Washington, D.C. on April 4, 2014.
U.S. Attorney General Eric Holder testifies before a House Appropriations Committee Commerce, Justice, Science, and Related Agencies Subcommittee hearing on the Justice Department's fiscal year 2015 budget request on Capitol Hill in Washington, D.C. on April 4, 2014. Nicholas Kamm—AFP/Getty Images

Attorney General Eric Holder says the Justice Department will investigate whether the lightning fast transactions violate insider trading laws. The FBI said earlier this week that it is also probing high-frequency trading

Attorney General Eric Holder said Friday that the Justice Department is investigating high-frequency trading to determine if it violates insider trading laws.

“The Department is committed to ensuring the integrity of our financial markets—and we are determined to follow this investigation wherever the facts and the law may lead,” Holder said in prepared remarks Friday for a hearing of the House Appropriations subcommittee that oversees the Justice Department.

High-frequency trading is when financial institutions, traders or brokers use sophisticated computer algorithms and high speed data networks to make lightning fast trades. For the Justice Department to find it illegal, it would have to establish that the traders are buying or selling a security while in possession of nonpublic information about the product.

The Federal Bureau of Investigation said earlier this week that it too is probing high-frequency trading. New York Attorney General Eric Schneiderman, the Commodity Futures Trading Commission and the Securities and Exchange Commission are also looking into the practice.

The debate has gained increased public momentum—and some angry finger-pointing—due to Michael Lewis’ new book Flash Boys: A Wall Street Revolt, which alleges that the stock market is rigged against the average investor in favor of high-speed traders at hedge funds and investment banks. In the past week, the New York Times published an excerpt of the book and CBS’ 60 Minutes featured Lewis on its program.

TIME wall street

High-Speed Trading Gets Scrutiny Again, This Time From the Feds

Authorities are probing whether firms utilizing high-frequency trading are doing so in a way that is tantamount to insider trading as they process deals in tiny fractions of a second. The FBI and the attorney general of New York are both investigating

Federal investigators are currently probing high-speed-trading firms to see if the outfits are practicing a form of insider trading — that is, making deals based on nonpublic market information.

High-speed-trading firms use powerful computers to process trades in fractions of a second, taking advantage of tiny price fluctuations. A new FBI inquiry will seek to establish whether traders are abusing information in doing so, the Wall Street Journal reports. Authorities are probing if the trades, which are based not on human decisions but computer algorithms, could be classified as wire or securities fraud — although it may be more difficult for prosecutors to prove nefarious intent is present in the case of computer trades.

New York State Attorney General Eric Schneiderman and financial regulators are also examining the activity of these firms. Schneiderman’s office is looking into whether high-speed or rapid-fire traders receive unfair advantages from U.S. bourses, Bloomberg reports, and also whether the information purchased by such traders from expensive research firms — which market their products based on exclusivity, speed and depth of detail — amounts to nonpublic information.

“There is a big concern that high-frequency traders are getting … nonpublic information ahead of others and trading on it,” an FBI spokesman told the Journal.

The FBI is also taking a closer look at the reported practice of placing a group of trades and then rescinding them in order to create the illusion of market activity. Many critics of high-speed firms have accused them of creating market instability.

About 90 people have been charged with insider trading by the U.S. attorney’s office in Manhattan since 2009.

[WSJ]

TIME White Collar Crime

‘Guilty’ Verdict in Biggest U.S. Insider Trading Case

Former SAC Capital portfolio manager Mathew Martoma (C) arrives at the Manhattan Federal Courthouse with his lawyer in New York, January 7, 2014. Martoma is charged with using confidential information provided by two doctors involved in clinical trial to trade in drug companies Elan Corp Plc and Wyeth, which is now owned by Pfizer Inc.
Former SAC Capital portfolio manager Mathew Martoma (C) arrives at the Manhattan Federal Courthouse with his lawyer in New York, January 7, 2014. Martoma is charged with using confidential information provided by two doctors involved in clinical trial to trade in drug companies Elan Corp Plc and Wyeth, which is now owned by Pfizer Inc. Brendan McDermid—Reuters

Former SAC Capital trader Mathew Martoma becomes the 79th person convicted as part of a sweeping Wall Street insider trading crackdown

Mathew Martoma, the former hedge fund trader charged with what federal prosecutors called the most lucrative insider trading scheme in U.S. history, was found guilty on Thursday. Martoma, who once earned millions of dollars working for Steven A. Cohen’s hedge fund SAC Capital, faces decades in prison, but will likely serve less than that.

The guilty verdict, which was delivered by a 12-member jury in a federal court in lower Manhattan, is the latest blow for SAC Capital, which last fall pleaded guilty to fraud charges and agreed to pay a $1.8 billion in the largest insider trading fine in U.S. history. As part of a settlement with the government, SAC agreed to shut down its investment advisory business and turn itself into a so-called “family office” to manage Cohen’s multibillion-dollar wealth.

Martoma, 39, was charged with trading illegally on inside information he obtained from doctors involved in a 2008 pharmaceutical trial for an Alzheimer’s drug. Martoma’s trades allowed SAC to make gains and avoid losses of $276 million. In court proceeding over the last several weeks, prosecutors said that Martoma “corrupted” two doctors involved in the drug trial in order to obtain advance notice of its results. After the verdict, Richard Strassberg, Martoma’s lawyer, said, “We’re very disappointed and we plan to appeal.”

(MORE: Inside the Biggest Insider Trading Case in American History)

Martoma was found guilty of two counts of securities fraud and one count of conspiracy to commit securities fraud. Each fraud count carries a maximum penalty of 20 years in prison; the conspiracy charge carries a maximum sentence of five years. Experts believe Martoma could ultimately be sentenced to seven to ten years behind bars. In bringing the case, Bharara said the alleged insider trading occurred “on a scale that has no historical precedent.” Martoma becomes the 79th person convicted as part of Bharara’s sweeping crackdown on insider trading on Wall Street. Bharara’s office has not lost a single case.

“Martoma bought the answer sheet before the exam — more than once — netting a quarter billion dollars in profits and losses avoided for SAC, as well as a $9 million bonus for him,” Bharara said in a statement. “In the short run, cheating may have been profitable for Martoma, but in the end, it made him a convicted felon, and likely will result in the forfeiture of his illegal windfall and the loss of his liberty.”

When the FBI showed Martoma’s multimillion-dollar Florida mansion in late 2011, the trader fainted on his front lawn. Prosecutors had hoped to discuss Martoma’s fainting spell during the trial, arguing that it constituted “evidence of his consciousness of guilt.” But U.S. District Judge Paul Gardephe denied that request, saying that “when an individual who works in the hedge fund industry is approached by the FBI and is accused of having engaged in insider trading in specific stocks and while employed at a specific company, it is likely to be a shocking and highly disturbing event, whether the person is innocent or guilty.”

Federal prosecutors were successful in their attempt to unseal documents related to Martoma’s 1999 expulsion from Harvard Law School for fabricating his academic transcript and then trying to cover his tracks by concocting “evidence” from a phony computer forensics firm. After his expulsion, Martoma changed his name, which previously had been Ajai Mathew Mariamdani Thomas, to Matthew Martoma. He later applied to, and was accepted by, Stanford Business School, where he earned an MBA.

(MORE: Here’s Why Former SAC Trader Martoma Was Booted From Harvard)

Federal authorities have been investigating SAC for a decade — rumors of insider trading have been swirling around the firm for years — and have secured guilty pleas or convictions from eight of its former employees. Cohen, who remains under investigation by the FBI, has not been charged with a crime — and has maintained that he acted appropriately at all times — but he does face civil charges alleging that he failed to supervise Martoma and another SAC trader who was convicted of insider trading last December.

Cohen is a legendary Wall Street figure who amassed a $9 billion fortune while building a reputation as one of the most successful hedge fund traders of his generation. For years, SAC Capital consistently delivered astounding returns of 30% or more to its clients. During one seven-year stretch, SAC only had two losing months. Thanks to SAC’s trading success, Cohen amassed a fortune that enabled him to purchase a 35,000 square-foot Connecticut mansion filled with hundreds of million of dollars worth of art and a 6,700-square-foot ice skating rink.

Last year, SAC was charged with securities and wire fraud for a decade-long scheme in which the fund engaged in a pattern of “systematic insider trading” that allowed it to reap hundreds of millions of dollars in illegal profits. Federal prosecutors said Cohen’s firm displayed “an institutional indifference” to unlawful conduct that “resulted in insider trading that was substantial, pervasive and on a scale without known precedent in the hedge fund industry.”

Bharara’s investigation into insider trading in the hedge-fund industry has already led to the convictions of former Galleon Group founder Raj Rajaratnam and former Goldman Sachs director and McKinsey managing director Rajat Gupta. Rajaratnam is currently serving an 11-year prison sentence, and last year Gupta was sentenced to two years in prison. Bharara says the U.S. Wall Street insider trading investigation is ongoing.

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