Insider Trading 101

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Somewhere downtown in the spring of 2001…

The club is at capacity, but V.I.P. is spacious. It’s darkly lit to perfection. My feet vibrate from the booming bass; the bottle in front of me reflects the candlelight and beautiful women flutter about. It’s like a hedge fund mafia up in here with a few dot com clowns mixed in. Sitting across from me is Lance. Like me, Lance is a hedge fund trader. He’s got an in at a few research boutiques like Avalon. Lance always gets a wink or a nod before they put out a scathing report on a company. Over in the corner is Michael, he’s on the sell side; he’s good for an early heads up on stock upgrades and downgrades. He’s sitting next to his client, Pesto who knows what’s on the front cover of Baron’s on Thursday before it comes out. A few tables down are some bankers with knowledge of some imminent takeovers. The guy trying to get into the V.I.P. section is a Frenchman from U.B.S., Lance tells me the guy leaks all of their program trading flow. That’s a nice call. If you know a billion dollars of S&P are coming to market, adjust accordingly. The V.I.P. host is playing defense so I make my way over. “He’s with me,” I say. The Frenchman smiles as he goes to shake my hand. Typically I don’t like to share my cocaine, but for him I’ll make an exception. I slide the tiny bag from my pocket into his hand with the skill of a professional pickpocket. “We should talk,” I say.
“Indeed,” he says sliding the baggie into his own pocket. “I’ll hit you up on Monday.”
handincookiejar

I don’t remember the first time I jaywalked, it was probably somewhere in Cleveland in the early 70’s. I’m sure I was holding one of my parent’s hands as we looked both ways. Not for the authorities, but for oncoming traffic. I know what you’re thinking… This joker is going to try to compare insider trading to jaywalking – what a shame. But the truth of the matter is, ever since I arrived on the street in 1994 insider trading was commonplace. There were things that might be a bit questionable, but qualified as part of the game. In the span of two years I went from a sales assistant at Morgan Stanley making about 40k a year to being the head trader on a billion dollar fund at the Galleon Group. We called it edge. It wasn’t considered insider trading. Maybe the late 90’s and beyond can be compared to the steroid era in major league baseball. If you want to put an asterisk next to my earning statistics, that’s fine. And I was never getting into the Wall Street Hall of Fame. It’s how things were done, maybe still are. Get an edge or get cut.

I’m not sure I’d have been able to stay at the Galleon Group if I didn’t try to get every available edge possible. There were three primary ways to get an edge: inside, outside and sideways. Insider trading has been around since, well, probably forever. For me the landscape shifted in August of 2000. Individual investors cried no fair, but we know it’s called edge. So the Securities and Exchange Commission introduced Regulation FD which simply stated that all public companies must disclose material information to all investors at the same time. It was an effort to put an end to selective disclosure. The change didn’t happen overnight. It took years for companies and investors to comply. What we were left with was an even playing field of no disclosure.
But somebody needed to start talking. So the emergence of “expert networks” started to come into full bloom. Let’s say someone from Pfizer won’t tell us what’s going on. Well then maybe a doctor or a lawyer familiar with Pfizer will have material information to help formulate a trade. To say this was the beginning of expert networking is simply not true; this has been going on across every country club in America and all over the world forever.
Another primary source of insider tips comes within the very walls of Wall Street. Analyst know about upgrades before they become public, bankers work on deals before they’re announced and traders see behemoth order flows. There are more people not operating on this level than are, but to think its taboo isn’t correct either.
“We’re going to upgrade XYZ in ten minutes,” or “We’ve got seventeen million shares of XYZ to buy at the close from our program trading desk,” hardly makes you feel like Charlie Sheen posing as a janitor and stealing files from a law office. It’s a great call, its edge. And the end result is a couple of fist bumps, maybe a smile from your portfolio manager (they’re hard to come by) and more money. The guy on the other end of the phone gets more order flow, more commissions and a few gold stars next to his name.
wallstreet

One of the many things I learned at the Galleon Group was how to not get caught. If you want to play it fast and loose there are certain rules you must abide by.
• Never trade options on a sure thing; it’s the first place they look.
• Always have a paper trail, an email pitching you the idea for every reason except the inside information.
• Buy more than you want and then sell some before the announcement. It shows misperception. If you knew about the announcement then why would you sell some right before?
• Never have anything in print. Only use the phones (this one is changing)
• Find the derivative stocks that will benefit from the news, play those big.
• Be prepared for a phone call with the S.E.C. Play dumb, but have your story straight.
• Discuss the trading idea with other employees, but withhold the secret sauce.
• Reward your informant handsomely.

I’m sure there are hundreds of reasons why this wouldn’t work, but I know one way to stop or slow down insider trading. Instead of fishing around trying to get lower level guys to flip and wear a wire, I think you should go after the informants, the guys supplying the information. Then instead of arresting them right away, we should make them remain at their current jobs as trusted informants. As an alternative of wearing wires we have them supply wrong insider trades. If they know a stock is going to decline on particular news item, have them leak misinformation to get their buddies to purchase the stock. Personally if I touch a hot stove and burn my hand, I don’t touch the stove again. So instead of worrying if your phone is tapped, you’ll worry if the information is correct.
macktruck
This is the thing about jaywalking though. Chances are you aren’t getting a ticket or having to pay a fine, sure it’s happened, but highly unlikely. That’s not the risk. Even if you do get caught, you’ll probably just be told not to do it. The risk to jaywalking is being run over by a Mack truck. In the last five years the risks have dramatically increased – so if you’re still planning on jaywalking – look both ways.

3 comments on “Insider Trading 101
  1. Jenn says:

    Awesome!

  2. Dave says:

    Eloquent, insightful and ironic … as usual. :)

  3. kia lyons says:

    good sheeeeeet, as always my friend

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