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Insider trading in the ‘new normal’

 

By Randy Neumann

What is insider trading?  Why is it bad?  Who has done it in the past? Who has done it recently?  How were they punished?  Who is doing it now and getting away with it?  This column will answer all these questions.
According to Wikipedia, the online free encyclopedia, “Insider trading is the trading of a corporation’s stock or other securities (e.g., bonds or stock options) by individuals with potential access to nonpublic information about the company.
“In most countries, trading by corporate insiders such as officers, key employees, directors and large shareholders may be legal, if this trading is done in a way that does not take advantage of nonpublic information.  However, the term is frequently used to refer to a practice in which an insider or a related party trades based on material nonpublic information obtained during the performance of the insider’s duties at the corporation, or otherwise in breach of a fiduciary or other relationship of trust and confidence or where the nonpublic information was misappropriated from the company.”
Okay, now we know what insider trading is.  But why is it bad?  Illegal insider trading raises the cost of capital on securities issuers, thus decreasing overall economic growth.  This is especially true today when we are in the “new normal” economy.  Proponents of the new normal project that the economy will grow very slowly, unemployment will remain high and returns on investments will be lower than they have been in the past.
The treatment of those who are found guilty of insider training can be rather draconian.  If you want an affirmation of this, just ask Samuel D. Waksal, the founder of ImClone.
ImClone’s stock price dropped sharply at the end of 2001 when its drug, Erbitux, failed to get the expected FDA approval.  It was later revealed by the SEC that prior to the announcement of the FDA’s decision, numerous executive sold their shares.
Sam told his family and friends to sell their stock in his company, and Uncle Sam sent him to prison for seven years.
But wait, the plot thickens.  Our own Martha Stewart, born Martha Helen Kostyra in Nutley, was dragged into this case, as well.  Despite Stewart’s protestation of her innocence, the government sentenced her to five months in prison, five months of home confinement and two years probation for selling $230,000 in ImClone shares on Dec. 27, 2001, just one day before the announcement of the FDA decision.
On Oct. 16, 2010, the New York Times reported that Angelo R. Mozilo, the former chief executive of Countrywide Financial, once the nation’s large mortgage lender, agreed to pay $67.5 million for insider trading and fraud charges.  As part of the settlement, Mozilo also agreed to be permanently banned from serving as an officer or a director of any public company.  A heavy hand, no doubt.
Alright, you, me, and just about everyone else is treated with a heavy hand when it comes to insider trading, but there is a very small, yet well-known group, who are treated with kid gloves when they abuse the insider trading rules.  Would you like to take a guess at who that group is?  Here’s a hint, many of them were elected in November 2010.  Now, here is the answer from a Wall Street Journal story dated Oct. 11, 2010:
“Washington – Chris Miller nearly doubled his $3,500 stock investment in a renewable-energy firm in 2008.  It was a perfectly legal bet, but he’s no ordinary investor.  Mr. Miller is the top energy-policy adviser to Nevada Democrat and Senate Majority Leader Harry Reid, who helped pass legislation that wound up benefiting the firm.
“Jim Manley, a spokesman for Mr. Reid’s office, initially defended Mr. Miller’s purchase of shares in the company, Energy Conversion Devices Inc.  He said the aide had no influence over tax incentives for renewable-energy firms, and that other factors boosted the stock.
“But on Sunday, Mr. Manley added: ‘Mr. Miller showed poor judgment and Sen. Reid has made it very clear to Chris and all his staff that their actions must not only follow the law, but must meet the higher standards the public has a right to expect from elected officials and their staffs.’”
Why should they meet higher standards?  Because the insider trading rules should apply to Congress as well!  A story headlined  “Lawmaker Vows to Outlaw Insider Trading on the Hill,” on Oct. 12, 2010, said: “Congress is immune from insider trading laws; federal regulators have never brought an insider trading case against either congressional members or their staffs.”
A few lawmakers proposed a bill that would prevent members and employees of Congress from trading securities based on nonpublic information they obtain.  Unfortunately, the “Stop Trading on Congressional Knowledge Act” (STOCK Act) has languished since 2006, the year it was proposed.
The Oct. 11 story from the WSJ documents many examples of congressional aides, who make $170,000 annually, hitting home runs in the market without fear of insider trading charges and the resulting punishments.
As the old saying goes, “You can’t make this stuff up.”

 The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual.  Randy Neumann CFP® is a registered representative with securities and insurance offered through LPL Financial.  Member FINRA/SIPC.  He can be reached at 12 Route 17N, Suite 115, Paramus, 201-291-9000.

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