Politics & Policy

The Insider-Trading Hysteria

Insider trading had nothing to do with the financial meltdown, but it’s an easy Wall Street target.

Look up the sentencing guidelines for committing rape in New York State and you’ll find that the guilty serve anywhere from four to 25 years in jail — which is roughly what those convicted of trading stocks using “material non-public information,” a.k.a. insider trading, serve.

Anything wrong with this picture? I’d say a lot.

I do not write this as a fan of fat-cat traders who know the rules and wantonly violate them. But take a deep breath and consider the actions of Mathew Martoma, the latest in a long line of Wall Street hucksters snared by the government in what may be the largest and most costly effort to rid the world of insider trading in modern history.

Martoma made a chunk of money for his hedge fund by trading on non-public information involving a couple of drug stocks. The scheme, according to the government (Martoma is appealing his conviction), went something like this: Martoma befriended and paid the doctor who was conducting tests on certain drugs being developed by Elan and Wyeth.

When Martoma discovered that the tests weren’t going well, he “shorted” the stocks, betting that share prices would decline once the information was publicly released, which they did. For that, the Feds say, he earned an illegal $9 million bonus and, at least according to the man leading the crackdown, Manhattan U.S. Attorney Preet Bharara, the status of one of the great masterminds in the history of white-collar crime.

Martoma faces as much as two decades in jail for cheating the system, but who are his victims? Well, that’s more difficult to determine. Peel back the reality of what exactly goes on in an insider trade and you come away scratching your head over who exactly was wronged.

Yes, Martoma had illegally obtained (“misappropriated,” in the legalese pertaining to insider trading) non-public information that would allow him to profit over other market participants who lacked that information. But the people on the losing side of the trade would have lost money anyway. No one forced them to buy the stock in the open market. In other words, they were victimized not by Martoma but by their own lousy bet.

So why are we hearing so much about insider trading? Bharara will tell you he’s protecting the “integrity of the markets.” If average people believe that the system is rigged or that certain privileged investors have an advantage over others, they won’t buy stocks.

Sounds good until you peel back that one as well. Average investors flocked to the stock markets during the bad old days before the insider-trading crackdown began in 2008.

Indeed, most of the average investors I speak to hate the notion of someone having an unfair advantage, but they base their investment decisions on stuff like monetary policy and the health of the financial system, which is why the markets tanked during the 2008 financial collapse and began a massive rally when the Fed started printing money in 2009.

Okay, but haven’t many small investors sat out the current rally (buying gold, for example, rather than stocks) precisely because they think the markets are rigged? Maybe, but the rigging they’re worried about is the notion that the markets are being primed not by a strong economy, but rather by the printing of money, and when that ends, the whole system will come crashing down as it did in ’08.

As I point out in my book Circle of Friends, which chronicles the current insider-trading hysteria, the Feds, and the Obama administration in particular, have some very political reasons for diverting so much time, effort, and money (getting wire taps isn’t cheap) to make something as simple as trading on information that others don’t have into a serious crime.

Keep in mind, insider trading has been a crime since at least the late 1960s, though the courts have grappled for years with exactly what constitutes an illegal trade. In other words, there is no specific insider-trading law, just a bunch of court precedents that are supposed to guide law enforcement in determining what is and isn’t a dirty trade. All of which has made it difficult for the feds to put people we all think committed insider trading in jail for insider trading. Neither Michael Milken nor Martha Stewart went to jail specifically for insider trading. Rather, both committed other crimes that were tangential to their trading activities.

Something changed around 2007, when law enforcement began to seek and receive court approval to wire-tap the telephones of those suspected of insider trading.

Until then, wire taps had been reserved for terrorists and mobsters – i.e., people who kill other people — for the simple reason that the courts didn’t want law enforcement to be spying on just anyone for just any crime.

By treating possible white-collar criminals as if they were in the same category as Osama bin Laden or John Gotti, law enforcement could hear the targets discuss their crimes in their own words, and prosecutors could play those conversations back to their juries, making convictions that much easier.

And the timing was perfect. Following the financial crisis, and in the midst of the subsequent Great Recession, the Obama administration believed it needed to show the public that Wall Street wasn’t above the law. There was just one problem: Prosecuting bankers for taking too much risk in the complicated transactions that were at the heart of the banking meltdown is difficult.

But prosecuting traders for profiting off inside information when you have them wired for sound was, according to one regulatory official, “like shooting fish in a barrel,” even if these traders had nothing to do with the meltdown in the first place.

And, while they were shooting those fish, consider what else had been happening in the runup to the meltdown: Bernie Madoff was getting away with the largest Ponzi scheme in history, where people lost their life savings because someone had actually stolen from them.

At the same time, the banks were engaged in risk-taking of such epic proportions that the economy still hasn’t recovered some five years later.

Remember both those things the next time Preet Bharara (who is coincidentally on everyone’s short list to replace Eric Holder as attorney general) and his agents show up at some trader’s home in the middle of the night to mete out justice for insider trading, and then ask yourself if it’s all worth the fuss.

Charles Gasparino is a senior correspondent for Fox News and the Fox Business Network.

Exit mobile version