The Independent Investor: Insider Trading Is No Surprise

Over the last few years, government authorities have gone after insider traders with increasing success. Now, news headlines indicate that there was actually a hedge fund club of sorts that regularly traded on illegal information.

Why should this surprise us? Over the last few years an increasing number of investors I talk with have argued that "the game is rigged" against us little guys. Time after time, I have watched the markets trade up in advance of good news or down before the opposite occurred. It happens much too often to be coincidence.

Back in the early '80s, straight out of graduate school, I joined Drexel Burnham Lambert, a venerable investment banking firm back in the day. There, I made the acquaintance of Mike Milken, who at the time was diligently putting together a junk-bond empire for Drexel. He moved his operation to California and invited me along, but I joined Merrill Lynch instead to establish their foreign equity effort.

That turned out to be a smart move. Milken and his associates went on to make millions but ultimately went down in flames as authorities uncovered an enormous insider trading scam centered on the "junk bond king." As a spectator, I had a front-row seat throughout the entire sordid affair. Milken and some of his buddies went to jail. Drexel went bust and I understood how deceptive and easy it was for individuals to be sucked into insider trading.

The SEC and the FBI are focusing on specific transactions involving individual securities where insider information was leaked. The FBI contends that there was a criminal ring of analysts, traders and fund managers among some prominent financial firms that regularly took advantage of illegal information and garnered millions in profits for the alleged violators.

Readers may recall that last year, Raj Rajaratnam, the founder of a well-known hedge fund, was sentenced to 11 years in prison for making millions in an insider trading scam. Altogether the FBI has wracked up 56 convictions in their four-year probe called Operation Hedge.

I applaud their efforts. Like the FBI, I believe insider trading has exploded in financial markets and goes far beyond a few hedge funds and their associates. But insider trading between government and the private sector is even bigger than the abuses presently being uncovered among and between Wall Street firms. However, I doubt that either the FBI or the SEC has much stomach to actively probe the connections between our elected officials, government bureaucrats and their campaign contributors within the private sector.

As readers are aware, I have already written two columns denouncing the present legal ability of our senators and congressmen and their families and friends to profit from insider information that they have acquired in the course of the legislative process.

My last column on the subject centered on the passage of the STOCK Act (Stop Trading on Congressional Knowledge), a bill that would have prevented that practice. It was no surprise that House majority Leader Eric Cantor, R-Va., scuttled the bill in December.

Insider trading will remain a serious and debilitating side effect of a financial system where "greed is good" and the amount of money you make is never enough. At most, the SEC and FBI will be able to catch those sloppy enough to leave a trail but the really insidious information exchanges will continue to fall under "business as usual."

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or email him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.