Insider trading is a no no. The profits are not worth the risk.
On Saturday, July 16, 2014 I played in a tennis tournament with a partner that worked at Trulia, an online real estate company. He just got his job and was explaining to me how the company makes money through its ad placements for Realtors.
If you've ever wondered why companies like Trulia and Zillow have done nothing to lower selling commission rates from 5%, it's because real estate agents are their clients.
Asking how a company makes money or plans to make money is always my number two question after understanding what the company does.
We had a really fun time playing against Berkeley Tennis Club across the bay. After getting home, I decided that I was going to buy Trulia stock because I liked their business model, the stock had corrected somewhat, I was bullish on the real estate market, and it seemed like a prime takeover target. I was set on buying $50,000 worth of the stock on Monday, July 18.
For some reason, I got too busy that Monday and didn't execute my order before 1pm PST. Mondays and Wednesdays were my consulting days for one of my ex-clients. I forgot about buying Trulia that entire week until I saw news after the close on July 28, 2014 that Zillow was acquiring Trulia for $3.5 billion in stock at a 25% premium! Damn! I could have made $12,500 in just a couple weeks!
What a shame. Or how fortunate. Let me explain.
INSIDER TRADING AND POROUS WALLS
Insider trading is some serious, serious business. A day before ImClone stock was set to drop due to an unfavorable FDA ruling, Martha Stewart sold about $230,000 in ImClone shares on December 27, 2001, purportedly due to an insider tip.
Martha Stewart was found guilty of insider trading and sentenced on July 16, 2004 to five months in prison, five months of home confinement, and two years probation for lying about a stock sale, conspiracy, and obstruction of justice. The total amount sold was $230,000, a pittance compared to her 9-figure net worth.
Unlike Martha, I didn't receive any insider tips about Trulia. I just thought it was an interesting stock idea at the time after speaking to my double's partner about his new job. But I got to wondering what would happen to me if I actually purchased $50,000 of Trulia stock a week before the takeover.
$50,000 is a much greater portion of my net worth than $230,000 is to Martha. But it's well within the band of stock purchase sizes I've done in the past.
I tell ya San Francisco is a small city. I ended up playing doubles on August 22, 2014 with one of the lead bankers who engineered the deal! We partnered up and lost 6-2, 3-6, 6-7 in a very tight match against my other buddies, who are money managers.
So I asked my MD doubles partner during change over what would have happened had I bought, and he quipped, “We probably would both be in jail now.“
Related: Take Advantage Of Zillow And Redfin's Bad Pricing Estimates To Buy Property
Big Brother Is Watching You For Insider Trading
Holy crap! “Come on, really?” I responded.
He replied, “Well, I'm not quite sure actually. Every time we do a deal, I get asked to review a list of names of about 100 people who are suspected of insider trading or are on the list for whatever reason. If I know them, then we've got to begin the vetting process.“
I told them there was no way I would be in trouble because I simply never got any insider information. No electronic or voice records would be found, because there weren't any. Buying Trulia before the sale would have been a sheer coincidence.
“I suppose. But $50,000 worth of stock is a very common amount of stock a lot of famous or more wealthy people have purchased and ended up getting in trouble because of it. There was this one deal where half a certain NHL hockey team was investigated because they bought stock of the takeover candidate the day before the deal was announced!“
“Whatever happened to them?” I asked.
“I'm not sure,” he responded.
I looked up the star NHL player for insider trading, and found nothing.
It Takes A Lot To Convict Someone Of Insider Trading
If you happen to buy a stock that gets taken over for a nice premium quickly after purchase, don't panic. Instead, celebrate! You just won a mini-lottery. Risk-arbitrage hedge funds look for these type of events all the time and buy ahead. They also short takeover initiators all the time as well to try and capture the spread.
If you are innocent, it is practically impossible for the SEC to find you guilty, so don't worry. And if you are guilty, well shame on you. But looking at how few cases have come to light where people have been convicted for insider trading, it must be tough to convict guilty people as well.
All we see are really wealthy, super high profile people getting convicted. The US Securities And Exchange commission wants to get the biggest return for its effort. They are now going after Sam Bankman-Fried with a vengeance after FTX collapsed.
It's really interesting how people in power hold so much ability to illegally enrich someone with just a whisper. Surely there is some temptation to say, “Hey long lost cousin in Italy, I'm about to close a huge deal where Apple is going to buy Twitter for $40 billion in cash and stock (35% premium), so buy some now!” But the downside risk is huge for the person in power.
Tread Carefully
When you're worth over a billion dollars like ex-Gallen hedge fund manager Raj Rajaratnam, why bother trying to make an extra million through insider trading? If you are a multi-millionaire, on multiple boards, and reached the top of McKinsey, why would Rajat Gupta bother to feed insider tips to Raj? Is all the prestige and money in the world not enough?
There must be some type of “Superman complex” where no matter how much you have, all you want to do is win and feel invincible. If you've got the whole world in your hand, don't mess it up!
Related Reading
- Congressional Insider Trading Is What America Wants
- Why I Dislike Investing In The Stock Market Even In Good Times
- How Do Hedge Funds Make So Much Money? An Inside Look
- Invest Like The Richest Members Of Congress For Big Bucks
- How Does Bail Work?
Invest In Private Growth Companies
Finally, consider diversifying into private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
Check out the Innovation Fund, which invests in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. You can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
Manage Your Finances In One Place
The best way to become financially independent is by signing up with Empower. They are a free online platform which aggregates all your financial accounts in one place. This way, you can better optimize your money.
Before Empower, I had to log into eight different systems to track 25+ difference accounts to manage my finances. Now, I can just log into Empower to see how my stock accounts are doing. I can also easily track my net worth.
The best tool is their Portfolio Fee Analyzer. It runs your investment portfolio through its software to see what you are paying. I found out I was paying $1,700 a year in portfolio fees I had no idea I was paying!
They also recently launched the best Retirement Planning Calculator around. The tool uses your real data to run thousands of algorithms to see what your probability is for retirement success. Once you register, simply click the Advisor Tolls and Investing tab on the top right and then click Retirement Planner.
There's no better free tool online to help you track your net worth, minimize investment expenses, and manage your wealth. Why gamble with your future?
Recommendations
Pick up a copy of Buy This, Not That, my instant Wall Street Journal bestseller. The book helps you make more optimal investment decisions so you can live a better, more fulfilling life.
For more nuanced personal finance content, join 55,000+ others and sign up for the free Financial Samurai newsletter and posts via e-mail. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009.
Martha Stewart was not convicted of insider trading. She was convicted of making false statements to a federal agent.
Off-topic, but if you could do a post some time on why real estate commissions are stuck in 1970 and if there are any legitimate possibilities/ strategies for unsticking them, that would be fantastic. In Kentucky it’s 6%, which just seems crazy. I get that real estate agents provide a service for which they should be compensated, but that service has decreased over time. Buyers are doing more of their own homework, now, than they were in the past, which means less time invested for both listing and buying agents.
Interesting.I think that the SEC should be more focused on manipulation of stocks by short traders more than anything else with M&A insider trading, as I believe the manipulation is much more rampant. I’m in a few small cap stocks and you see what appears to be manipulation quite regularly.
1) One time a stock dropped 9.9% in after hours trading on no news. All after hours trading for the first 59 minutes and 45 seconds was within a few pennies of the closing price. Suddenly that last trade goes through, and the volume? 6 shares. On a $5.20 security, that was done on a $31.20 order (plus commissions). The drop was picked up and reported, effectively showing that $50m in market cap was lost. Thankfully, it didn’t hold and it opened up at the normal level the next morning, but you think that was ‘just a normal trade’? It was a clear attempt at manipulating the price lower.
2) I’ve seen examples where when you look at patterns you can see where volume drops and immediately the price starts churning lower in a pattern that’s repetitive and predictable.
There are others that I’d have to go back and think of.
I’m not a fan of short trading but it does serve a designed purpose. However, on smaller cap stocks, shorts can all but orchestrate price activity with predictable and destructive trading patterns. I wish these types of activities would get looked at, but I don’t believe that they ever do.
To be precise – Martha Stewart was not found guilty of insider trading. It was obstruction of justice. It stemmed from the IT charge, but that is not what she was convicted of.
That’s exactly right. The real risk to Sam here was not an insider trading charge, but an obstruction of justice charge.
Picture an investigator coming to your house and asking you some seemingly irrelevant question. They don’t even have to tell you it is you who is being investigated. You don’t remember the answer exactly and reflexively say something that makes you look good without consulting your lawyer – all of a sudden you have lied to an government agent and they can get an easy conviction at their leisure.
This is what happened to Martha Stewart, and this is what can happen to anyone caught up in a government investigation. This is why you NEVER talk to authorities without your lawyer.
Most of the convictions in cases like this come from trying to cover up or minimize, not from the actual deed.
You made quite an interesting point that the real insiders have no incentives to leak the material information. However one can argue that some people (who are probably not millionaires themselves) possessing the same information may face the opposite problem of how to use it or basically whom to sell it. On the other side many people are desperately willing to buy this valuable commodity. So there should exist a kind of hidden market for these tips.
Surprisingly even supposedly sophisticated and well educated individuals may lack the basic skills of identity protection which are necessary for those involved into this market:
https://www.businessinsider.com/disney-bonnie-jean-hoxie-insider-trading-2010-5
I suppose that it is safe to assume that the general risk of being caught is mostly manageable if the persons involved into these communications just follow the basic rules:
– they are based in different countries (the buyer preferably is not the US citizen)
– they do not use their personal e-mail addresses, mobile numbers and computers.
– they use Bitcoins for payments
Fascinating! I can see how on one hand you were disappointed you didn’t act on your trading idea and totally relieved on the other that didn’t so that you weren’t accidentally flagged and wrongly accused. It does sound like you would have been fine even if you did make a trade, but what a stressful headache that would have been if you were flagged and questioned. You could have totally cut back on trading anything if that happened and ended up with a much different portfolio now, who knows. Seems like you’ve more than made up for that missed opportunity now with all the other trades and investments you’ve done since then, so that’s good!
I still remember the whole Martha Stewart thing very clearly. I was a big fan of her show and magazine and was in total shock that she actually was sent to jail. “Martha Stewart’s in jail?!” I’ve heard through the grapevine that she’s not nearly as nice she seems on TV, but I’ve never met or worked with her myself so I have no idea. I still flip through her magazines every now and then and think, “gosh it’s crazy she actually went to jail!” She seems to have learned from that mistake and her business bounced back. And life goes on!
Mark Cuban commented about BABA and other Chinese companies that insider trading is inevitable as China is very corrupted, and it is difficult to hold them accountable.
I don’t trade pharmaceutical and healthcare companies, because I can get the information on these companies very quickly at my institution. Even the trials are not finished, I sorta know the direction of the result. Anyhow, why would I risk my license that most of my life to get for some dumb money?!! Plus, it would cloud my judgement professionally.
Why CEOs or Rich people risk small amount of money for it? They probably don’t spend most of their life working for a degree?! Money comes too easy?! And They are on top of the world, nothing can touch them?!! Or simply greed or information was volunteerly coming at them, so why not?
On another note, I’m not looking forward to the Zillow, Trulia merger. The difference between Trulia estimate and Zillow estimate is 250k for my home. For simplicity purposes for now I just use original purchase price for personal net worth calculations.
I’ve been trying to go longer with my spare cash by investing ~100 a day…
My buy for 3/24/15 was 1 share of Kraft…news broke on their merger with Heinz later that day.
Sold within 24 hours for 35% gain…
Should’ve invested 50k!
1 share?! Come on now! Gotta bet bigger or else the commissions will eat you alive :) It’s one of the reasons why I like Motif Investing so much. I never thought I’d be able to assemble a 30 stock/ETF, $10,000 portfolio for only $9.95. In the past, I would feel like I had to invest at least $10,000 in one position alone.
lol one share?!
Thanks for the reply Sam!
Really sorry about going off-topic there but I didn’t see a general “ask” section which is why I posted here. It was selfish of me to disregard your post; sorry.
Thank you for the advice!
My firm audits a number of companies on the ASX, and although I don’t work in the audit practice, we are restricted from buying stocks of companies the firm audits. Once or twice in the past I’ve bought a stock but in the excitement of it all forgotten to confirm whether it’s an audit client. Once I realised I sold straight away. But it scares me to think what if I did this just as they announced a major takeover offer!! That would be an awkward one to explain, and stories like yours just help me stay diligent about this now when it comes to buying stocks! (Fortunately, I’m about to move to a smaller firm where this is less likely to be an issue…)
I bought Marvel (comics, not Marvell electronics) and soon after, it was bought by Disney. Also Audible, which was bought by Amazon. Not knowing anyone working at either company, it never occurred to me that I might get a call.
On the other hand, there are screens you can use to find unusual trading activity in stocks or their options. You buy an option based on that activity and you’ve used public knowledge. The underlying cause could easily have been inside trading. I’d keep good records and screenshots in case I got the call for that.
You would have been in the clear. Now that you know that already here is how it works.
The first M&A deal I ever closed *did* have a guy go to jail.
1) They track anyone who purchased shares $25K+. This was back in 200X. Maybe they moved it up to $50K? Not sure because never had it come up since then (phew)
2) if you bought shares around the time the deal went live is (always exceptions), you’re usually *not* investigated because rumors are picked up on industry blogs. In addition 90% of M&A deals fall apart even after going “live”
3) if you bought within ~15 days of when the merger agreement document is being *made* you will be investigated. This is especially in your case since you had TWO direct links to potential insider information. (when the official agreement is done it is usually 25 days until he announcement – Merger Monday’s baby! Or takeover Tuesday’s!)
4) they start a vetting process with a list of names as the MDmentioned and as long as you are honest you are in the clear.
—
Here is the thing. You must be 100% honest. Without giving too many details the guy who got busted was on the other end of the table (advisor for the party not on our side). He had left his laptop open at an event with the document open and one of his colleagues from the past saw it and idiotically bought it (the guy was already a millionaire?!?! Stupidity!)
He bought for $25-75K, not going to disclose exact amount (your md friend is right, $25-75K is common)…
Result? 2 years in prison, lost career and lost the money as well.
There you have it!
TL;DR they would have looked at you no doubt. But since you didn’t do anything wrong you’d be fine.
Fascinating insights! Thanks for sharing. It must be one of the biggest fears of anybody to be wrongfully convicted of something s/he didn’t do. Can you imagine being sentenced to years in prison or life in prison being innocent?
Now I’m thinking of the podcast Serial, and Adnan. But it seems evident Adnan did it.
Generally, they lean *against* convicting.
Meaning if someone is on the fence, they usually assume innocence.
So you’d be fine and generally the guys that get convicted deserve it.
Sam, that gives me anxiety just to think about!
This is an interesting topic and I agree with the basics on how the investigations work, but I think the article and the reply leave out a big gap between “in the clear” and “convicted.” As Sam mentioned, it takes a lot to get convicted. And, even if the government has a lot of evidence, they might not even want to go to trial because of the time and resources involved (unless you are a celebrity like Martha Stewart). But, a government investigation can disrupt your life even without a conviction.
Here is more typical scenario: Trader has a great idea and buys 50k of a stock. Soon after, merger, clinical trial, etc. happens and the stock skyrockets. The government puts together the lists of names mentioned above and starts showing it around. A couple people at the company identify that they know Trader (I played in a tennis tournament with him, our kids go to the same school, we used to work together, etc.). Government sends a subpoena to the Trader. Trader then hires a lawyer who collects some documents (emails about the tennis tournament, phone records, etc.) and sends them to the government.
Then… nothing. The government does not have to tell you when the investigation is over, and they usually don’t. You don’t look like you did anything actually wrong, so your file goes to the bottom of the pile on some SEC agent’s desk. Now you face a dilemma – you really want some closure, but if you ask your lawyer to call, all of a sudden that file folder comes to the top of the stack and you are on the radar again. Even more nerve-racking, maybe the SEC agent does some spring cleaning or a new agents takes over all his old cases and you get a follow-up request or two for some more information a year later and you think the investigation is still active. Most lawyers will likely tell you to let sleeping dogs lie and quietly wait out the statute of limitations period without getting back on the government’s radar.
So what happens during this time? Thinking you may be facing at best some serious legal fees and at worst a government fine, do you buy that new rental property? Do you go on an expensive vacation? Do you even keep buying stock now that the government might be scrutinizing every trade? You can easily lose a couple years of productivity because of an investigation. Most people end up just holding large amounts of cash for long periods of time just in case. There is a good reason to be paranoid and steer very clear of anything that looks like insider trading. Even if you came up with the idea yourself, I would think twice about investing in a stock where your neighbor is on the board or your tennis partner is running the clinical trial. The person below has the right idea when they mentioned that they do not trade in pharma companies because their company has access to information even if they personally are not privy to it. Insider trading investigations can disrupt your life for years even if the SEC agent assigned to the case is pretty sure you did nothing wrong from the first five minutes of looking at your documents and no charges are ever filed.
Hello Financial Samurai!
I have been reading your blog for a couple of weeks now and it seems that you really interact with your audience; which is rare for a blog this size. I just want to get some advice from someone who has financial freedom like yourself.
I have done everything wrong all my life. According to your site I’m suppose to be worth a substantial amount and making my way towards 100k a yea, but I’m not. I’m not going to blame it on anyone but myself which is something new I’m trying, lol. A bit on my financial background…huge financial hole and I want to start climbing out instead of digging myself deeper. I’m 27, about 33k in debt (student loans, personal loans, car loan, credit cards). I was a very lazy individual with no purpose or direction and was partying and spending what I made plus more. Now, I’m about to finish an AA in Business and I don’t know what to do or how to approach my situation correctly because I’m afraid of messing up again.
My schooling was always on the back burner until last year when I decided to quit my job and go back to school and finally get a degree in order to obtain a higher position. I’m finally getting my AA this fall which will hopefully open doors to a better job where I can work full-time and still get my Bachelor’s part-time. I have about $1,200 in bills each month and I want to get back on track and secure my financial future.
I’ve been offered a couple of jobs while in school that pay about 40-60k/year starting which isn’t so bad with my work experience. Without a degree I was making 30-35k/year so with my AA and experience hopefully my worth will jump a little. My plan is as soon as I get my AA apply for one of those jobs and start making at least 40k/year and pay down most of my debt within 2 years.
With how I’m going right now I would think of finishing my B.S. by 28-29 which will increase my worth a little more and I would hopefully be debt free. By this time I plan to be making around 50-55k/year and starting a 401k ( super late, I know). With no debt, at 28 I plan to contribute the max (18k) each year which will hopefully leave me with a nice little cushion by age 60 (2mil and change with no employer contribution @ 7% return).
I definitely want a family so I don’t know how much that will change things. I still think I’m young enough to make a complete 360 and head in the right direction. What would you do if you were in my situation?
Thank you in advance!
– Greatful Financial Samurai Reader
Hi Jerry,
Nice to hear from you, although, perhaps your situation is a little off topic from the topic of this post? Some thoughts:
* Good job wanting to make a difference, recognizing your weaknesses, and finishing up school. The earlier you can get your degree, the longer you can leverage that degree in your career.
* Once you make more money, save all that extra money as if you didn’t make that extra money. Attack your highest interest rate debts first and ask yourself why you are buying things you can’t afford. Try to find the crux of the reason for over consumption.
* You’re definitely young enough to change your life around.
* Take a communications class, as conveying messages, building relationships, and developing a strong emotional quotient goes a long way.
* Try and think of others first, and yourself second. For example, asking for help in this post is thinking about yourself first, disregarding the time I spent writing this post, and not even mentioning anything in this post. A better way is to acknowledge people’s efforts, see how you can help them, and then see how you can help them some more. Maybe help them 3X before asking for help.
We live in a selfish society where we want things that we can’t afford and don’t deserve, and we want them now. We want to go to the corner office without doing the work. We’ve become mercenaries with no loyalty towards our employers, only to whomever pays us the most. The person who acts differently will flourish.
Best, Sam
Sam – you handled that way better than I would have…
;<)
I recommend networking with whoever you can. That’s where you’r going to learn valuable things that you can apply to your life. Meet as many successful people as you can that are willing to share their business successes.
Wow. Sam – awesome response. I read and re-read it because it was so well written.
Thanks for the post as well. It’s a topic I’ve always wondered about, so glad to read about it.
I suspect insider trading makes the financial world go ’round, only the really rich and powerful do it in a more subtle way. There is no reason all the rich people need to live in and very close to Manhattan, other than this business needs to be done face to face.