Is Insider Trading Hard To Detect?

I was talking to a senior Goldman Sachs Tech M&A banker the other day while playing tennis. I asked him whether insider trading is hard to detect. This is what he told me.

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.”

When I asked him what happened to the NFL players, he responded, “Nothing. Insider trading is hard to detect.”

His response made me realize that insider trading probably happens all the time. But the government only catches a small portion of people who use inside information to profit.

We only hear about insider trading cases from famous people like Martha Stewart or billionaire hedge fund manager Raj Rajaratnam.

In a way, insider trading is probably like tax evasion. Plenty of people do it, but the IRS can only catch so many.

Insider Trading In Politics

We see insider trading happen all the time among members of Congress.

For example, Paul and Nancy Pelosi bought up to $6 million worth of call options in just four tech stocks right before a Department of Defense decision was made regarding reigning in big tech. They made millions in profits as a result.

I'm not sure why politicians with inside information are allowed to invest in single stock names while they are in office and make massive fortunes. But that is how the system is set up.

Congress writes the laws. And clearly, Congress people will write laws to benefit themselves.

Is Insider Trading Hard To Detect?

Black and white insider trading is receiving a tip from someone in the know about something that will happen. You then invest according to the inside information and hope the government doesn’t catch you.

This type of insider trading happens all the time at the highest levels. Some get caught, like ex-hedge fund billionaire Raj Rajaratnam who traded on insider information from his friend at McKinsey. Another example is ex-New York Congressman Chris Collins, who passed along insider information to his son to make a trade.

Insider trading is hard to detect because you've got to catch the information exchange in the act. There needs to be some type of electronic or paper trail. If you are speaking to someone face to face with no hidden recording, it's very hard to prove insider trading.

While investigating an insider trading case, the government will go down all your list of known associates and relatives. If there is a connection, they will press until they can find evidence of impropriety. But if two colluding people have no recording or paper trail, it's hard to prove inside information was passed along.

Then there are grey areas of passing along insider information. This type of gray insider information could lead to insider trading. But it's very hard to detect.

Below are examples of how inside information may get passed along inadvertently.

1) Playing Tennis And Having Small Talk

I was playing tennis with this one guy who worked at Trulia back in 2014. He mentioned they were extra busy due to a potential partnership. He didn’t say what, but I figured they were probably going to get acquired since there was a race for market share between Zillow and Trulia. Redfin wasn’t really a contender back then. 

Lo and behold, Zillow ended up buying Trulia for $3.5 billion the next week. I didn’t buy the stock, but I could have. Having small talk isn't considered insider information.

And even if I did buy Trulia stock, I'm not sure how the government can prove this is insider trading. What if I bought Trulia because I simply believed in its people and the online real estate space?

2) Management One-On-One Meetings

Let’s say you’re in a management meeting with a publicly-traded company. A C-level executive knows the quarter is going great. But of course, he cannot specifically say earnings will likely beat estimates.

Instead, the executive says, “We are seeing surprise robust demand from new regions where we previously did no business. These new regions could one day be our main earnings driver going forward.”

From this statement, you can infer your earnings estimates need to be revised up. And given better-than-expected earnings is usually a strong catalyst for a stock, you buy more stock. Time will quickly tell whether the C-level executive can be trusted or not.

Is this inside information if the C-level executive is telling multiple investors the same thing? Probably not. What if the C-level executive gave a winky wink? Who knows!

3) Catching Up With Business School Friends

Let’s say you’re at a mutual friend’s party with unlimited amounts of free alcohol. All of you guys went to business school together so you’re all chummy.

You work at a hedge fund. Your business school classmate is the VP of Business Development at some publicly-traded company. You guys are doing shots for old times sake and having a blast!

At 2 am, you casually ask your buddy, “So how’s business?”

Without telling any specifics, your buddy says, “Business is doing great! We’re planning on expanding into China. To do so, we’re looking to partner up with a leading local player.”

The next day, you go to work on analyzing who those partners might be in the industry. There’s only two “leading” local players so you invest in both.

As an investor, you have a right to do your research and try to connect the dots. This isn't considered insider trading.

4) Having Brunch With A Girlfriend

You’re out getting mimosas at Blue Water Grill with your girlfriend. You ask her, “How are you and Bobby doing?” Bobby is a senior lawyer at a publicly traded company. 

She says, “Not too good. Bobby has been working late every night for months because they’re looking to sell one of their subsidiaries. We never have date nights anymore!”

Given you tell your venture capitalist husband everything, he goes out and buys your friend’s husband’s company. He knows the subsidiary has been a thorn in the company’s side for two years. Any news of its sale, even at a poor price, will likely push the stock higher. 

Is it your fault you shared your day with your loving husband? Probably not.

Insider Information Gets Passed Along All The Time

Now that I've shared with you various examples of information exchange that could be considered insider information, you can conclude that various types of insider trading happen all the time. People just don't know it or simply don't call it that.

True insider trading is exchanging sensitive information you're not supposed to that can move a stock price in either direction. The recipient of the insider information then investments based on this secret information.

But there are gray areas of insider trading that really can't be detect or punished. What if someone just winks at you when you ask a question about business? Or what if you just say “things are going well.” This isn't really insider information. It's just normal social banter.

Either way, don't ruin your life over insider trading. It's not worth throwing away your reputation and your freedom for money.

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