Top 4 Most Scandalous Insider Trading
Debacles
By Andrew Beattie | Updated September 09, 2013
Insider trading has been a part of the U.S. market since William Duer used his post as
assistant secretary of the Treasury to guide his bond purchases in the late 1700s. In this
article, we will look at some landmark incidents of insider trading. (For more background
info, check out What exactly is insider trading?)
1.
Albert
H.
Wiggin:
The
Market
Crash
Millionaire
During the Roaring '20s, many Wall Street professionals, and even some of the general
public, knew Wall Street was a rigged game run by powerful investing pools. Suffering
from a lack of disclosure and an epidemic of manipulative rumors, people believed coattail
investing and momentum investing were the only viable strategies for getting in on the
profits. Unfortunately, many investors found that the coattails they were riding were
actually smokescreens for hidden sell orders that left them holding the bag. Still, while the
market kept going up and up, these setbacks were seen as a small price to pay in order to
get in on the big game later on. In October, 1929, the big game was revealed to be yet
another smokescreen.
After the crash, the public was hurt, angry, and hungry for vengeance. Albert H. Wiggin,
the respected head of Chase National Bank, seemed an unlikely target until it was revealed
that he shorted 40,000 shares of his own company. This is like a boxer betting on his
opponent – a serious conflict of interest.
Using wholly-owned family corporations to hide the trades, Wiggin built up a position that
gave him a vested interest in running his company into the ground. There were no specific
rules against shorting your own company in 1929, so Wiggin legally made $4 million from
the 1929 crash and the shakeout of Chase stock that followed. (Learn how to distinguish
tops and bottoms in the equity market when short selling, read Finding Short Candidates
With Technical Analysis.)
Not only was this legal at the time, but Wiggin had also accepted a $100,000 a year pension
for life from the bank. He later declined the pension when the public outcry grew too loud
to ignore. Wiggin was not alone in his immoral conduct, and similar revelations led to
a 1934 revision of the 1933 Securities Act that was much sterner toward insider trading. It
was appropriately nicknamed the "Wiggin Act".
2. Levine, Siegel, Boesky and Milken: The Precognition Rat Pack
One of the most famous cases of insider trading made household names of Michael Milken,
Dennis Levine, Martin Siegel and Ivan Boesky. Milken received the most attention because
he was the biggest target for the Securities and Exchange Commission (SEC), but it was
actually Boesky who was the spider in the center of the web.
Boesky was an arbitrageur in the mid-1980s with an uncanny ability to pick out potential
takeover targets and invest before an offer was made. When the fated offer came, the target
firm's stock would shoot up and Boesky would sell his shares for a profit.
Sometimes, Boesky would buy mere days before an unsolicited bid was made public - a
feat of precognition rivaling the mental powers of spoon bender Uri Geller. (Learn more
in Tales From Wall Street's Crypt.)
Like Geller, Boesky's precognition turned out to be a fraud. Rather than keeping a running
tabulation of all the publicly traded firms trading at enough of a discount to their true values
to attract offers and investing in the most likely of the group, Boesky went straight to the
source - the mergers and acquisitions arms of the major investment banks. Boesky paid
Levine and Siegel for pre-takeover information that guided his prescient buys.
When Boesky hit home runs on nearly every major deal in the 1980s - Getty Oil, Nabisco,
Gulf Oil, Chevron (NYSE:CVX), Texaco - the people at the SEC became suspicious.
The SEC's break came when Merrill Lynch was tipped off that someone in the firm was
leaking info and, as a result, Levine's Swiss bank account was uncovered. The SEC rolled
Levine and he gave up Boesky's name. By watching Boesky - particularly during the Getty
Oil fiasco - the SEC caught Siegel. With three in the bag, they went after Michael Milken.
Surveillance of Boesky and Milken helped the SEC draw up a list of 98 charges worth 520
years in prison against the junk bond king. The SEC charges didn't all stick, but Boesky
and Milken took the brunt with record fines and prison sentences. (For more on Milken,
see 4 History-Making Wall Street Crooks.)
3.
R.
Foster
Winans:
The
Corruptible
Columnist
Although not high-ranking in terms of dollars, the case of Wall Street Journal columnist
R. Foster Winans is a landmark case for its curious outcome. Winans wrote the "Heard on
the Street" column profiling a certain stock. The stocks featured in the column often went
up or down according to Winans' opinion. Winans leaked the contents of his column to a
group of stockbrokers, who used the tip to take up positions in the stock before the column
was published. The brokers made easy profits and allegedly gave some of their illicit gains
to Winans. (For more, see Why do stock prices change following news reports?)
Winans was caught by the SEC and put at the center of a very tricky court case. Because
the column was the personal opinion of Winans rather than material insider information,
the SEC was forced into a unique and dangerous strategy. The SEC charged that the info
in the column belonged to the Wall Street Journal, not Winans. This meant that while
Winans was convicted of a crime, the WSJ could theoretically engage in the same practice
of trading on its content without any legal worries. (Find out how news can affect your
stock in Trading On News Releases and Can Good News Be A Signal To Sell?.)
4.
Martha
Stewart:
The
Homemaking
Hoaxer
In December 2001, the Food and Drug Administration (FDA) announced that it was
rejecting ImClone's new cancer drug, Erbitux. As the drug represented a major portion of
ImClone's pipeline, the company's stock took a sharp dive. Many pharmaceutical investors
were hurt by the drop, but the family and friends of CEO Samuel Waksal were, oddly
enough, not among them. Among those with a preternatural knack for guessing the FDA's
decision days before the announcement was homemaking guru Martha Stewart. She sold
4,000 shares when the stock was still trading in the high $50s and collected nearly $250,000
on the sale. The stock would plummet to just over $10 in the following months.
Stewart claimed to have a pre-existing sell order with her broker, but her story continued
to unravel and public shame eventually forced her to resign as the CEO of her own
company, Martha Stewart Living Omnimedia. Waksal was arrested and sentenced to more
than seven years in prison and fined $4.3 million in 2003. In 2004, Stewart and her broker
were also found guilty of insider trading. Stewart was sentenced to the minimum of five
months in prison and fined $30,000.
The Bottom Line
Although the cases in this article are glaring examples, insider trading is often difficult for
the SEC to spot. Detecting it involves a lot of conjecture and consideration of probabilities.
While it's possible that Boesky was that good at predicting takeovers, it was
highly improbable.
Truth be told, the SEC has made mistakes and accused the innocent in cases that are
borderline, at best. This is one of the prices we pay to guard against insiders trading on
information that the public doesn't yet know. That said, Stewart offers the best example of
why it's best not to trade on material insider information – leaving the moral aspect aside.
If she had simply held her ImClone stock, it would have hit the $70-$80 range during the
Eli Lilly takeover, making her holdings worth around $60,000 more than what she sold out
for. Instead, she was fined $30,000 and ended up in jail. The risks, in this case, definitely
outweighed the returns.