Can the Federal Government Really Deter Insider Trading?

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Steve Marcus / REUTERS

Hedge-fund manager Steven A. Cohen, founder and chairman of SAC Capital Advisors, listens to a question during a one-on-one interview session at the SkyBridge Alternatives Conference in Las Vegas on May 11, 2011.

It’s been two decades since Michael Milken, a.k.a. the junk-bond king, pleaded guilty to securities fraud following a blockbuster insider-trading investigation that shined a light on bad Wall Street behavior during the go-go 1980s. At the time, federal prosecutors hoped the Milken guilty plea, and the conviction of fellow Wall Street titan Ivan Boesky, would send a powerful message to Wall Street that there are serious consequences for insider trading. (Milken was never convicted of insider trading. He pleaded guilty to six counts of securities fraud and ultimately served two years in prison.)

Since then, however, insider trading has continued unabated, with a series of high-profile cases, including the conviction of lifestyle guru Martha Stewart, who served five months in prison for trading shares of ImClone Systems based on material, nonpublic information she received from her broker. In short, whatever message federal prosecutors thought they’d been sending to Wall Street does not appear to have gotten through.

Manhattan U.S. Attorney Preet Bharara, working together with the Securities and Exchange Commission (SEC), is aiming to change that. Since taking office in 2009, Bharara has charged 75 people with insider trading and obtained 69 convictions or guilty pleas, according to the New York Times. (Six cases are still pending, and there are surely more to come.) Bharara’s probe has already led to the convictions of former Galleon Group founder Raj Rajaratnam and former Goldman Sachs director and former McKinsey managing director Rajat Gupta. Rajaratnam is currently serving an 11-year prison sentence, and in October, Gupta was sentenced to two years in prison. (Earlier this year, TIME featured Bharara in a cover story and later named him to the TIME 100.)

(MORE: Preet Bharara — the Street Fighter)

Bharara’s latest target appears to be SAC Capital Advisors, the giant hedge fund run by billionaire Wall Street titan Steven A. Cohen. Last month, federal prosecutors charged Mathew Martoma, a former portfolio manager at SAC subsidiary CR Intrinsic Investors, with acting on confidential information he received from a neurology professor who played a key role in a major pharmaceutical trial. Martoma is the seventh former SAC employee to be linked to insider trading. In a parallel civil complaint filed by the SEC, Cohen is referred to as “Portfolio Manager A.” Cohen has not been charged with a crime, but federal prosecutors say Portfolio Manager A worked closely with Martoma on the allegedly fraudulent trades. Days after the charges were unsealed, SAC acknowledged that the hedge fund itself is under investigation by the SEC.

It’s no secret on Wall Street that Cohen, one of the most successful hedge-fund managers of the past two decades, has a target on his back. The feds have been investigating the hedge-fund mogul, who has a net worth of $8.8 billion, for five years, with little to show for it other than the convictions of a handful of his underlings. But in recent weeks, it’s become clear that federal prosecutors have intensified their scrutiny of SAC — and on Friday, Reuters reported that U.S. authorities are investigating SAC for possible insider trading involving shares of diet company Weight Watchers. According to the news agency, the probe “potentially could implicate” Cohen. A spokesperson for SAC did not return a TIME request for comment on the Weight Watchers report.

If the feds can pin charges on Cohen, it would be one of the most high-profile insider-trading cases in U.S. history. The reclusive hedge-fund titan is one of the most legendary figures on Wall Street, famed for his trading prowess, as well as his gargantuan 3,300-sq-m mansion in Greenwich, Conn., and his vast art collection, which is reportedly worth $1 billion and includes works by Picasso, Monet, de Kooning, Bacon and Warhol.

(MORE: SAC Capital: Feds Are Probing Insider-Trading Scandal)

Like other federal prosecutors before him, Bharara aims to send a message to Wall Street that insider trading carries heavy consequences. “What we’re trying to accomplish is deterrence,” Bharara told the New York Times recently, adding that jurors in the Gupta trial wept as they delivered the guilty verdict that destroyed Gupta’s once sterling reputation. “I want smart people to see that and say, ‘I never want that to happen to me.’” In an interview with TIME earlier this year, Bharara declared: “Securities fraud generally and insider trading in particular should be eminently deterrable crimes.”

But is that really true? If insider trading really is a “deterrable crime,” why does it continue — on a rampant basis — two decades after Milken and Boesky, and nearly a decade after Martha Stewart? The simple fact is that most folks on Wall Street are pretty smart, and risk-vs.-reward calculations constitute a sizable chunk of what they do every day. As long as bad actors on Wall Street believe the rewards of insider trading outweigh the risks, it will continue, according to veteran Wall Street securities lawyer Bill Singer, a partner at New York–based securities-law firm Herskovits.

Look at Martoma: he earned a $9 million bonus for his alleged insider trading, enabling him to purchase a garish mansion in Florida. Martoma, a graduate of Stanford Business School, fainted when FBI agents showed up on his front lawn.

“We can all agree that insider trading is a pernicious evil,” says Singer. “It is corrosive, and it undermines confidence in our capital markets. But if you think that putting Steven Cohen in jail is going to deter or prevent the next Steven Cohen or Michael Milken, good luck.” Singer says he would prefer to see federal authorities using their limited resources to target predatory scammers like Ponzi masterminds Bernie Madoff and Allen Stanford, whose devious machinations wiped out the life savings of thousands of ordinary investors.

(MORE: Insider-Trading Scandal: Are the Feds Closing In on Billionaire Hedge-Fund Mogul Steven Cohen?)

In a provocative recent post for Forbes, Singer went so far as to suggest that insider trading should be decriminalized. “Given the inability to outlaw insider trading, it’s probably best to legalize the practice so that the public gets the message, once and for all, that Wall Street is not a level playing field and that you must enter the casino knowing that some or all of the games of chance are fixed,” he wrote.

That’s not going to happen, of course, but Singer makes a good point. Given the fact that insider trading continues unabated, even after all of the high-profile cases and convictions, it’s worth asking just how effective the federal government has been in attempting to deter the practice.

Like all crime, insider trading will never be completely eradicated. There’s just something about human nature that compels people to seek unfair advantage over others, even when they rationally understand that their actions could result in hefty fines or incarceration. The Wall Street hedge-fund community is particularly susceptible to insider trading because Wall Street’s entire raison d’être is to seek “an edge” over the competition in order to generate profit.

Bharara and his colleagues should be commended for their aggressive campaign to crack down on insider trading. (To get an idea of the scope of the federal insider-trading crackdown, take a look at the list of recent SEC cases.) Singer is right: insider trading is pervasive, pernicious, dishonest and disgraceful, and it undermines public confidence in the capital markets. But Bharara may be a tad optimistic if he thinks his crackdown is actually going to substantially reduce insider trading on Wall Street. Realistically, 10 years from now, we’ll still be talking about the deterrent value of insider-trading investigations, as unscrupulous Wall Street actors continue to seek advantage over others by just about any means necessary.

Correction: An earlier version of this story implied that Michael Milken was convicted of insider trading. He was not. Milken pleaded guilty to six counts of securities fraud in 1990.

6 comments
gchu
gchu

Martha Stewart received no "material, nonpublic information" in a NUISANCE call from her broker.  Informed by sound investment management principles, she sold 3,928 shares of ImClone stock based on her decison two months earlier to sell ALL ImClone stock in a tender offer from Bristol-Myers despite ImClone's rebuff of Bristol-Myers takeover bid.  Falsely featuring Martha Stewart as TIME "high profile" poster person for "insider trading" is deplorable cesspool journalism from Gustin and TIME. 

gchu
gchu

As propagandists and apologists for the colossal waste of taxpayer resources in the Martha Stewart case, and the enormous, unconscionable wasting of her own resources, Gustin and TIME flagrantly lie to readers about "the conviction of lifestyle guru Martha Stewart, who served five months in prison for trading shares of ImClone Systems based on material, nonpublic information she received from her broker." 

As propagandists and apologists for legal malpractice in her grossly incompetent legal representation, Gustin and TIME flagrantly misrepresent that her "trading shares" was illegal.  She was never charged with illegally "trading shares" or "insider trading" because she never engaged in "insider trading."  All of the trumped-up charges, including the big-time charge with a $2 million fine and 10 years prison that was thrown out in court as baseless and bizarre, had no connection to any "insider trading" laws, and they all related to the time period AFTER her legal stock sale.  

gchu
gchu

As propagandists and apologists for the colossal waste of taxpayer resources in the Martha Stewart case, and the enormous, unconscionable wasting of her own resources, Gustin and TIME flagrantly lie to readers about "the conviction of lifestyle guru Martha Stewart, who served five months in prison for trading shares of ImClone Systems based on material, nonpublic information she received from her broker." 

As propagandists and apologists for legal malpractice in her grossly incompetent legal representation, Gustin and TIME flagrantly misrepresent that her "trading shares" was illegal.  She was never charged with illegally "trading shares" or "insider trading" because she never engaged in "insider trading."  All of the trumped-up charges, including the big-time charge with a $2 million fine and 10 years prison that was thrown out in court as baseless and bizarre, had no connection to any "insider trading" laws, and they all related to the time period AFTER her legal stock sale.    (Contd)

gchu
gchu

The "Columbia Univesity's Graduate School of Journalism" obviously graduates propagandists with no journalistic integrity and TIME is propaganda media with no journlistic integrity. 

"If insider trading is a really a 'deterrable crime,' why does it continue - on a rampant basis - two decades after Milken and Boesky, and nearly a decade after Martha Stewart?"  Martha Stewart is of no relevance to "insider trading."  She was never involved in any "insider trading" criminal trial, and there was no legal adjudication in a court of law that she was ever involved in any "insider trading." Gustin and TIME are no court of law to pontificate "insider trading" on her very legal, small, personal sale of 3,928 shares of almost 8,000,000 Imclone shares traded. 

As propagandists and apologists for the abuse and misuse of the criminal justice system on Martha Stewart by the Bush Administration, the mendacious Gustin and TIME are abusing and misusing the media power of TIME and the freedom of the press on her. 

The Martha Stewart case stands as a condemnation of the legal system, a repudiation of the American constitution, a blot on American democracy, and American-style human rights violation.   

AdamSmith1
AdamSmith1

After working for 25 years for somebody else I decided it was time for a change, trading was the answer for me because I need to work from home. I say stop working for somebody else and make your own money trading, you just need to learn how to trade which isn't very hard. Go to the website Traders Superstore, that's where I started and now I'm doing great trading averaging $1500 a week which is enough money for me.

DeweySayenoff
DeweySayenoff

Insider trading is LUCRATIVE.  Get a hundred million dollars, pay a fifty million dollar fine, get ten years in jail and walk away from it for five mil a year.

If they can walk out of prison a rich man, they'll continue to do it.  Now, MY way to deter this kind of behavior is a touch over the top (Two 9 mm behind the ear upon conviction and let the buzzards eat them then distribute their assets to charity), but I imagine society would settle for complete seizure of ALL assets, given to a fund that helps offset student loan payments (or something equally useful), plus prison time.  In short, bankrupt them, lock them up for a decade or two and release them into the streets with the hundred bucks and a suit they release all felons with.

The punishment has to be horrific enough to act as a deterrent.  And regulations have to be implemented to ensure that it is easier to catch them doing it and/or to make it harder for them to do it in the first place.