Martha Stewart was famously accused of insider trading in the early 2000s, but she didn't
face criminal insider trading charges.
She was actually convicted of obstruction of justice.
It is incredibly difficult to prove an insider trading case.
Incredibly difficult.
Insider trading is judge made law.
There's no definition of insider trading.
The typical insider trading case is probably not against who you might think.
One surprising statistic is the median insider trading profits that the SEC actually
files complaints over is $58,000.
What are the incentives of the agency?
What are the incentives that would push them towards going after the big bads versus sort of like the
klutzy, the klutzy criminals?
When you're in a situation where you're trying to prove someone's intent, which is incredibly difficult without
some smoking gun of epic proportions, like an email that says, 'Hey, we're going to manipulate this stock
this week, let's all get the gang together.' You rarely have a smoking gun.
Few people wake up and say, 'Yes, today is the day I'm going to steal from this person and ruin my life.' But
it's subtle, bad decisions over a period of time without holding yourself accountable and without
understanding how these decisions are putting you on a path to continue to make really bad decisions.
So what is insider trading and why is it so difficult to stop?
Congress has never actually defined what insider trading was and explicitly outlawed it.
So as a consequence, there's sort of two types of or two theories of insider trading.
The first is known as classical insider trading.
An officer director of a company uses information that they get to enrich themselves.
So, for example, they get a look at the earnings announcement before the earnings announcement becomes
public, and then they trade accordingly.
The other type of insider trading theory is misappropriation.
The misappropriation is by individuals who are potentially outside of the corporation.
A good example of this is there was an insider trading case against a couple of analysts at Capital One credit
card. So these analysts at Capital One were basically looking at Capital One's retail sales
receipts for various retailers and using that credit card data to actually trade in
front of those corporate earnings announcements.
And they made several million dollars doing that.
But those individuals, at least in the SEC filing a complaint, didn't actually have any specific tie
to the corporations that they were trading.
A Capital One spokesperson told CNBC "Safeguarding confidential information is essential to our role as a
financial institution...
Back in 2015, Capital One identified a violation of company data confidentiality policies,
immediately terminated the employment of two data analysts, and actively worked with the proper
authorities in their investigation."
If the SEC could establish that the individual who made the trading decision
knowingly possessed material nonpublic information concerning a company, that will
create a presumption that that information was used by that individual in connection
with that trading activity, and that would constitute securities fraud.
In 2022, the SEC amended an existing rule to "enhance investor protections against
insider trading.
The DOJ prosecuted the first insider trading case exclusively based on this rule in March
2023. Insider trading can be prosecuted through either civil or criminal law.
The Securities and Exchange Commission or the SEC handles civil litigation at the federal level, and the
Department of Justice handles criminal cases.
Let's start with civil proceedings.
This means a person would be found liable for an infraction and have to pay a fine.
The SEC makes rules that cover the trading on stock exchanges, regulates broker dealers, regulates
financial markets.
The SEC took on 760 total enforcement actions in fiscal year 2022 and recovered more than
$6.4 billion that year.
Martha Stewart was charged civilly in addition to the criminal conviction, but she settled the civil case and
paid $195,000 in monetary relief.
She did not make any admission of wrongdoing.
It's really important to distinguish two kinds of investigations.
One is, was there a violation of the reporting rules?
The reporting rules require disclosure if one is intending to
sell. So the amendment may have been deficient or defective.
You gave a report that was missing some important information.
That's still very different from a fraud investigation, because if the question is whether the
behavior is fraudulent, what regulators are looking at is not just did you fail to complete a
question, but was this part of a deceptive scheme?
The odds are against the SEC significantly, you need a false statement.
You need scalping, selling into your own buy recommendations.
You need insider trading, trading on material nonpublic information.
You need 17(b) violation, which is when you're being paid by a company failing to disclose the nature source
and amount of that compensation.
You're not looking for a needle in a haystack, but it's pretty close because you're looking for signs of a
manipulative intent or more blatant violations of some of the more clear cut rules.
The problem comes in tying that individual's mindset to knowing
that that disclosure of nonpublic information was going to occur somewhere close in time
and that they knew about that information and that that information is what
compelled them to do the securities transaction that they engaged in tied to that information.
Under the civil statute, you have to prove that they were using that nonpublic information to
trade. And it was the impetus or the reason why they made the transaction that they did.
Criminal proceedings have a higher threshold for guilt and penalties can come with prison time.
From the criminal side of it.
That would be the mens rea.
That's the mental state.
You have to prove that the person had an evil mind, that they wanted to take action to violate the law.
Sometimes intent is even unclear to the person who's engaging in the crime.
One of the biggest reasons people go to trial or do not agree with their plea agreement with the United States
government is because they'll say, 'I did not have bad intentions.
I didn't mean to do this.
I was swept into this.' The people who claimed they didn't have bad intentions fail to understand that
when faced with that choice, they chose to engage.
Justin Paperny pled guilty to one count of conspiracy to commit securities fraud in 2007.
After serving time in federal prison, he now guides those accused of white collar crimes through the
investigation.
In 2005, I learned that I was the subject of a government investigation.
I didn't know anyone that had been through the system, so I responded poorly.
Very few people wake up and say, yes, today is the day I'm going to commit a white collar crime.
It's when they face that dilemma or decision that they might feel that pressure, rationalize that decision
and then seize an opportunity.
I had a client who was running a hedge fund.
We learned that he was raising money and losing money, raising money and losing money.
Our experience told us if he's losing money, how in the hell is he continuing to raise money?
We knew, therefore, that he was lying to people, but we all schemed and turned the other way because we
wanted the gravy train of commissions to continue.
Eventually it all comes crashing down.
In my experience, it has not been hard for the Department of Justice to prove cases, and it's driven
by real experience.
I'm not a criminal defense attorney, so I don't bear responsibility, though I can tell you more than 60 of
our clients since 2009 have gone to trial.
None of them have won.
So I would argue the DOJ is not going to bring a case unless they know they can win.
And of course, even when it's dubious or they're unsure when they bring a case, as we know, the lion's
share of defendants plead guilty.
When it's your name versus the United States of America, it's incredibly difficult to prevail.
Before I started doing research on it, I guess as more of a lay person on the street, I would think, 'Well,
okay, they're going to go after sort of the big fish, the big bads.
They're going to go after the Emperor Palpatines, the scheming puppetmaster behind the scenes.' If you
actually start digging into the complaints, what you find is there are very, very few instances
of Emperor Palpatines in the data.
Instead, there's a case where they went after a postdoc and they had his browsing history and he typed
in how to engage in insider trading in Google.
That's an easy win for the SEC.
We've had cases where the person who is the least culpable, in other words, the person who received the
tip and the person receiving the tip could have been one of ten.
They get a longer sentence than they should because the FBI tends to get to the organizer first.
That's why the criminal justice system is so warped and twisted.
The orchestrator, the facilitator of the crime could get a shorter sentence than the people he swept in.
The SEC's budget. It's like $2.2 billion.
And they have to enforce across all financial markets.
You know what J.P. Morgan spent on IT this past year?
Over $14 billion.
So when you think about who the typical defendant is for insider trading at the SEC, which you start to
realize is this really is a crisis of resources.
How can they effectively deploy those resources to police Wall Street?
And unfortunately, things sort of have gravitated towards, well, that means getting easy wins per
dollar spent. And the easiest way to get wins per dollar spent is to go after defendants that can't
afford high powered representation.
This doesn't mean the government steered clear of big name suspects.
The DOJ and the SEC filed insider trading charges against British billionaire Joe Lewis in July
2023. Federal prosecutors are accusing Lewis of orchestrating a "'brazen' insider trading
scheme by passing tips about companies in which he invested to friends, personal assistants, private
pilots and romantic partners." Lewis entered a plea of not guilty.
His attorney told CNBC in a statement "The government has made an egregious error in judgment in charging Mr.
Lewis. [He] has come to the U.S.
voluntarily to answer these ill-conceived charges, and we will defend him vigorously in court."
In July 2022, the government took both criminal and civil action against former Indiana Congressman Stephen
Buyer for alleged insider trading infractions.
Buyer was convicted on four counts of securities fraud in March 2023.
Buyer did not respond to CNBC's request for comment.
Successfully nailing a famous or wealthy individual is a major boost to a
prosecutor or enforcement lawyer's career.
So there have been successful enforcement actions against the individuals.
Investigations get complicated when activist investors are brought into the mix.
An activist investor is typically a high profile firm that buys a stake in a public company it deems
undervalued with the hopes of influencing governance or corporate strategy.
Ultimately, the investor wants to raise shareholder value and make changes that result in share price
appreciation.
Any time you do anything, if you're a public figure and you're an activist investor, you're going to be
scrutinized. You're going to be reported to authorities, you're going to be subjected to all sorts
of conspiracy theories.
You're always going to have suspicions on someone when there's a big trade, when they suddenly get out of a
stock and they're a big activist investor, you're always wondering, what did they know?
Activist investors may be more involved with the board of directors of the company, which could raise
questions about whether that investor could have access to nonpublic information.
Activist investors may also have influence over the public, which can lead to potential for a
different type of market abuse known as a pump and dump scheme.
The term encompasses basically any scheme to drive the stock price up, buy the shares,
drive the stock price up and sell at the peak.
The pump is driving the price up.
The dump is selling at the peak.
And then as soon as it goes up enough, you dump your shares, take your profits and move on to the next scam.
The challenge with defining pump and dumps is that some of them are based on just
false information being put out there, like just lying about the company.
But some of them are not based on false information.
They're based on misleading the market about your trading strategy.
Social media has made prosecuting certain types of market manipulation more complicated.
Social media has made coordinated retail investing extremely easy and very low
cost.
In general, the idea that an activist campaign would be coupled with a meme stock
campaign or meme stock interest, it is concerning.
The way they do that is by selling their shares at a higher price than they bought them.
The incentive of the meme stock crowd is to drive the price up similarly.
So what this creates is the potential for something like a pump and dump situation where the price
gets driven up, not because the activist is actually changing the fundamental value of the company, but
because meme stock investors are excited.
The interesting question that this raises, though, is what kinds of
obligations might these types of influencers have to their followers?
Currently, there are certainly no legal obligations.
But do we want to live in a world where retail investors look to these social
media leaders and are heavily influenced by them?
Or do we want to live in a world where regulators perhaps are a little more paternalistic
and try to protect those retail investors?
Typically, when we think of market manipulation, we think of a group of related individuals acting together
to manipulate stock prices to gain from that.
But let's say that there is a mob out there, and you know how to incite the mob.
And the mob drives prices around.
Is that market manipulation?
Not sure we've answered that question.
The real danger here is that when you follow an activist investor is when they change their minds,
you're going to be left with nothing because everybody's going to run away from that.
The SEC would say, do your homework, follow a company.
If you think the company is really good, then invest in it.
Look at public filings, look at information, talk to someone you trust, talk to an expert and
find as much information as you can about that stock and then make your decision based on that.
I've investigated insider trading cases where it just seemed like absolutely somebody
was doing something wrong and it turned out they weren't.
And I've invested cases where it didn't look like there was any impropriety.
And then suddenly an informant popped up and told me how everything was a lot worse.
You never know what you're going to find.