Insider Trading Is Running Rampant on Wall Street

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TXU. Dow Jones. Acxiom. Aquantive. HCA. First Data.
What do these companies have in common?

All of these companies were acquired by other companies, and in every single case, the stocks experienced a huge surge in the buying of call options just before the acquisitions were announced, meaning that someone made a whole lot of money. Well-timed trades? Highly doubtful. Word leaked about the deals and someone made a heck of a lot of money, and will likely never be punished by the SEC.

Take a look at this stat. In the three days before the 17 biggest US takeovers in 2006, options activity jumped 221%.

The problem is that takeover deals are usually so complicated nowadays that so many people are needed in order to complete the deal. You have scores of lawyers, accountants and tax planners on both sides looking over the proposed deals. You have brokerages and hedge funds involved in the negotiation of deals. All it takes is one lawyer's assistant to leak word of an impending deal, and all of a sudden you have an order to buy 10,000 call options five minutes before the closing bell. This is just out of the movie "Wall Street", except you don't have Bud Fox posing as a janitor to glean information. People are much more brazen about it, due to the SEC not having enough resources to investigate everyone.

Sure, every now and then, the SEC will announce that a number of people have been indicted and are now facing charges. These announcements are normally symbolic, and are done to prevent other people from attempting such schemes. The SEC knows that it doesn't have the resources to investigate every insider trading claim, so they try and make high-profile busts when they can.

The thing that makes me mad is that this insider trading is so egregious. People are bold because they know that there is just a small chance that they will get caught. For every high profile bust, there are ten other cases of blatant insider trading that goes unpunished.

What is the remedy here? More funding for the SEC, and more teeth in the punishments doled out by the SEC. The SEC is woefully underfunded; everyone knows that. The best way to chase down and investigate insider trading is to allocate more resources to the cause. Also, the SEC needs to be able to recommend extremely harsh penalties for insider trading infractions. Instead of a year of probation and a financial penalty, how about 10 years in jail? That'll make people think twice about trading with insider information.

Until then, any time there is a major buyout, examine the trading activity the day before the announcement is made. Almost always you will see a huge uptick in volume and options activity. This is people flouting the law and laughing all the way to the bank.
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