Inside trade: A wager in life


By Richard Hurley, Ph.D., J.D., CFE, CPA; and Tim Harvey, CFE, JP
richard-hurley-80x80.jpg   tim-harvey-80x80   Global Fraud Focus: Examining cross-border issues

 SeptOct-business-risk    
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What’s the difference between an inside straight and an inside trade? One involves gambling in a game of poker, and the other involves wagering with your life. One may net you $5,000 in a poker tournament while the other may collar you with five long years in a federal penitentiary.

So why do people — who really should know better and who probably don’t need the money — make a life-changing wager to grab some quick cash with an inside trade? For example, take Scott London: a 29-year seasoned auditor at KPMG who until recently was head of its Los Angeles audit practice where he supervised 53 audit partners and approximately 500 professionals. London’s life came crashing down when it was discovered that he had provided inside information to his golfing partner, Brian Shaw.

The Financial Times reported that London “passed earnings information about Herbalife, Skechers and Deckers to Mr. Shaw. He [London] also gave him [Shaw] early information about takeovers involving RSC Holdings and Pacific Capital.” (See “Golf pair that landed KPMG in the rough,” by Kara Scannell and Matthew Garrahan, Financial Times, April 12.)  

KPMG fired London one day after the U.S. Department of Justice (DOJ) released an FBI photo of him allegedly accepting payment from Brian Shaw, a jeweler in the Los Angeles area. Prosecutors allege that in exchange for insider tips London received 10 percent of Shaw’s gains, a $12,000 Rolex watch and thousands of dollars’ worth of concert tickets including some for a Bruce Springsteen concert. KPMG says London is a rogue employee.

According to the Financial Times article, Shaw alleges that London told him not to worry because “insider trading was like counting cards at a casino in Las Vegas — if you were caught, they simply ask you to leave because they cannot prove it.” London forgot that there’s no ethics among crooks. He was under surveillance and Shaw was wearing an FBI wire.

London pleaded guilty to insider trading on July 2 and faces up to 20 years in prison.“I didn’t do it for money,” London said outside the courtroom after his plea, according to “Scott London pleads guilty to insider trading at KPMG,” by Stuart Pfeifer in the July 2 Los Angeles Times. “I did it to help out someone whose business was struggling. It was a bad, bad mistake.” According to the LA Times article, Shaw pleaded guilty to a conspiracy charge in May. He’s scheduled to be sentenced Sept. 16.

AND YET ANOTHER AUDITOR

It’s a rare event when an auditor of a major accounting firm is indicted for providing non-public material information to an accomplice. However, Thomas P. Flanagan, a former vice president and partner with Deloitte Touche LLP was sentenced to 21 months in prison in October 2012 after he pleaded guilty to trading on inside information for his own account, according to “Former Deloitte partner Flanagan gets prison term for insider trading,” by Steven R. Strahler, Oct. 26, 2012, Crain’s Chicago Business.  

Flanagan’s illegal trades generated at least $420,000 in profits and subsequently $14 million in lost pension and deferred compensation benefits. The judge in the case said, “The only explanation I can come up with [for the crime] is hubris. He certainly didn’t need the money,” according to the Chicago Business article. Assistant U.S. Attorney Jason Yonan said Flanagan possessed an “arrogant belief he could get away with it, ” according to the article. Flanagan said he was just stupid. Trouble is that stupidity alone doesn’t land one in jail, but acting on non-public information does.

Investors are always looking for a competitive advantage in the global financial world, and perhaps some think it’s worth the risk to take a chance on trading on inside information.

The Wall Street Journal reported that from October 2012 to April 14, 2013, the Securities and Exchange Commission (SEC) filed 26 civil cases for insider trading. Moreover, “the total number of people and firms accused by the SEC of insider trading since October 2009 has grown to more than 430.” (See “Limits of Insider Probes Expand,” by Jean Eaglesham, April 14, The Wall Street Journal.)  

PAY THE FINE, ADMIT NOTHING

Then there are cases in which companies don’t admit or deny any wrongdoing but pay a fine rather than take their chances in protracted legal proceedings. SAC Capital Advisors LP, a $15 billion hedge fund, paid a $616 million insider deal fine in March. The SEC alleged that SAC “profited from trading in the shares of two pharmaceutical companies, Wyeth and Elan, ahead of the release of negative clinical drug trials results.” (See “SAC in record $614m insider settlements,” March 15, by Kara Scannell and Dan McCrum, The Financial Times. Note that this article erred on the amount.)

With a new SEC administration, the agency is tightening the screws on SAC’s owner Steven A. Cohen. On July 19, the SEC accused Cohen in a civil case of failing to supervise former employees who face criminal charges. (See “S.E.C. Charges Are the Latest Test for SAC’s Cohen” in the July 19 DealB%k [sic] blog by Peter Lattman and Ben Protess in The New York Times.)  

And then — in the coup de grace — on July 25 the U.S. Attorney’s Office of the Southern District of New York, in a 41-page indictment, filed numerous criminal charges against SAC, including four counts of securities fraud and one count of wire fraud. The indictment charges that numerous employees at SAC committed insider-trading offenses “made possible by institutional practices that encouraged the widespread solicitation and use of illegal inside information.” The indictment said employees’ unlawful conduct and an “institutional indifference” resulted in “insider trading that was substantial, pervasive and on a scale without known precedent in the hedge fund industry.” The government stopped short of indicting Cohen. The obvious question is why? Corrupt company but not a corrupt CEO?

FOLDING TOO SOON

The story of Sam Waksal, former founder and CEO of the biopharmaceutical company, ImClone, is a seminal example of folding too soon. According to “ImClone Ex-Chief Embarks on New Biotech Venture,” by Andrew Pollack in The New York Times, Oct. 31, 2010, Waskal heard that the Food and Drug Administration wasn’t going to approve ImClone’s cancer drug, Erbitux. Before the company announced the news, Waskal alerted relatives and friends, including Martha Stewart, to sell their ImClone stock, and he tried to sell some of his, according to The New York Times article.

Waksal was convicted for securities bank fraud, perjury, obstruction of justice and conspiracy and served five years in prison. Stewart sold her shares and was given a five-month sentence and five months of home confinement for lying to federal investigators, according to The New York Times article. If they had only held out and not sold they would have made money, kept their careers intact and avoided convictions. (See “United States of America vs. Samuel Waksal.”) 

THEY CAN RUN BUT NOT HIDE

The Galleon Group inside trading investigation demonstrated that getting caught was becoming a real possibility. The DOJ’s aggressive probe into the investigation of the firm and its web of insider trading characters netted several convictions.

In March of 2013, Rengan Rajaratnam was indicted on insider trading charges. Rengan’s brother, Raj Rajaratnam and co-founder of Galleon Group and billionaire, is serving an 11-year prison sentence after being convicted in 2011 in the largest case of insider trading at a hedge fund in U. S. Apparently Raj passed along his inside information to his sibling.

“As alleged, Rengan Rajaratnam and his brother shared more than DNA, they also shared a penchant for insider trading,” said Preet Bharara, U.S. Attorney for the Southern District of New York (and 2013 ACFE Cressey Award recipient) in a media release. “Along with his brother Raj, Rengan Rajaratnam was allegedly at the heart of an insider trading scheme that swept up an unprecedented number of people in its web of corruption, and with his indictment, we are one step closer to closing that chapter.” (See the U.S. Attorney’s Office, Southern District of New York press release, “Manhattan U.S. Attorney And FBI Assistant Director-In-Charge Announce Insider Trading Charges Against Former Galleon Portfolio Manager Rengan Rajaratnam,” March 21.)  

Rengan, a graduate of the University of Pennsylvania, earned an MBA at Stanford University. Raj, an MBA graduate of the Wharton School of Business at the University of Pennsylvania, should have known not to engage in illegal activities to gain an edge in the global investment community.

The web of corruption that Preet spoke of meant many individuals shared information about several companies including Clearwire and Advanced Micro Devices Inc. (AMD).

According to the U.S. Attorney’s Office press release, “The Inside Information concerning AMD originated from Anil Kumar, who was, at the time, a partner of McKinsey & Co., … the global management consulting firm. In 2008, AMD hired McKinsey to advise it in relation to a strategic transaction in which AMD would spin off its manufacturing business into a new entity, and the investment authority of Abu Dhabi would invest in the new entity and in AMD itself. On August 15, 2008, Kumar advised Raj Rajaratnam that AMD and the Abu Dhabi investment authority had ‘shaken hands and said that they’re going ahead with the deal.’ ”

Anil Kumar (another Wharton Graduate) pleaded guilty to insider trading in 2010, and Rujat Gupta (who has a Harvard MBA), former CEO of Mckinsey & Company and Goldman Sachs board member, was convicted of insider trading in 2012 and received a two-year prison sentence. (See “Famous HBS Alum Surrender to FBI,” by John A. Byrne, “Poets & Quants.”) 

The SEC’s website provides this assessment: “Insider trading continues to be a high priority area for the SEC’s enforcement program. The SEC brought 58 insider trading actions in FY 2012 against 131 individuals and entities. Over the last three years, the SEC has filed more insider trading actions (168 total) than in any three-year period in the agency’s history.” Illicit profits or losses avoided totaling approximately $600 million. 

WHY DO THEY DO IT?

So why are highly, highly driven individuals willing to wager highly successful careers for a chance at “success” using inside information? Perhaps it’s as simple as the addiction to success and the fear of failure no matter what the cost. So, if a friend offers you a tip on stock you should buy, then consider being a better person and tell him, “No, thank you!”

Richard Hurley, Ph.D., J.D., CFE, CPA, is a professor at the University of Connecticut (Stamford) School of Business. 

Tim Harvey, CFE, JP, is director of the ACFE’s U.K. Operations and a member of Transparency International and the British Society of Criminology. 

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