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(Lauren Victoria Burke/AP Photo/Lauren Victoria Burke)
(Lauren Victoria Burke/AP Photo/Lauren Victoria Burke)

Galleon insider trading probe

Convictions rare in regulators' battle against a near-invisible crime Add to ...

Martha Stewart's downfall began when she avoided a $50,000 (U.S.) loss by dumping her ImClone shares before the stock tanked on some bad news.

She went to jail in 2004 for lying to investigators about the circumstances of the sale and her relationship to ImClone founder Sam Waksal.

Junk-bond king Michael Milken suffered a similar fate in 1990. Insider trading got him in trouble, but he wound up in prison on racketeering and securities fraud charges.

These are the kinds of challenges prosecutors face as the U.S. Justice Department and the Securities and Exchange Commission (SEC) embark on their largest insider trading case in decades - charges against 20 people linked to the New York-based Galleon Group hedge fund.

Prosecutors know insider trading when they see it, but proving it can be a lot tougher.

Under U.S. law, a defendant must knowingly possess insider information and then trade on that knowledge. It need not be a corporate insider. Individuals who tip off others, misappropriate secrets or act on inside knowledge may also be breaking the law.

Illegal insider trading goes on all the time and it often leaves no fingerprints. It's quite common, for example, for trading to spike just before a company announces significant news - a takeover, a share buyback or surprising results.

Prosecutions apparently account for a tiny share of suspected illegal activity. Last year, the New York Stock Exchange referred just 146 cases of suspected insider trading to prosecutors, and that was an all-time high. The SEC went after less than half of those, launching 61 cases in 2008.

Until 1929, insider trading wasn't even illegal in the United States. And there are still many countries where the practice remains legal.

Since the 1960s, enforcement authorities have struggled to keep pace with an explosion of stock market trading and a corresponding rise in suspected illegal activity.

Many prominent libertarian thinkers still argue that insider trading might actually be a good thing, improving the efficiency of markets.

George Mason University economics chairman Donald Boudreaux made the case in a recent Wall Street Journal opinion piece, arguing that insiders trading on what they know helps keep "asset prices honest."

And until the SEC changed the rules in 2006, it was also common practice for public companies to disclose key information at private meetings to select analysts, giving some investors an advantage over others.

Now the content of these briefings must be made available to all investors.

Another pitfall for prosecutors is the tenuous line between legitimate research and insider information. Acting on a stock tip you inadvertently hear on the subway isn't insider trading unless you know it's "material non-public information." Nor is it illegal to put disparate pieces of information together to draw conclusions about a corporate acquisition.

The Galleon case, however, stands out due to the sheer breadth of the alleged conspiracy. Prosecutors have laid out evidence of several elaborate networks of lawyers, traders, corporate insiders and other Wall Street players who made it their business to get inside information, trade it for cash or further secrets, and then make highly profitable trades.

And unlike many previous cases, which relied heavily on circumstantial evidence, investigators tapped phones, intercepted cellphone chatter and wired up co-operating witnesses with concealed microphones to draw out targets.

Prosecutors also claim to have substantial evidence the Galleon defendants were aware they were breaking the law, which could prove they were knowingly trading in non-public information.

But the greatest benefit of the much-publicized case is obviously the deterrent effect.

Authorities know they can't possibly keep up with a deluge of insider trading. So they charge a handful prominent individuals, make a big splash, and maybe send several of them to jail.

There is also a touch of politics in what's going on. The Justice Department and the SEC are eager to shore up their image as tough regulators and restore investor confidence following the market meltdown and their failure to uncover Bernie Madoff's Ponzi scheme.

But the Galleon investigation isn't a watershed. It's just another attempt by regulators to reinforce the dikes in the face of relentlessly rising waters.

bmckenna@globeandmail.com

Follow on Twitter: @barriemckenna

 

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