Rogue trading on rise

Four days after Galleon Group founder Raj Rajaratnam was arrested on insider-trading charges, hedge fund manager Bill Ackman ap-peared before a hotel ballroom full of colleagues and suggested a clever way to profit.

His advice: Buy stock in Corrections Corporation of America, the big private-prison operator. After all, the government has only so many jail cells to hold all of Wall Street’s inside traders, so Uncle Sam will have to turn to the private sector for help. Investing in Corrections could be smart for another reason, too. “It’s also a hedge against your hedge fund business, because as the SEC ramps up …” Mr. Ackman cracked before being interrupted by laughter. “We shouldn’t joke about that.”

It’s certainly no joke that the Galleon case is the first of many insider-trading cases to come. A look at regulators’ data suggests how pervasive the practice of trading on material non-public information has become since the latest corporate-merger wave began in 2004. In short, the favorite pastime of Ivan Boesky and Gordon Gekko is back.

The New York Stock Exchange referred a record 146 suspected insider-trading cases to the Securities and Exchange Commission last year — 57% more than in 2004. And the SEC brought 61 such cases to court last year, 30% more than the year before. The latest figures from the United Kingdom’s Financial Services Authority reveal that for the past few years, nearly 30% of mergers have shown “abnormal” trading in the companies’ stocks in the days leading up to the deal announcement.

“The issue is that hedge fund managers all too often feel they’re above the law,” said David Feldman, a veteran mergers-and-acquisitions lawyer. “It’s been many years since insider trading was seen as a big problem, and people have come to think of it as a victimless crime.”

NOT THE BEST TIMING

The renewed spotlight on insider trading comes at a time when public mistrust of Wall Street is already high and Congress is tightening oversight. Insider trading only further tarnishes the investment industry’s reputation, especially that of hedge funds, which have escaped regulation for years.

The U.S. government, after missing so many Wall Street scandals of recent years, clearly is trying to crack down on illegal profiteering. In September, just two days after Perot Systems agreed to be acquired by Dell Inc. for $3.6 billion, the SEC charged a Perot employee with insider trading. In May, for the first time, the agency sued Wall Street professionals who allegedly used credit default swaps to trade on inside information. Federal prosecutors in Manhattan have brought at least four criminal cases of insider trading so far this year.

Insider-trading charges can be tough to prove in court, because lawyers must show that the parties who got tips knew they had an obligation to refrain from acting on the information.

Investors who specialize in takeover situations say insider trading appears to have taken place most frequently in 2006 and 2007, when private-equity firms were busy bidding against each other — or sometimes teaming up — to acquire companies. Indeed, as the size of deals has grown over the years, inside information has been leaked to more parties, including bankers, lawyers, accountants and public-relations teams. The SEC once even brought an insider-trading case against a butler for allegedly intercepting faxes concerning his boss’ attempts to buy a company.

Seekers of recent examples of possible insider trading could start with Adobe Systems Inc.’s $1.8 billion acquisition of software maker Omniture. Adobe made a formal bid Sept. 8, the same day Omniture’s stock went on a tear that lifted it nearly 20% before the deal was announced Sept. 15. The result: a fat profit for those who exhibited “rather fortuitous timing,” in the words of Measuredmarkets Inc., a research firm.

Dozens, if not hundreds, of people were in a position to time the deal. Omniture was advised by Morgan Stanley and law firm Wilson Sonsini Goodrich & Rosati, while Adobe had The Goldman Sachs Group Inc. and Latham & Watkins LLP. Also, in the weeks before the deal, Omniture had conversations with “several other parties,” according to a subsequent regulatory filing.

MERCK, SCHERING-PLOUGH

In March, it appears insider trading took place in the days before a $47 billion merger was announced between two pharmaceutical giants, Merck & Co. Inc. and Schering-Plough Corp.

The Friday before the deal was announced, Schering-Plough shares rose 8%, and trading volume jumped to 34 million shares, more than double the average of the previous three weeks and the highest in nearly a year.

Will the spike in unusual trading activity land more Wall Streeters in jail? Time will tell. But it’s worth noting that Oct. 20, when Mr. Ackman cheekily made his pitch for Corrections as a hedge against hedge fund prosecutions, the company’s shares rose 5%, hitting a new 52-week high.

Aaron Elstein is a reporter for sister publications Crain’s New York Business.

Related Topics: Money Management Institute (MMI), Securities and Exchange Commission