Thursday, October 23, 2014

Insider Trading: Employing Mob-like Tactics to Realize Tremendous Profits

An article from earlier this year on said that “more than half of the best-known white-collar inmates… are in prison because of insider trading.” What causes people to risk being one of the next infamous white-collar inmates by committing insider trading? For most people it’s because of the unbelievably high profits. But just how profitable can insider trading be, and how do people get away with it?

In Kenneth R. Ahern’s research paper, he investigates some of the reasons why and how insider traders do what they do. Ahern says that “traders earn prodigious returns of about 35% over 21 days… [earning] about $72,000 per tip at the median.” That is significantly higher than the average market return, and it occurs over a shorter time period. With that size of return, there is definitely a high incentive to participate in insider trading, but how do insider traders commit the crime? Who do they trade information with?

Surprisingly, Ahern found that insider trading is run primarily through families and long-time friends. 93% of insider traders met either before or while in college and live a median distance of 26 miles apart. This idea is further confirmed by the fact that law enforcement employs mob-busting tactics to uncover and bring down insider traders. An article in The New Yorker said that the tactics used to bring down some insider traders “echoed the approach the F.B.I. had used to dismantle the New York Mob.”

Even with the number of whistleblowers increasing and jail sentence times lengthening for insider trading, there is still a great deal of incentive and opportunity through the high returns and mafia-like (albeit non-violent) tactics used by insider traders. Until the incentive or the opportunity is removed or at least significantly diminished, I think we will continue to see insider trading occur.

(Check out this previous post for a further discussion on elements needed for fraud to occur and this link for more posts about insider trading.)

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