An article from earlier this year on fortune.com
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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