There is a very fine line between insider trading and informed trading. A trader is supposed to gather all of the information he or she can in order to make decisions that make money - either for the company or for the investors. Often times that information comes from a seemingly innocuous comment overheard at a cocktail party, or even from a speaker at a conference. For example, in the oil business it is not unusual for a trader to hear at the weekly booze-up (oops, I mean business lunch) that his colleague's oil company has a refinery problem. If the trader goes back to work and trades on that information before it is known to the press and the outside world, is that insider or informed trading?
I once went to a conference where a software company that provides solutions to a mobile phone company told us that the mobile phone was selling like hotcakes in Europe and Asia and that the company was going to have a very good year. I bought shares in that company (although, being the worst trader in the world, by the time I bought them it had already hit its all-time highs and I ended up getting slaughtered). Was I guilty of insider trading? What about others in that room, those who maybe did go back to their offices and buy the shares (in far greater numbers than my paltry 20 shares)? Were they guilty too?
The line begins to become clearer when the activities that can be construed as insider move markets. Once those markets are moved, and it becomes clear to regulators that something funny was going on, it is a question of careful forensics to sift through whatever evidence they can find.
The SEC and FSA have been very busy of late doing just that - sifting through evidence and nailing criminals. The SEC found a high-ranking UBS investment banker was tipping off his buddies about health-care mergers over 2005-2009 using emails with code words like 'frequent flier miles' and potatoes (or something). The FSA, with the help of the police, just dug up a ring of up to 11 bankers and hedge fund traders, including Deutsche Bank, Exane and Moore Capital Management, who had been reportedly front-running block trades.Also in London a whistle-blower chastised the CFTC for not following up on his tip (in November 2009) that JPMorgan was manipulating the gold market there.
The pattern that is emerging in all of these investigations (or lack thereof) is that the crimes are being detected well after they happen. There is a reason that insider trading and front-running and market manipulation still goes on today - because people can make money from these practices. And the likelihood of getting caught is very small indeed.
Hector Sants, the outgoing CEO of the FSA, said that the regulator would be implementing an intensive supervisory model, which should make people "very frightened" of the FSA, according to the Economist. I think he was alluding to tougher cell-phone and email monitoring, which is what caught the most recent scoundrels. What would really make the wannabe inside traders tremble in their boots would be if the FSA, SEC and CFTC installed market surveillance software. Surveillance software can detect market anomalies and abuses as they happen, not after the fact. Using this kind of software, inside trades and market manipulation can be tracked down by compliance managers before the traders get to finish the deals. Position limits, such as those that were manipulated by Jerome Kerviel at Socgen in 2008 and hiding losses of nearly 5bn euros, can also be monitored real-time and alerts sent to managers to tell them when something fishy is going on. Fat fingered trades can be spotted and caught (and hopefully unwound) before they are settled and cause a firm big losses.
So the question is - why don't the regulators use this kind of software? Maybe the US Congress should think about adding a mandate to do so to the financial regulation reform bill. Then rogue traders would be afraid, very afraid.