Regulators band together to fight insider trading

WASHINGTON Wed Aug 15, 2007 7:25pm EDT

Traders work on the floor of the New York Stock Exchange, July 26, 2007. Investigators from major U.S. stock exchanges and the U.S. Securities and Exchange Commission have formed an elite unit to investigate suspicious trades and tackle insider trading. REUTERS/Brendan McDermid

Traders work on the floor of the New York Stock Exchange, July 26, 2007. Investigators from major U.S. stock exchanges and the U.S. Securities and Exchange Commission have formed an elite unit to investigate suspicious trades and tackle insider trading.

Credit: Reuters/Brendan McDermid

WASHINGTON (Reuters) - Investigators from major U.S. stock exchanges and the U.S. Securities and Exchange Commission have formed an elite unit to investigate suspicious trades and tackle insider trading.

Investigators from the Financial Industry Regulatory Authority (FINRA), the Options Regulatory Surveillance Authority (ORSA), NYSE Regulation and the SEC have created "scheme teams" to crack serial insider trading rings.

The securities cops also meet informally as a larger group every three months or so to share tips and information, and strategize. They have been getting together for about a year.

An increase in the level of merger and acquisition activity has forced securities officials and government prosecutors to take a closer look at questionable trades ahead of market moving news, especially those by hedge funds and other institutional traders.

"We can talk at a high level about what is happening and what we're seeing, with no red tape," said Cam Funkhouser, vice president in charge of market regulation for the Financial Industry Regulatory Authority.

Self-regulated organizations like the NYSE have increased communication and coordination with each other domestically and internationally.

"It's a way as a cop on the beat to keep up," said David Steiner, NYSE Regulation's vice president of market trading analysis and a former prosecutor.

The number of irregular hedge fund trades referred to the SEC by NYSE Regulation rose from 20 in 2002 to 88 in 2006. This year, the tally already stands at 56 cases, most related to insider trading, Steiner said.

What securities cops have on their side is the technology to track every single trade.

"There is no such thing as a trade falling under the radar," said Stephen Cutler, former chief of enforcement at the SEC and now JP Morgan Chase & Co.'s (JPM.N) general counsel.

It is that electronic footprint that investigators use to start connecting the dots.

ANALYZING TRADES

FINRA's market surveillance operation is run out of an office building on the outskirts of Washington, D.C.

Investigators analyze trades on the Nasdaq and the American Stock Exchange with desktop computers that sift through a plethora of information. The software matches up company news releases against graphs displaying share trading, research and trading volume, and then flags suspicious market activity.

The SEC has two carpeted rooms dedicated to market surveillance in its 10-story glass building in downtown Washington.

NYSE Regulation's Stock Watch unit, where irregular trades may first be spotted, is housed in a small office in the exchange's main building in lower Manhattan, where John Grisham novels jostle for space with computers.

As at FINRA, most of the SEC and NYSE Regulation's analysis and detective work is done the old-fashioned way.

"Regulators can get access to all the trades. The question is whether they can put two and two together," said Cutler. "That is where the gumshoe work comes in."

Lawsuits from the detailed and painstaking investigative work are up sharply. In the first half of 2007, the SEC sued twice the number of professionals for insider trading than during the latter half of the 1990s, when only 10 Wall Street professionals were charged.

The accused "smart guys," as Funkhouser calls them, include a senior UBS professional accused of tipping off traders about proposed analyst upgrades and downgrades, and a Morgan Stanley lawyer who the SEC said passed on information about upcoming corporate acquisition announcements.

TOO YOUNG

Some of the new offenders are too young to remember the lessons of such high-flying defendants as Ivan Boesky, Dennis Levine and Michael Milken from the 1980s.

Milken, a former Drexel Burnham Lambert executive, pleaded guilty to six securities and reporting violations and paid some $900 million in fines and settlements. Boesky pleaded guilty to one criminal charge and paid $100 million in penalties. Levine, another ex-Drexel executive, pleaded guilty to securities fraud charges. Each served less than three years in prison.

"You've got a new generation coming into the workforce," said John Malitzis, NYSE Regulation's new head of market surveillance. "A lot of young analysts, not knowing the history or that this is something regulators are keenly focused on ... end up doing stupid things."

Scott Friestad, associate director of enforcement at the SEC, said his team has seen an uptick in the number of insider trading cases. Most are not small cases by unsophisticated investors operating on a leak.

"There have been more multimillion dollar cases lately," Friestad said, noting that the environment has changed with an increase in merger activity. The SEC is also paying attention to more exotic derivatives and products that provide new opportunities for insider trading, he said.

Funkhouser said meetings among regulators are helpful for simply sharing names of repeat insider trading offenders, preventing them from striking in different jurisdictions undetected.

"It's the same people who were robbing the bank 20 years ago, but instead of using a Saturday Night Special, they are using a Glock weapon," he said.

(Additional reporting by Anupreeta Das in New York)

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