#12 Outsider Interest in Insider Trading

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by Mike Lally

Was Rene Rivkin prosecuted for who he is or for what he did? I suspect even Salvador Dali would have found the whole case more than a trifle bizarre!

Given his entertaining performances on Andrew Denton’s Enough Rope, I’m sure an alternative, equally stimulating career for the charismatic Rene is there for the asking.

Considering the circumstances surrounding the case, one can’t help concluding that he is an unfortunate victim of the tall poppy syndrome. Rene Rivkin always bounced back.

Rivkin’s case is small beer compared with other notorious insider trading and fraud cases. In the US, the well-known female CEO, Martha Stewart is currently facing prosecution for giving false statements in an attempt to prevent further falls in the share price of her company.

Some presumably will argue that this has celebrity and gender bias!

In another infamous case, President George W Bush in 1990 declared he didn’t know that Harken Energy Corporation was in poor financial shape prior to selling over 200,000 shares in the company.

Then there were the criminal cases against Michael Milken and Ivan Boesky, which spawned Michael Douglas’s hit movie “Wall Street”. When art starts to make money by imitating real life financial matters we know we’re in deep fiscal trouble.

Insider trading goes hand in hand with company fraud. Stockmarkets globally have suffered from the fall-out damaging publicity has caused as a chain of fraudulent behaviours got reported.

Matters were made much worse with the knowledge that these ventures were apparently sanctioned in the corridors of power of some of the world’s leading institutions.

Many investors are only too aware of the troubles, for example, at WorldCom where, among a glutton of misdemeanours, the board rubber-stamped a $400 million loan to its former CEO and allowed him to sell $70 million of company stock

For insider trading to be successful, the real decision-makers and power brokers – the chosen few who know what’s really going on – are usually involved.

What exactly is insider trading?

In a nutshell it is against the law for any investor to buy or sell shares of any company if the transaction is based on information not yet in the public domain.

It is necessary to have laws in place to prevent this pursuit in order to protect the integrity of the whole financial system.

Supply and demand through anticipated earnings should drive price and not corporate Arthur Daley’s. Would you bother trading or investing if you knew other investors had an unjust advantage?

For the game to be scrupulously fair it’s vital a level playing field applies to all investors, both individual and professional.

Of course, insiders frequently have access to exclusive information and many will want to legitimately trade the shares. That said, a provision is in place for reporting the transactions made.

But not here, surely?

Australia is not immune from insider trading and corporate fraud. In the celebrated case of HIH, we have witnessed seriously dodgy behaviour and it is patently obvious somebody enjoyed spelling HIH as HAH as they laughed all the way to the bank.


The price chart to the rescue!

As traders and investors, we rely on the price chart to accurately provide the data essential to make trades with a reasonably high probability of success.

It is the humble price chart that allowed savvy investors to avoid making huge, costly mistakes in some of the celebrated collapses.

However, it often requires steering a wide-berth away from broker recommendations. If a stock is trending down it should not be bought irrespective of its “bargain” price.

Few investors gain access to the inner sanctum of the corpoprate high-fliers.

Investors must observe the price chart and if a stock is downtrending consideration must be given to accepting the warning against buying or acknowledging the unequivocal sell signal.

The market will always throw up potential trades and if a better opportunity lies elsewhere, why back an obvious loser?

For those advocates of technical analysis, should an indicator be created which can directly display potential insider trading?

Or does one already exist? What information would be needed to constitute such an indicator?

If there is a sudden flurry of insider buying, how can the astute trader cash in? Once gossip hits the newsstands it’s normally too late to act. Clearly knowing a few companies extremely well affords the investor the chance to form timely decisions and provides the opportunity to follow any lead.

Investing in what you know best seems good advice if only to reduce the time it takes to properly understand a company or industry. It also makes buying and selling decision making much swifter.

Users of technical software can perform simple extrapolations based on price and volume to reach similar conclusions.

In essence then, everything needed is virtually in place to hop on board an accelerating gravy train. If you know the state of “current play,” you are in position to make well-timed moves.

What of the fundamentalists?

The on-going accounting mayhem particularly in America has tossed a hand grenade into the workings of many fundamentalists who rely on objective reporting using company reports.

Who can you trust these days? An analysis of anticipated earnings is a key determinant of future price activity and when it is predicated on spurious current data it becomes next to useless. The daddy of all fundamental indicators, the P/E ratio, starts to look less than rosy, doesn’t it?

We know that high P/E ratios are not de rigeur in these more conservative days. Fortunately, the screws seem to have been tightened sufficiently to deter further offensive behaviour.

Apart from the ethics involved in attempting to use insider trading as an investment strategy, it does require monitoring the markets very closely. It is easier to track excess buying rather than selling.

There is rarely enough sales volume to make this worthwhile. The timespan of possible action is extremely short-term if selling is used. Often the stock is dumped, news quickly follows and it’s too late to act.

In the majority of cases the best move if a company’s share price falls or a hint of fraudulent activity is suspected is to sell and fast. If the institutions sell then the price is unlikely to recover in the immediate term.

A modern approach to insider selling by smart operators is to use sophisticated derivatives to protect against downside risk rather than being noticed by selling the stock openly.

This makes the job of detection significantly more difficult. For those budding sleuths who enjoy and have the time to ferret it is possible to access the SEC’s Form 4’s which are used to detail change in ownership of share holdings.

A good solution is to track buying that is gradually increasing as this has more potential for short-term gain. This can be achieved using price and volume data.

If insider buying is on the march it can be the precursor of good news, which eventually will cause the share price to rise rapidly. If you are fortunate or clever enough to discover one of these, trade only for a short-term gain.

I doubt using an “Insider Trader” signal alone is sufficiently robust without accessing other market tools to confirm any abnormal movement in price and volume. This is true of all market indicators as standalone they are all more than capable of sending false signals.

Other scams

Faithful followers of Internet chat rooms and bulletin boards need to guard against advice urging a quick buy or sale of any stock. Be doubly suspicious if the writer claims to be in possession of insider information.

At the very least scan the chart and avoid letting temptation hold sway. Better to scan than be caught in a scam! If it seems too good to be true, it probably is!

It is often overlooked that the simple price chart overrides all other information coming from a rich variety of sources.

Traders and investors should never buy or sell a stock without analysing its chart.

This allows an instant, snapshot deduction, and it prevents not only the havoc caused by company collapses such as WorldCom but also provides the basis for deciding whether the continued holding of a household stock such as Telstra is prudent.

Often stocks engaged in long-term declines experience price falls below significant trading ranges and this is the time selling should be considered. Side-stepping the realities of risk is not helpful or a good trading ploy.

The price, volume and trend of a stock coupled with the general direction and strength of the overall market can act as a buffer against imaginative
earnings manufactured by creative accountancy and other sleights-of-hand.

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