Insider Trading Persists, and Gets Stealthier

Insider Trading Persists, and Gets Stealthier

In March 1991, Michael R. Milken, once the richest and most powerful financier of his generation, entered prison, signaling the end of an era of junk bond-financed hostile takeovers and high-visibility prosecutions that law enforcement officials hoped would deter insider trading for generations.

But now, less than one generation later, federal prosecutors and enforcement lawyers at the Securities and Exchange Commission have exposed a vast network of insider trading that in its sophistication, breadth and profits dwarfs that of the earlier era. And with the emergence of Steven A. Cohen, the founder of the hedge fund SAC Capital Advisors, as a subject of interest, the government has identified a financier whose power and wealth surpasses even that of Mr. Milken in his heyday.

Why has insider trading proved so persistent, even in the face of prosecutions and popular Hollywood films like “Wall Street”?

The risk-versus-reward equation that has always been a factor in financial markets has changed drastically in the last 20 years. Ivan F. Boesky, the once-celebrated arbitrageur who admitted to insider trading after preaching to graduates of the University of California, Berkeley in 1986 that “Greed is all right, by the way,” had to pay fines and restitution then considered a milestone: $ 100 million.

When the government revealed that Mr. Milken earned $ 550 million in a single year in the 1980s, the sum astonished Wall Street and even his fellow traders at his now-defunct firm, Drexel Burnham Lambert. The Wall Street Journal calculated that $ 550 million was more than it cost to launch the space shuttle, build a B-1 bomber or, adjusted for inflation, pay for the Louisiana Purchase. (Mr. Milken’s take would be $ 1.07 billion in 2011 dollars.)

By contrast, the average hedge fund manager in the top 25 performers today makes that in a good year, and a few have earned more than $ 4 billion in a single year. Mr. Cohen reportedly earned $ 1.4 billion in 2009, and Forbes estimated his net worth in 2012 at $ 8.8 billion. (Mr. Milken’s fortune, by comparison, is estimated by Forbes at $ 2 billion, which puts him in the middle of the magazine’s list of the richest 400 Americans.)

At the same time, the tactics and technologies available to inside traders today are more sophisticated and more difficult both to detect and to prove.

A large majority of hedge funds have not been tainted by any wrongdoing, just as most junk bond traders were never accused of any crime. Mr. Cohen hasn’t been accused of any wrongdoing nor has his firm, although the S.E.C. has said it may face civil charges.

This week, I stopped by St. Andrews Plaza in Lower Manhattan to see Preet Bharara, the United States attorney for the Southern District of New York, and his deputy, Richard Zabel, the former head of the criminal division. Both said they couldn’t discuss any pending cases. But many people who work in financial markets “are highly skilled at cost-benefit analysis,” Mr. Bharara told me. “They’re highly intelligent. They’ve been to the best schools. They weigh the risk of getting caught against the potential reward, and they decide it’s worth the risk. We’re trying to tilt that equation.”

There’s no doubt that the potential for gain “has soared,” Robert S. Khuzami, head of enforcement at the S.E.C., told me, and not because there are more takeovers and other market-moving events to trade on. “That’s a big change from the 1980s and ’90s. Hedge funds can take massive positions, use short-selling and derivatives, and employ trading techniques that aren’t transparent, and make huge amounts of money on small fluctuations on price. They don’t need to hit a home run on a $ 20 pop on a takeover announcement. These bets may be bunts and singles, but they get to the same place.”

Even at lower rungs of the hedge fund world, the potential gains have shot up. Mathew Martoma, a former SAC trader who was accused last month of using secret information to help SAC gain profits, was paid a $ 9.4 million bonus in 2008, when he was just 34. At the same time, the cost of failure can be catastrophic. When he failed to replicate that kind of information, he was fired a little more than a year later. (Mr. Martoma pleaded not guilty to the charge, and, through his lawyer, has denied any wrongdoing.)

The pressure to get an “edge,” as hedge fund traders often put it, has never been greater. “There’s a cruciblelike intensity of competition now that didn’t exist at the time of Boesky,” Mr. Zabel told me. “With hedge funds, there’s a lot of capital, and they’re competing ruthlessly. You have to be better every quarter or you’re not going to exist. Add the tremendous incentive of great wealth, and it’s not surprising that some people lack the moral fiber to resist that kind of pressure.”


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