Insider Trading: Anatomy Of An Investigation

The recently concluded Stock Exchange Summit organised by Invest India witnessed some interesting discussions on investigations and the role of the regulator in the capital market.

The Sebi senior executive director L K Singvi made a presentation on actions taken by the capital market watchdog in cases varying from price rigging to non-payment of margins.

One area that did not witness any active discussion was insider trading.

The reference papers given to participants included an article under the title 'Wrong numbers: Looking for insider trading: Anatomy of an investigation.'

The article speaks of the three-year investigation that was carried out by the Securities Exchange Commission (SEC) of the US involving tracing out zip codes, phone bills, hotel receipts, back records and a network of 18 people involved in illegal trading. It brings out a significant disparity in powers of the capital market watchdog in India and that in the US.

 

In India, Sebi is investigating cases of insider trading in mergers which made waves a year back. The article throws some light on the methodology that is adopted for insider trading investigation.

In 1986, Thrifty Corporation and Pacific Lighting of the US announced their merger on May 29. Two days prior to the announcement, New York Stock Exchange (NYSE) officials detected an increase in the Thrifty price and volume.

When they contacted the Los Angeles-based office of Thrifty, it was revealed that negotiations for a takeover by a NYSE listed firm were underway. Stockwatch alerted the floor governor and trading was halted immediately and then resumed when the news was made public.

However, senior officials in the surveillance department at NYSE suspected insider trading. The exchange wrote to both companies asking for a list of persons who had been involved in the merger process from board members to their secretaries.

The investigation incharge was senior analyst John O'Rourke of NYSE.

He sent out requests to brokers who traded in Thrifty stocks for information about trading on the days in question asking names, addresses and telephone numbers of all their customers.

He also demanded investment profiles. Questions like when the account was opened and did the investment follow the normal pattern of purchases were asked. Several names were shortlisted out of which William S Banowsky was to show up later.

When O'Rouke compared the chronologies leading to Thrifty-Pacific Lighting merger with customer information from brokers, it was observed that several accounts were in Texas. One such account was opened by a partnership just to buy Thrifty stock. From a new sweep of queries, he received names and addresses of each member of the partnership.

He took a zip code, entered into an automated search and match program with a list of one-and-half million executives, attorneys, accountants and investment bankers in more than 75,000 companies, along with their addresses, colleges and club affiliations and discovered that William S Banowsky, mentioned in the Thrifty chronology had the same zip code as someone in the group.

SEC also received a call from an investigator at the American Stock Exchange and an official at Pacific Lighting. Armed with information, SEC began to unravel the web of trading that led to Banowsky.

On May 20, the day he had first heard of the special board meeting, Banowsky had made three telephone calls from his hotel room - to his secretary, one of his sons, and his father.

Although the board meeting about the merger was still two days away, Banowsky knew there had been rumours of a takeover and he suggested all three have their brokers look into Thrifty. By tracing Banowsky's incoming and outgoing calls, he finally gathered corroborating testimony and the SEC structured its case.

In March 1989, after three years of sifting through hundreds of phone records and stacks of transcripts of testimony taken under oath, SEC informed Banowsky that they were prepared to file a complaint. Barnowsky chose to settle the case by paying the fine.

When it came to pay the $311,613.71 fine and disgorge the $443,287.54 in profits made by various people, Banowsky forked out $50,000 from his own pocket and the rest was paid by those who traded, actually using the information.

Banowsky took the fall for everybody in exchange for the SEC agreement that nobody else would be named other than him.