What do we really know about insider traders?

Here is my latest Bloomberg column, based on the research of Kenneth R. Ahern at USC.  Here is to me the most interesting bit:

Some aspects come pretty close to what we see in the movies. The average insider trader is 43 years old, and nine out of 10 are male. The practice also seems correlated with some features of recklessness: Insider traders are younger than their associates, less likely to own real estate, and have fewer family members on average. More than half have criminal records, with almost all charges stemming from traffic violations.

To my eye, the most striking data involve personal connections: Insider traders appear to be pretty careful in choosing their accomplices. Of the known pairs of people who provide and act upon private information (“tipper and tippee”), 64 percent met before college, and 16 percent met in college or graduate school. Another 23 percent are family relations — more siblings and parents than aunts and uncles, despite the added capital that the latter might have provided. Tips are also commonly shared among people with ethnically similar surnames: Of 24 tips coming from people with Celtic surnames, for example, 14 went to individuals who also had Celtic surnames.

The choice of accomplices demonstrates how hard it is to trust people you haven’t known very long, especially if you’re not all that trustworthy yourself. It also implies that modern corporations are, in some ways, more honest places than one might think. Not that people are always so law-abiding; rather, many workplace relationships may be too superficial and too transient to develop the trust and cooperation typically required for villainy and law-breaking.

Do read the whole thing, there is much more at the link, including information on the size of profits earned, and how much the practice is addictive.

Comments

Given the "petty nature of the crime" as you describe it in your essay, should we cut back on government intervention in the securities markets? Do you believe government intervention likely does more harm than good given the "petty nature of the crime"? Or do you believe that government intervention promotes "confidence" in markets, and that the added "confidence" justifies government intervention even given the "petty nature of the crime"?

"the sordid and petty nature of the crime as it is practiced," namely, "the median insider trader invested only about $200,000 per tip and received $136,000 in profit."

That is not exactly Michael Milken levels of profit. It's more like Martha Stewart. And the sooner material, nonpublic information is reflected in the stock the price, the sooner the price signal becomes more accurate.

There are no insider trading laws in commodities or FX, and those markets seem to be working perfectly fine.

NO insider trading in commodities or FX?

http://www.cfr.org/united-kingdom/understanding-libor-scandal/p28729

http://www.bloomberg.com/news/articles/2014-01-16/metals-currency-rigging-worse-than-libor-bafin-s-koenig-says

The LIBOR & US Treasuries fixing are the biggest price fixes EVER

Back in the olden days, MR used to have better trolls.

Those issues have literally nothing to do with insider trading.

& your remark [& furtive handle] have absolutely nothing to do with the subject matter of this post!

"Back in the olden days, MR used to have better trolls."

Self-recommending.....

Keep in mind, this is a study one specific type of insider trading activity: those that got caught.
Of those not caught, it would be so interesting to see where people work etc.

"More than half have criminal records, with almost all charges stemming from traffic violations."

Speeding or driving without wearing a seat belt makes one a criminal.

about a third of all American adults have a criminal record of some type.

that says more about the American government than the American people.

Speeding is an (inverse) measure of risk-aversion in personality.

Similarly, that golfer Phil Mickelson would be more likely to get tangentially involved in an insider-trading scandal than, say, golfer Jim Furyk wouldn't come as a big surprise to fans who have watched how they each plays golf: Mickelson tries more high risk-high reward shots than does Furyk.

Good column Tyler!

Does this apply to politics? Corruption and crime more likely among old friends instead of coalition governments?

Plus one. Indeed, this is interesting as well as probably true. A government controlled by one person (e.g. a US Administration) will probably be more prone to such activities.

"Overall, I'm struck by the sordid and petty nature of the crime as it is practiced "

"the median insider trader invested only about $200,000 per tip and received $136,000 in profit. That's hardly enough to retire on. Granted, the much higher average profit of $2.3 million indicates that some investors hit it big "

You and I clearly have different views on what's considered petty. Consider the fact that the average household in the US probably has less than $20K in disposable yearly income. So, he median insider makes an extra $136K that year. That doesn't seem petty.

The appropriate comparison is between average disposable income of the insider trader vs the average insider trade.

"The appropriate comparison is between average disposable income of the insider trader vs the average insider trade."

Why is that the appropriate comparison? People aren't legally punished based upon some percentage of their salary. A billionaire doesn't get to walk because he only stole a few million dollars.

" A billionaire doesn’t get to walk because he only stole a few million dollars"

Oh yeah?

https://en.wikipedia.org/wiki/Jamie_Dimon

The point was that a billionaire shouldn't get to walk because they stole a few million dollars. Not that some don't get away with it.

Not to mention that the paltry $136K is per tip.

It's interesting to compare insider trading profits and penalties with other crimes. In New York, third degree burglary - the least serious kind - can get you up to seven years.

Very interesting. One question comes to mind for me: As this is the dataset of who is charged and convicted, does this tell us more about what the investigators look for than anything else? Would more random pairs of individuals be more likely to get away with it - particularly if they only did it a few times and in amounts that weren't conspicuous?

Non-survivor bias

Right you are. By analogy, I recall reading about how 'rogue traders' (a form of insider trader abuse, in that they are using house money to make oversized bets) result in just as many 'windfalls' that help the rogue traders' employer (and during bonus time the rogue trader) as do the spectacular 'busts' which end up in the newspaper. In fact, one quarter I recall reading how a financial firm made extraordinary profits because it is believed a rogue trader scored big and helped their employer.

Likewise, how many hedge fund that make money are due to insider trading? I bet most of them, since the weak form of the Efficient Market Theory says it's hard to make money based on public information. I bet most "good" traders are trading on inside information, and like star athletes that dope (e.g., Lance Armstrong) they get away with it undetected.

Right, the conflict between the EMH and the existence of the hedge fund industry seems like one of the more interesting intellectual questions of our time.

But, instead, the topic seldom seems to come up ...

"Likewise, how many hedge fund that make money are due to insider trading?"

Ask Stevie Cohen.

Just to pick a nit, Ray, I think that's the "semi-strong" version of EMH, not the weak version.

No credit to Dean Manne, a man with the straight out courage to argue, over decades, that insider trading should not be considered a crime at all?

After all, it is in the public record - https://www.jstor.org/stable/1071677

Or here - 'The much-hyped modern insider-trading prosecutions and their results are reminiscent of nothing so much as Prohibition-era government attacks on bootleggers. There is about as much chance of stopping trading on undisclosed financial information as there ever was of stopping the consumption of booze.' http://www.wsj.com/articles/SB10001424052702304279904579516170211639290

That was then, this is now, post 2008. You used to see that kind of stuff in the 1980s and 90s at GMU, but not as much anymore. In fact, in Brian Doherty's book on Libertarianism, the younger Tyler Cowen was identified as an up and coming libertarian star, before the great moderation due to advancing middle age and the fails of the Great Recession made him today's Great Mediator between the extremes.

And nothing since 2008 gainsays his main arguments. It's merely the silly political atmosphere of the era.

"Of 24 tips coming from people with Celtic surnames, for example, 14 went to individuals who also had Celtic surnames." It's not often one sees such a lack of sentimentality about the Irish in American blogs. (I assume it wasn't a reference to the Taffia?)

Americans also slavishly worship the English for their accent (usually RP, they'd not know what to do with say, cockney). The Irish accent is gently made fun of, like the Scottish. As our resident Englishman on this blog you should know that.

English? Me? The usual Irish level of accuracy.

"Easy as it may be to call the perpetrators criminals..."

It's a pretty rococo offense, actually.

Well, they are breaking the law, like it or not.

If you did some research, you'd find that "law" is pretty rococo as well.

Members of Congress are exempt from Insider Trading oversight:

http://www.zerohedge.com/news/2016-08-02/something-strange-emerges-when-looking-congresswomans-daytrading-records

The total was about 1 billion in profit spread over 5 years. I assume his dataset is all the people that got caught and convicted. I assume the set of insider traders who didn't get caught is vastly larger and different.

It is an interesting article with interesting statistics. The US capital market is by far the world's deepest and most efficient market. It is also by far the world's best regulated, or at least most regulated, market. Countries that are fairly similar to the US such as Canada and the UK have markets that are far less regulated than the US. Insider trading is prohibited in many countries but nowhere in the world are those prohibitions strongly enforced. It would be interesting to know whether the US's enforcement of prohibitions against insider trading have helped the growth of the US capital markets.

Isn't this all about Inside Traders *Who Get Caught*. This seems an important distinction. Could it be that there are factors more inside traders who do none of these things (go outside of close circle, go big, etc.) who never get caught - providing no research data?

https://en.wikipedia.org/wiki/Abraham_Wald

64 + 16 + 23 = 103%

I first assumed that the 23% of family relations were within the 64% of "met before college," but he says "another 23%" which would imply in addition.

hmmm

I have to say I find it funny when Tyler always tells us to "do read the whole thing" when it comes to *his* columns. Yet he earlier commented that he regularly stops reading books (and I presume other things) if it isn't working for him.

many workplace relationships may be too superficial and too transient to develop the trust and cooperation typically required for villainy and law-breaking.

I wonder about places like Tyco, Enron, Worldcom etc. How did they get so many people to go along? In many cases, these were people with ample job prospects so it would have taken slightly more than returning a call to a recruiter to land a new job. So, why did they stay?

"Of 24 tips coming from people with Celtic surnames, for example, 14 went to individuals who also had Celtic surnames."

A lot of people who get caught for involvement in lower level stock market shenanigans are Outer Boroughs types. For example, the real story behind "The Wolf of Wall Street" movie was very much a Long Island suburban ethnic network, although Scorsese couldn't portray it very incisively due to his (perfectly reasonable) commitment to using Leonardo DiCaprio as his leading man even when DiCaprio doesn't much resemble the real life character he is playing.

In his memoir, "The Wolf of Wall Street," swindler Jordan Belfort—who was portrayed so energetically by Leonardo DiCaprio in Martin Scorsese’s movie—reflects upon his motivations. In a prose style he evidently developed from reading "The Bonfire of the Vanities" and "Fear and Loathing in Las Vegas" in prison, Belfort rationalizes:

"The country club was remarkably close to my estate … But, of course, I never bothered applying for membership, what with my status as a lowly Jew, who had the utter gall to invade WASP heaven. And it wasn’t just the Brookville Country Club that restricted Jews. No, no, no! All the surrounding clubs restricted Jews, or, for that matter, anyone who wasn’t a blue-blooded WASP bastard. …

"I came to realize that the WASPs were yesterday’s news, a seriously endangered species no different than the dodo bird or spotted owl. And while it was true that they still had their little golf clubs and hunting lodges as last bastions against the invading shtetl hordes, they were nothing more than twentieth-century Little Big Horns on the verge of being overrun by savage Jews like myself, who’d made fortunes on Wall Street and were willing to spend whatever it took to live where Gatsby lived."

Rob Eshman, publisher of the Jewish Journal, noted in an interesting essay, “‘The Wolf’ and the Jewish problem”:

"The hole in him wasn’t from poverty, but from desire for acceptance. The “blue-blooded WASPs,” Belfort writes, “viewed me as a young Jewish circus attraction.” Belfort had a chip on his shoulder the size of a polo pony, and so did everyone he recruited. They were, he writes, “the most savage young Jews anywhere on Long Island: the towns of Jericho and Syosset. It was from out of the very marrow of these two upper-middle-class Jewish ghettos that the bulk of my first hundred Strattonites had come.”"

http://takimag.com/article/the_myth_of_the_golf_nazi_steve_sailer/print#ixzz4GOkgIdip

Of course, the people who get caught for stock market related crimes tend to be the more out of control marginal personalities like Jordan Belfort. It's hard to be too sure of the demographics of the more careful individuals who don't get caught.

For example, when I was at UCLA in 1981 I was taught all about the Efficient-Market Hypothesis. This seemed to explain why there really weren't all that many Wall Street zillionaires anymore in the postwar era, not like there used to be before insider trading became a crime.

But in 1981 a couple of miles down Wilshire Blvd., Michael Milken was looking at how few guys these days got really rich off the financial markets and thinking: That's pathetic.

So, after 1981, things changed ...

Financial market outcomes started moving away from what seemed logical to Steve Sailer based on the EMH and in the direction of how Mike Milken thought the world ought to work.

I thought Boiler Room starring Giovanni Ribisi was both a better movie and a more realistic depiction of that Outer Boroughs/Long Island world of lower end stock brokerages and the ambitious, aggressive ethnic types that try to make their fortunes there than The Wolf of Wall Street was. The Wolf was too focused on over the top antics. Also Boiler Room had a better cast - Ribisi, Ben Affleck, Vin Diesel - all of whom are more believable as Long Island stock brokers than DiCaprio is.

Shia LaBeouf probably best captured the up and coming trader in Wall St. II.

"Boiler Room" is not bad.

Here's what I blogged about "Boiler Room" in 2009:

"Boiler Room" has lots of great lines, although it's a little clunky overall. This is a very young writer-director's first movie (Ben Younger was 27 when it was released) and it shows.

The casting is a little off. I wonder if somebody told Ben Younger that for his lead, the conflicted college dropout who can't decide whether he wants the money or his soul back, he should get, "You know, what's-his-name, that young guy, the pale one with the really Italian-sounding name," but instead of getting Leonard DiCaprio, he got Giovanni Ribisi instead. (Of course, there are a lot of movies that could have gone from half empty to half full just by DiCaprio in the title role.)

Ribisi's quite good in the selling scenes, but he never sold me on the idea that he should be a Hollywood leading man -- he's too toad-like and his complexion resembles the singer's in My Bloody Valentine. ...

With DiCaprio starring, Martin Scorsese directing, and an extra $100,000 of script doctoring, "Boiler Room" would be one helluva movie. But it's still worth seeing to learn some of the tricks of the selling trade, both for playing offense and defense.

http://isteve.blogspot.com/2009/03/boiler-room.html

"The Wolf of Wall Street" is too loud and too long for viewing in one sitting, but it works well in bite-sized highlights on Youtube. For example, here's the Cousin Marriage scene:

https://www.youtube.com/watch?v=DQlejCvaODw&feature=youtu.be

Good points. You're right that Ribisi is not really leading man material, and his skin does look like he's always sick or playing a vampire or something.

A Scorsese directed, DiCaprio starring Boiler Room that would give a Goodfellas style window into that particular stock brokerage subculture would have been excellent, better than The Wolf, which I thought had too many crazy/over the top scenes that overwhelmed the movie.

I wrote back in 2013 in Taki's Magazine:

The Efficient-Market Hypothesis taught at every MBA program says that you can’t beat the market consistently without trading on inside information, which is illegal. Economic theory thus implies that Wall Street should have become a low-margin commodity business, much like being a wheat farmer in South Dakota. A glance at the Forbes 400, though, suggests this hasn’t quite happened yet.

To get some sense of the long-term effects of constant electronic surveillance, one of the more intriguing perspectives comes from examining federal investigations into financial malfeasance, such as insider trading. If the government is in the mood, it can subpoena emails, phone records, and even order wiretaps to see if financial players know more than they ought to know.

For example, former McKinsey CEO Rajat K. Gupta, a member of Goldman Sachs’s board of directors, was convicted of insider trading for calling his billionaire buddy Raj Rajaratnam 23 seconds after he was done hearing from Goldman CEO Lloyd Blankfein that the vampire squid was going to announce a terrible quarter in late 2008.

Virtually nobody has been convicted of wrongdoing in the mortgage meltdown that set off the great crash of 2008, but the largest individual fine was the $67.5 million levied on former Countrywide Financial CEO Angelo Mozilo.

Much of the SEC’s case against Mozilo was based on frank emails the Ventura County golfer occasionally sent his executives, such as his sensible 2006 critique of Countrywide’s zero-down subprime mortgage: “In all my years in the business I have never seen a more toxic product.”

In other words, what plunged hyper-salesman Mozilo into the minimal amount of legal trouble he has endured were some of his rare moments of prudent management when he emerged from his Always-Be-Closing frenzy long enough to notice the looming risks.

http://takimag.com/article/does_israel_have_a_backdoor_to_us_intelligence_steve_sailer/print#ixzz4GOxXGMkO

The efficient market hypothesis, even in its weakest form is clearly wrong. It's fairly obvious if you actually do any trading that stocks that are clearly going insolvent based on fundamentals on debt prices still trade well above zero, several stocks trade well below announced merger prices, and there is wide disparity between price/earnings, dividend, and other key ratios. These are sufficient to beat all major indexes over time, although probably not in a way that scales. Why is this the case?
1) A lot of money is managed by agents that get paid about the same whether it performs well or it doesn't. It is efficient for them to do zero work and let the chips fall where they may. If you have any money in a 401k, you should expect it to substantially underperform every year.
2) Markets are driven by cycles of extreme greed and extreme fear. If you are one of the few who can resist buying into extreme greed and selling into fear, you can beat the market. Many other things are purely psychological - just look at Tesla.
3) There are diseconomies of scale. If you have a billion under management picking up another 30k from mispricing won't do much for you and anything more will move the market against you. If you have 200k, you just made your year.
4) Many people just buy and hold, or don't get into options, won't go short, or don't fully invest their assets. You can do okay with corporate bonds, but if you want to win you need to be all-in every day and adapt to circumstances. Institutional investors have problems with reserve requirements, even when they care about outcomes.

Dan, if the EMH is wrong why are you not insanely rich? And why are we all not insanely rich? EMH is just common sense.

One lesson to be learned is: Don’t use email, text messages, or anything else that leaves a digital trail. Face-to-face communications offer less legal danger, because in court who can remember exactly who said what?

Perhaps that explains something about the mysterious failure over the last couple of decades of what used to be called the Information Superhighway to decentralize elites. We were all promised that in the Age of Cyberspace it wouldn’t matter where we lived. No more having to live near an expensive, crowded city. Freedom!

Instead, it turned out that three metropolitan areas–New York, Washington, and San Francisco/Silicon Valley—became far richer, while much of the rest of the country got poorer.

It seems strange today, when the financial industry is so concentrated in the short stretch from Greenwich, CN to Jersey City, but back in the 1980s the biggest figure on Wall Street wasn’t on Wall Street. Instead, junk-bond king Michael Milken worked on Rodeo Drive in Beverly Hills. Milken had to put up with inconveniences to live in his native San Fernando Valley, such as being at his desk at 5AM every day to account for the three-hour time difference with New York. Yet even before the Internet, it could be done.

Then the elder Bush Administration nailed Milken on insider-trading charges and he went to prison for 22 months (which would be astonishing under the current Democratic administration).

One lesson that the financial industry may have drawn from the travails of these far-flung Californians is that it doesn’t pay to be so far away that communication inevitably leaves digital trails.

This doesn’t mean the government is defenseless against insider trading carried out in random restaurants in Greenwich. As Charles Ferguson pointed out in Inside Job, the state always has the ability to work their way up to Mr. Big by arresting some Manhattan call girls, getting them to roll over on Wall Street traders, then going after their managers who might have some dirt on the man in the corner office.

But that’s grittier police work than merely imposing electronic surveillance. The Obama Administration has shown little appetite for taking the Street to the mat.

One lesson to be learned is: Don’t use email, text messages, or anything else that leaves a digital trail. Face-to-face communications offer less legal danger, because in court who can remember exactly who said what?

This is hardly new.

I well remember,

"Don't write if you can talk. Don't talk if you can whisper. Don't whisper if you can smile and nod."

"The Obama Administration has shown little appetite for taking the Street to the mat."

I expect Hillary Clinton to get right on that! /sarcasm

"One lesson to be learned is: Don’t use email, text messages, or anything else that leaves a digital trail. Face-to-face communications offer less legal danger, because in court who can remember exactly who said what?"

I thought the lesson was build your own email server and when questioned about it, delete all the damaging emails, wipe the hard drive clean, and then stall and delay as long as possible before turning the email server over to authorities. That behavior has a pretty good track record for success.

Tyler, re: "the median insider trader invested only about $200,000 per tip and received $136,000 in profit. That's hardly enough to retire on."

When I hear about a $136K profit over avg holding period of 21 days - well that's pretty substantial to me. That is a huge amount of money to most people in my world.

At least they got the nefarious Martha Stewart put away for awhile so us owners of common stock can sleep easy. Mrs. Bill Clinton's cattle futures trades don't figure because she was being carried on both sides of the play.

And let us completely ignore Nancy and Visa...

She's in Congress - immune from insider trading laws.

So how would you make more from the tip? The Wilson Sonsini traders had the right idea, they hooked up with a prop trading firm that camouflaged the trading within the many other trades the firm did, plus leverage. That would be the way to go. Find a prop firm that bundles trades so no particular trade can be traced to you. Of course you would need a way to communicate that can't be traced, that was the undoing of the Sonsini scheme.

Good stuff. On corporations and villainy, you need to distinguish between individual rule-breaking, and rigging the game. Sort of like the difference between the lawlessness within gunpowder regimes and the established 'order' of the military-industrial complex.

http://www.macroresilience.com/2013/12/04/how-to-commit-fraud-and-get-away-with-it-a-guide-for-ceos/

Facetious Quote of the Day ™ :

" ..and maybe the smartest, wealthiest and best-connected insider traders aren’t included in the data because they don’t get caught" [SNIP]

Gee, 'ya think? ;)

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