Insider trading has been a part of the U.S. market since William Duer used his post as assistant secretary of the Treasury to guide his bond purchases in the late 1700s. In this article, we will look at some landmark incidents of insider trading.

Key Takeaways

  • Insider trading is often difficult for the SEC to spot, and detecting it involves a lot of conjecture and consideration of probabilities.
  • While it's possible that Boesky was that good at predicting takeovers, it was highly improbable.
  • In the past, the SEC has made mistakes and accused innocent parties in cases that are borderline, at best.

1. Albert H. Wiggin: The Market Crash Millionaire

During the Roaring '20s, many Wall Street professionals, and even some of the general public, knew Wall Street was a rigged game run by powerful investing pools. Suffering from a lack of disclosure and an epidemic of manipulative rumors, people believed coattail investing and momentum investing were the only viable strategies for getting in on the profits. Unfortunately, many investors found that the coattails they were riding were actually smokescreens for hidden sell orders that left them holding the bag. Still, while the market kept going up and up, these setbacks were seen as a small price to pay in order to get in on the big game later on. In October of 1929, the big game was revealed to be yet another smokescreen.

After the crash, the public was hurt, angry, and hungry for vengeance. Albert H. Wiggin, the respected head of Chase National Bank, seemed an unlikely target until it was revealed that he shorted 40,000 shares of his own company. This is like a boxer betting on his opponent—a serious conflict of interest.

Using wholly owned family corporations to hide the trades, Wiggin built up a position that gave him a vested interest in running his company into the ground. There were no specific rules against shorting your own company in 1929, so Wiggin legally made $4 million from the 1929 crash and the shakeout of Chase stock that followed.

Not only was this legal at the time, but Wiggin had also accepted a $100,000 a year pension for life from the bank. He later declined the pension when the public outcry grew too loud to ignore. Wiggin was not alone in his immoral conduct, and similar revelations led to a 1934 revision of the 1933 Securities Act that was much sterner toward insider trading. It was appropriately nicknamed the "Wiggin Act."

2. Levine, Siegel, Boesky, and Milken: The Precognition Rat Pack 

One of the most famous cases of insider trading made household names of Michael Milken, Dennis Levine, Martin Siegel, and Ivan Boesky. Milken received the most attention because he was the biggest target for the Securities and Exchange Commission (SEC), but it was actually Boesky who was the spider in the center of the web.

Boesky was an arbitrageur in the mid-1980s with an uncanny ability to pick out potential takeover targets and invest before an offer was made. When the fated offer came, the target firm's stock would shoot up and Boesky would sell his shares for a profit. Sometimes, Boesky would buy mere days before an unsolicited bid was made public—a feat of precognition rivaling the mental powers of spoon bender Uri Geller.

Like Geller, Boesky's precognition turned out to be a fraud. Rather than keeping a running tabulation of all the publicly traded firms trading at enough of a discount to their true values to attract offers and investing in the most likely of the group, Boesky went straight to the source—the mergers and acquisitions arms of the major investment banks. Boesky paid Levine and Siegel for pre-takeover information that guided his prescient buys. When Boesky hit home runs on nearly every major deal in the 1980s—Getty Oil, Nabisco, Gulf Oil, Chevron (NYSE:CVX), Texaco—the people at the SEC became suspicious.

The SEC's break came when Merrill Lynch was tipped off that someone in the firm was leaking info and, as a result, Levine's Swiss bank account was uncovered. The SEC rolled Levine and he gave up Boesky's name. By watching Boesky, particularly during the Getty Oil fiasco, the SEC caught Siegel. With three in the bag, they went after Michael Milken. Surveillance of Boesky and Milken helped the SEC draw up a list of 98 charges worth 520 years in prison against the junk bond king. The SEC charges didn't all stick, but Boesky and Milken took the brunt with record fines and prison sentences.

3. R. Foster Winans: The Corruptible Columnist

Although not high-ranking in terms of dollars, the case of Wall Street Journal columnist R. Foster Winans is a landmark case for its curious outcome. Winans wrote the "Heard on the Street" column profiling a certain stock. The stocks featured in the column often went up or down according to Winans' opinion. Winans leaked the contents of his column to a group of stockbrokers, who used the tip to take up positions in the stock before the column was published. The brokers made easy profits and allegedly gave some of their illicit gains to Winans.

Winans was caught by the SEC and put at the center of a very tricky court case. Because the column was the personal opinion of Winans rather than material insider information, the SEC was forced into a unique and dangerous strategy. The SEC charged that the info in the column belonged to The Wall Street Journal, not Winans. This meant that while Winans was convicted of a crime, the Journal could theoretically engage in the same practice of trading on its content without any legal worries.

4. Martha Stewart: The Homemaking Hoaxer

In December 2001, the Food and Drug Administration (FDA) announced that it was rejecting ImClone's new cancer drug, Erbitux. As the drug represented a major portion of ImClone's pipeline, the company's stock took a sharp dive. Many pharmaceutical investors were hurt by the drop, but the family and friends of CEO Samuel Waksal were, oddly enough, not among them. Among those with a preternatural knack for guessing the FDA's decision days before the announcement was homemaking guru Martha Stewart. She sold 4,000 shares when the stock was still trading in the high $50s and collected nearly $250,000 on the sale. The stock would plummet to just over $10 in the following months.

Stewart claimed to have a pre-existing sell order with her broker, but her story continued to unravel and public shame eventually forced her to resign as the CEO of her own company, Martha Stewart Living Omnimedia. Waksal was arrested and sentenced to more than seven years in prison and fined $4.3 million in 2003. In 2004, Stewart and her broker were also found guilty of insider trading. Stewart was sentenced to a minimum of five months in prison and fined $30,000.

The Bottom Line

Martha Stewart offers the best example of why it's best not to trade on material insider information—leaving the moral aspect aside. If she had simply held her ImClone stock, it would have hit the $70–$80 range during the Eli Lilly takeover, making her holdings worth around $60,000 more than what she sold out for. Instead, she was fined $30,000 and ended up in jail. The risks, in this case, definitely outweighed the returns.