Fixed Leaks: Insider Trading and How It Affects Your Investment Strategies

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A headline of the New York Times’ Sunday Business section published May 19th, Gretchen Morgenson asks “Is Insider Trading Part of the Fabric?“, raising a potentially distressing question for regulators and market analysts alike. Morgenson profiles the woes of one Ted Parmigiani, a Lehman Brothers investment analyst whose career was apparently placed in peril in 2004, when his research was allegedly leaked by a colleague in his research department. Parmigiani was then planning to raise his assessment of computer chip producers Amkor Technology. The leak was apparently discovered by Parmigiani on the planned date of his announcement, when Amkor’s price quickly shot up that morning, an hour before his new assessment was to be broadcast. Such are the dangers those working in investment too often face, and therein lies the potential for such figures to become brave whistleblowers. Visit the Practice Areas section of Malecki Law’s website to learn more about the firm’s work in aiding whistleblowers of fraud and further financial corruption.

Parmigiani responded by spending years providing information to the Securities and Exchange Commission (SEC) about the trading and research climate at Lehman, where suspicious trades were all too common, and sales reps and analysts illegally shared both office space and data. As part of 1.4 billion collective settlement paid by Lehman and nine other firms following an Eliot Spitzer-induced inquiry into insider trading, Lehman agreed to separate analysts from sales teams. Parmigiani says he was asked to ignore this supposed divide, write praise for investment banks whether it was merited or not, and explicitly told not to make negative comments about Lehman-favored companies and executives.

Parmigiani alleged that Lehman traders were often advised of changes to analysts’ company ratings before the revisions were publicly announced, and that traders were tipped off by analysts so that they would make hedge bets with Lehman’s own money. According to reports, announcement of Parmigiani’s recommendations were delayed by sales management for days at a time for no justified reason. In the Times article Parmigiani compares his actions to his time in the U.S. military, where the duty to disobey unlawful orders was instilled. Following his outrage over the Amkor incident, Parmigiani was fired from Lehman and found himself unable to find work at comparable Wall Street firms.

Despite assertions from regulators that insider trading is today prosecuted with greater frequency and accuracy, Mr. Parmigiani’s story speaks to what many authorities consider to be a system-wide epidemic. Such observers might argue that for every SEC conviction of a notorious inside trader – such as billionaire Galleon hedge fund manager Raj Rajaratnam – there is an instance such as that of Bernard Madoff, whose financial crimes went unprosecuted for years despite alarming warning signs.

To their credit, the SEC takes a contrary public stance on Parmigiani’s claims. Spokesman John Nester asserts that the SEC performed an extensive review of the claims against Lehman, reviewing “nearly 100,000 e-mails” and conducting numerous interviews with Lehman employees before determining that there “simply was not any evidence in this case to support the conclusion that Lehman, its employees or its clients had committed insider trading.” Morgenson further notes that for critics, the issue is not the number of SEC prosecutions of insider trading, but the typically minor targets and sums fined. The article notes two major exceptions: a recent $22 million dollar fine to Goldman Sachs, and a 2007 case against a researcher at Swiss bank UBS that resulted in charges against eight individuals, one of whom went to prison.

Parmigiani cites the 2008 financial crisis, coupled with Lehman’s subsequent insolvency, as the point at which the SEC’s interest in his case faltered. Independent analysis from Babson College professor of finance Steven Feinstein was presented by Parmigiani to the SEC in 2010. Feinstein’s report concluded that Lehman had engaged in “tipping” that directly changed the stock price and caused damages for investors. Yet Nester again argues in favor of the SEC’s inquiry with direct company sources over autonomous investigations such as Feinstein’s. “Our staff can and does interrogate witnesses, review contemporaneous documents, including e-mails, and scrutinize records,” says Nester. “That is evidence, and that is what determines whether insider trading has occurred.”

The degree to which investors and insiders alike rely upon the SEC to act as the most steadfast regulatory body it can be is apparent. As the stakes of investment grow only larger, the temptations of many such brokers and hedge managers toward gaining illegally obtained information loom large. It seems that whether Ted Parmigiani and like-minded critics of these regulatory efforts are correct in believing that the Commission is failing to correct preventable damages will be confirmed or denied by the SEC’s tenacity amidst growing concerns of insider trading, and as always in the passing of legislature that further regulates practices that place investors in unreasonable harm.