In less than two months, two insider-trading scandals have broken on Wall Street -- yet, neither one is getting a whole lot of press. Let's change that.
Last Tuesday, the Royal Bank of Scotland announced that it will acquire Ohio-based Charter One Financial (NYSE: CF) for $44.50 a share. Before that announcement was made, Charter One was selling for just under $36 a stub.
The thing is, according to a Thursday column nestled deep within the columns of micro-fonted stock information in section C of TheWall Street Journal, someone (or several someones) knew the deal was going down ahead of time -- and apparently traded on that insider information.
Beginning on the Friday before the deal was announced, anonymous trade orders began flooding the American and Philadelphia Stock Exchanges, buying up call options on Charter One stock, entitling the option-holder to buy the shares at, variously, $35 or $40 a stub. In the two days immediately preceding the buyout announcement, trading volumes surged to more than 16 times heavier than normal, with calls outnumbering puts by 12-to-1 -- a ratio four times as large as normal. In all, the seemingly illicit trades may net as much as $5 million in profits at the expense of Charter One shareholders.
As the Scots might say: "Shabby business." But it is not the only recent instance of apparent insider options trading.
When General Electric (NYSE: GE) announced that it would acquire bomb-detector InVision (Nasdaq: INVN) for $900 million, there was much pride in Fooldom. InVision had recently been profiled by Fool contributor Daniel Hong as a possible hidden gem, and GE's buyout validated Daniel's insight. But then, the SEC announced that someone had apparently profited from insider trading, by buying call options on InVision stock just ahead of the announcement. And that was just sad.
The SEC is already investigating the InVision matter. For Charter One shareholders' sakes, I hope that an investigation is opened there as well. In fact, I hope that for all our sakes. For while the (alleged) insider traders may think they have cleverly profited without hurting anyone else, they are mistaken. Their profits come directly out of the pockets of honest shareholders who had no idea that their shares were worth more than $35 and who have now been fleeced of several million dollars.
Moreover, insider trading corrupts our faith in the "level-playing field" that underpins the market. When investors believe the system is rigged against them, this naturally depresses their demand for stocks. Lower demand results in lower prices for stocks.
It's Economics 101, folks. Insider trading hurts us all.
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Fool contributor Rich Smith owns shares of none of the companies mentioned here.
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