So here we are in the final days of 2005, a time to reflect on the year that was. And I'm going to do just that -- only not on the year that was 2005, but rather on the year that was just before this one.
Over a year and a half ago, I wrote a short column on the subject of insider trading in options to purchase stock in Cleveland-based Charter One Financial. The story went as follows: On May 4, 2004, a subsidiary of the Royal Bank of Scotland (RBoS) announced a deal to acquire Charter at a price of $44.50 a share -- about a 25% premium to its then-current market price of $35 and change. It was a great deal for Charter shareholders, but the thing was, a lot of shareholders missed out on those profits.
The reason: "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."
Yesterday, the FBI announced that it had identified and charged one of those "several someones," a gentleman by the name of Michael Tom, who ran a Massachusetts hedge fund called GTC Growth. Previously, Tom had worked for Citizens Financial Group, the RboS subsidiary that was making the Charter purchase. In April 2004, Tom allegedly received a tip from a former co-worker at Citizens that it was about to buy a Cleveland-based bank. After doing some digging, Tom concluded that the Charter was the target, and he began buying call options on the stock. Long story short, according to the FBI, on acquisition announcement day, Tom became $750,000 richer.
End of story? Hardly. First off, Tom's alleged $750,000 profit alone certainly makes this prosecution "news," and the fact that Tom's alleged inside informant has already pled guilty to insider trading suggests that the tip may not have been as vague as the allegations above make it sound. Still, we're only talking about less than 20% of the insider trading profits recorded from the Charter One deal.
Remember, $5 million in options profits were recorded prior to the deal's announcement. And if a big ol' head fund honcho made just $750,000 of them, it's unlikely that his bank clerk buddy accounted for the other $4.25 million.
Today, we laud the FBI for its vigor in pursuing the scandal and, if the facts are as they allege, wish them the best of it in proving their case. They've helped level the playing field for small investors who lack the resources of the hedge funds and the chummy contacts of the Wall Street crowd. But there's still more than $4 million worth of wrongdoing in this case that needs righting. So Happy New Year, FBI, keep up the good work, and good hunting in 2006.
What else is going on in the insider trading world? Read about recent investigations of dubious trading in:
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Fool contributor Rich Smith does not own stock in any company named above.