This article has been adapted from our sister site across the pond, Fool U.K.

One popular way to make money in the stock market is through what's known as "merger arbitrage."

A technique oft-favored by hedge funds and other professional investors, merger arbitrage involves buying the shares of a takeover target while at the same time shorting the shares of the bidder.

All being well, this should lead to a "riskless" profit, regardless of how things turn out. However, merger arbitrage can and does go awry when deals fall apart or take too long to close, thus reducing the trader's profit.

Apple to buy ARM?
The problem with taking advantage of takeovers is that there are far fewer actual acquisitions than there are rumored bids.

Indeed, from my experience, I'd reckon that bid rumors outweigh concrete bids by at least 10 to 1. Nevertheless, the rumor mill keeps churning out flimflam and gossip, with the vast majority of these reports being long on hearsay and short on truth.

On Thursday, the rumor mill spat out news that Apple (Nasdaq: AAPL) -- the world's largest tech firm and third-largest company overall -- is lining up a bid for British chip designer ARM Holdings (Nasdaq: ARMH). ARM makes low-energy chips for Apple devices, including the iPhone, so the two firms have a long-established commercial relationship.

At first glance, this deal seems to make sense for Apple. By buying ARM, it could prevent ARM's advanced technology from ending up in devices sold by Apple's rivals. Then again, Apple already licenses and uses ARM's chips, so why waste £4 billion or more buying its Cambridge-based rival?

This isn't the first time that an Apple/ARM tie-up rumor has done the rounds. The same tittle-tattle surfaced as recently as April 22, before ARM's CEO Warren East poured cold water on it the next day. What's more, it's not the only rumor identifying ARM as a takeover target. Indeed, four weeks ago, a leading technology executive told me that U.S. giant Cisco (Nasdaq: CSCO) would end up buying ARM!

As I write, ARM's share price is up 11% at 303p, having soared as high as 362p (up 33%) earlier today.

Suspicious trading ahead of takeovers
Naturally, level-headed investors take takeover rumors with a mountain of salt, since they know that only a small proportion prove true. That said, there is one sure-fire way to make money from takeovers: insider dealing.

Armed with solid evidence of an acquisition or approach, an insider can make a packet from buying shares in the target. Needless to say, such activity is a criminal offence, and City watchdog the Financial Services Authority (FSA) has been cracking down hard on insider dealing and similar market abuse.

Nevertheless, the guaranteed profits to be made from insider dealing are sometimes too tempting to resist, despite the threatened penalties. Indeed, in its latest annual report published this morning, the FSA warned that it found evidence of suspicious trading in advance of 30.6% of U.K. takeovers in the year ending April 30, 2010. This is the highest level of takeover misconduct in eight years.

That's right: In almost a third of takeovers of U.K.-listed firms, the regulator found evidence of unusual buying patterns in the run-up to bid announcements. Clearly, information is leaking in advance of bids -- whether from company executives and senior managers, advisors (bankers, lawyers and accountants), or printers -- with the unscrupulous and greedy happy to profit from these leaks.

This increase in pre-takeover misconduct comes in spite of the FSA's efforts to tighten its regulation and supervision of financial markets over the past three years.

Despite issuing 46 fines totaling a record £33.6 million and successfully completing two criminal insider-dealing prosecutions, the FSA still struggles to keep financial firms in line. Then again, this is shaping up to be another record year: So far in 2010/11, the FSA has issued 26 fines totaling £49 million.

So, regardless of its best efforts, the FSA has failed to clean up unfair and illegal trading in advance of merger and acquisition announcements. Thus, our crusading coalition government may decide to take steps to crack down on the City's dirty secret. An announcement on financial regulation is due next week, so watch this space.

More from Fool U.K.'s Cliff D'Arcy:

Brian Richards prepared this article for publication on Fool.com. It was originally written by Cliff D'Arcy. Brian does not own shares of any companies mentioned. Apple is a Motley Fool Stock Advisor recommendation. The Motley Fool has a disclosure policy.