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Institutionalizing Insider Trading?

Insider trading, I’ve often thought, must be one of the easiest white-collar crimes to pull off. Even easier than procurement fraud, which must be one of the most pervasive.

Someone in the accounts department of a listed company tells his friend or relative: ‘We’ve done better than expected this quarter. We’ll beat market expectations.’ The friend promptly buys a hundred shares of the company. And when the results come out and the share price surges, the friend is a few thousand rupees richer.

Now, how do prosecutors even begin to establish that price-sensitive information was used to profit from the trade? Unless, of course, the insider was foolish enough to put his tip on an email or a text message. Not only is insider trading easy to pull off (at least on a small scale), it is also horrendously difficult to prove.

There are tens of thousands of people in listed companies who possess such price-sensitive information from time to time. It’s not just the blokes in the accounts department, but also others too – both employees and outsiders (auditors, consultants, I-Bankers, advisors, etc.).

During my tenure at the Big Four audit/consulting firms, this was something we had to constantly look out for. The law explicitly prevents auditors and consultants from divulging such information – inadvertently or otherwise – to any party who may benefit from it. And we were prohibited from owning stocks of companies we audited or advised. Independence/propriety is indeed a big deal at these firms.

Be that as it may, many do believe that insider trading is prevalent in India. On a small scale, at least.

A couple of years back, I was wondering how insider trading could be ‘institutionalized’ (by a hypothetical Indian Prof. Moriarty, if you will) and scaled up. I sat down and ‘designed’ a suitable mechanism. To my delight, I found the scheme eminently workable, and reasonably watertight. And more importantly, it could be implemented with simple technology that is widely available.

I then put on another hat (that of an investigator or SEBI), and began looking at how one would go about discovering and unraveling the insider trading scheme once it was implemented. Clearly, that would require sifting through tons of stock market data, and possibly the use of analytics.

Once I had both ends of the scheme figured out, I built a murder mystery around it. That became Insider, the novel that Hachette has just released. If you do get to read it, please drop me a note. I’d like to hear what you think of the workability of the little scheme.

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Smartphones: A tool for insider trading?

In today’s wired and wireless world, it is impossible to stop information from flowing. Not only is it impracticable, it is also getting increasingly difficult to track down information flows after they happen.

Rajat Gupta was convicted on the basis of a telephone call he made immediately after a board meeting. Sixteen seconds after a board meeting ended (which Mr Gupta participated by phone), he is said to have called to Raj Rajaratnam at the Galleon Group hedge fund. A $5 billion investment by Warren Buffett had just been approved in the Goldman Sachs board meeting.

Two minutes later, Mr Rajaratnam ordered the purchase of one lakh shares of Goldman Sachs. A minute later, he ordered another 2.5 lakh shares. Total outlay? $43 million.

This conviction was possible because of phone records.

But what if no records were available? What if the information transmitted was indistinguishable from trillions of data packets traversing the web every hour? What if it had not been a phone call?

That must be happening today. Somewhere? Everywhere? In all probability, lots of price sensitive information is being transmitted over the web using devices like smartphones. With phone apps proliferating and smartphones becoming ubiquitous, it will not be easy to nail the next conviction for insider trading.

On its part, SEBI is beginning to take note of this issue. A recent article in ET spoke about SEBI taking ‘stringent action to check the risks of new smartphone messaging services’. The article goes on to say this:

Traders, possibly working as a cartel, are using these platforms for insider trading, front running and other manipulative activities, said market sources. For instance, a market operator buys a stock and then leaks price-sensitive information about it on instant messaging and social media platforms, leading to the stock running up sharply, at which point the operator exits his positions with huge profits.’

This is going to be an uphill battle. SEBI can’t keep pace with the growth of apps and smart devices. They may start thinking about ring fencing trading room environments and putting in place data monitoring mechanisms. But with encryption, cloaking and newer ways to ensure anonymity, that will not be easy either.

Perhaps the best way is for all capital market regulators around the world to get together to find technological solutions to track and log information flows that can be used for subsequent legal proceedings.