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Is Buying A Stock Coincidentally Before An Acquisition Insider Trading?

Insider Trading Jail Cell
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On Saturday, July 16, 2014 I played in a tennis tournament with a partner that worked at Trulia, an online real estate company. He just got his job and was explaining to me how the company makes money through its ad placements for Realtors. If you’ve ever wondered why companies like Trulia and Zillow have done nothing to lower selling commission rates from 5%, it’s because real estate agents are their clients. Asking how a company makes money or plans to make money is always my number two question after understanding what the company does. We had a really fun time playing against Berkeley Tennis Club across the bay. After getting home, I decided that I was going to buy Trulia stock because I liked their business model, the stock had corrected somewhat, I was bullish on the real estate market, and it seemed like a prime takeover target. I was set on buying $50,000 worth of the stock on Monday, July 18. For some reason, I got too busy that Monday and didn’t execute my order before 1pm PST. Mondays and Wednesdays were my consulting days for one of my ex-clients. I forgot about buying Trulia that entire week until I saw news after the close on July 28, 2014 that Zillow was acquiring Trulia for $3.5 billion in stock at a 25% premium! Damn! I could have made $12,500 in just a couple weeks! What a shame. Or how fortunate. Let me explain.

INSIDER TRADING AND POROUS WALLS

Insider trading is some serious, serious business. A day before ImClone stock was set to drop due to an unfavorable FDA ruling, Martha Stewart sold about $230,000 in ImClone shares on December 27, 2001, purportedly due to an insider tip. Martha Stewart was found guilty of insider trading and sentenced on July 16, 2004 to five months in prison, five months of home confinement, and two years probation for lying about a stock sale, conspiracy, and obstruction of justice. The total amount sold was $230,000, a pittance compared to her 9-figure net worth. Unlike Martha, I didn’t receive any insider tips about Trulia. I just thought it was an interesting stock idea at the time after speaking to my double’s partner about his new job. But I got to wondering what would happen to me if I actually purchased $50,000 of Trulia stock a week before the takeover. $50,000 is a much greater portion of my net worth than $230,000 is to Martha, but it’s well within the band of stock purchase sizes I’ve done in the past. I tell ya San Francisco is a small city because I ended up playing doubles on August 22, 2014 with one of the lead bankers who engineered the deal! We partnered up and lost 6-2, 3-6, 6-7 in a very tight match against my other buddies, who are money managers. So I asked my MD doubles partner during change over what would have happened had I bought, and he quipped, “We probably would both be in jail now.” Holy crap! “Come on, really?” I responded. He replied, “Well, I’m not quite sure actually. Every time we do a deal, I get asked to review a list of names of about 100 people who are suspected of insider trading or are on the list for whatever reason. If I know them, then we’ve got to begin the vetting process.” I told them there was no way I would be in trouble because I simply never got any insider information. No electronic or voice records would be found, because there weren’t any. Buying Trulia before the sale would have been a sheer coincidence. “I suppose. But $50,000 worth of stock is a very common amount of stock a lot of famous or more wealthy people have purchased and ended up getting in trouble because of it. There was this one deal where half a certain NHL hockey team was investigated because they bought stock of the takeover candidate the day before the deal was announced!” “Whatever happened to them?” I asked. “I’m not sure,” he responded. I looked up the star NHL player for insider trading, and found nothing.

IT TAKES A LOT TO CONVICT

If you happen to buy a stock that gets taken over for a nice premium quickly after purchase, don’t panic. Instead, celebrate! You just won a mini-lottery. Risk-arbitrage hedge funds look for these type of events all the time and buy ahead. They also short takeover initiators all the time as well to try and capture the spread. If you are innocent, it is practically impossible for the SEC to find you guilty, so don’t worry. And if you are guilty, well shame on you. But looking at how few cases have come to light where people have been convicted for insider trading, it must be brutally tough to convict guilty people as well. All we see are really wealthy, super high profile people getting convicted. The US Securities And Exchange commission wants to get the biggest return for its effort. It’s really interesting how people in power hold so much ability to illegally enrich someone with just a whisper. Surely there is some temptation to say, “Hey long lost cousin in Italy, I’m about to close a huge deal where Apple is going to buy Twitter for $40 billion in cash and stock (35% premium), so buy some now!” But the downside risk is huge for the person in power. When you’re worth over a billion dollars like ex-Gallen hedge fund manager Raj Rajaratnam, why bother trying to make an extra million through insider trading? If you are a multi-millionaire, on multiple boards, and reached the top of McKinsey, why would Rajat Gupta bother to feed insider tips to Raj? Is all the prestige and money in the world not enough? There must be some type of “Superman complex” where no matter how much you have, all you want to do is win and feel invincible. Now I wonder about Aaron Hernandez, the ex-tight end of the New England Patriots who was on a $40 million contract. If you’ve got the whole world in your hand, don’t mess it up!

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About the Author: Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He is aggressively investing in real estate crowdfunding to arbitrage low valuations and take advantage of positive demographic trends away from expensive coastal cities. Updated for 2021 and beyond.

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