Boesky to Waksal: Insider Trading's Decline

In an episode of the television show America's Dumbest Criminals, Florida police relate the case of a man who tried to rob a grocery store at gunpoint, using a paper bag as disguise with holes cut out so he could see.

The nefarious plot goes awry when the bag shifts, obscuring the man's sight, then splits completely, revealing his face to the desk clerk who recognizes him as a regular customer.

Sam Waksal, the former CEO of ImClone Systems (IMCL Quote), might have laughed at the story -- if only he wasn't charged with an equally stupid crime that was roughly as difficult to solve.

"If he did what is alleged, what was he thinking? It's almost like a 'kick me' sign that he's wearing," said Henry Hu, professor of corporate and securities law at the University of Texas (referring to Waksal, not the stickup man). "How can you defend a case like that, and how can you possibly think that people wouldn't be aware of it?"

LUDs

Waksal was arrested Wednesday and charged with passing trading tips to family members ahead of news that he knew would be disappointing to investors and send the stock sharply lower. Waksal is alleged to have made a series of phone calls to his father and daughter on Dec. 26 and Dec. 27, advising them to dump ImClone stock ahead of an announcement that the FDA would reject for review the company's main cancer drug Erbitux.

He also attempted to sell stock himself through his daughter's account but was unable to because two brokerages suspected the holdings were governed by ImClone restrictions.

(Jim Cramer wrote about Martha Stewart's connection to Waksal on TheStreet.com's subscription site, RealMoney.)

"The SEC canvasses the trading and the exchanges canvass the trading so it's very easy to find out who's been selling before some big announcement," noted Alan Bromberg, securities law professor at Southern Methodist University.

Waksal could have learned a thing or two from former Keefe Bruyette & Woods CEO James McDermott, who also passed on trading tips to a loved one -- a porn-star girlfriend in his case -- in 1999. He was sentenced to five months in prison.

Open, Shut

"There was no question of possession of material nonpublic information. If the facts are as alleged, it would be quite an easy case to litigate against," said Hu.

Bromberg said Waksal could face three to five years in prison for his alleged crimes.

Under U.S. securities laws, violators can be sentenced to as many as 10 years in jail, fined up to $1 million and forced to reimburse up to three times the value of their ill-gotten gains. In this case, Waksal could be forced to disgorge the several million dollars in losses avoided by family members who had been tipped off.

Securities experts say the government will want to send a message to the financial community that illegal trading is not acceptable and that white-collar crimes result in more than a slap on the wrist.

"When the government decides to take up criminal rather than relying on civil remedies, part of that decision is because of the impact it will have on deterring people," Hu said.

Past Masters

Both Waksal and McDermott's offenses are a far cry from the sophisticated securities crimes used by the likes of Ivan Boesky and Michael Milken in the 1980s.

The heart of the indictment against Milken, who headed up Drexel Burnham's junk bond department, revolved around the issue of "stock parking." Milken arranged to swap securities with his accomplice Boesky to hide their real ownership, using Boesky as a front to trade stocks in companies in which Drexel had an undisclosed interest.

Boesky was sentenced to 22 months in jail and forced to pay a $100 million fine while Milken was sentenced to 10 years, though it was later reduced to two years with three years probation.

Elaborate schemes engineered in the 1980s are much harder today, in part because of more sophisticated tools used to track unusual behavior in stock prices.

The NASD, SEC and New York Stock Exchange have computer surveillance software that monitors irregular price and volume swings in the 10 days before and after a major news event.

Better Cops

Meanwhile, enforcement has improved considerably and most public companies and brokerages have policies in place to prevent insider trading. The SEC pursued 57 insider trading cases in fiscal 2001, compared with just 34 in 1991. Still, just four out of the 57 actually made it to trial. Many others settled out of court.

Also, very few violators are prosecuted criminally, in part because the government often presents evidence that, while powerful, is often circumstantial.

"It is rare to have an arrest, but there are reasons that [the Waksal] case was brought," said Dennis Taylor, an attorney at Shepherd Smith & Bebel. "One is that the insider trading was so blatant, and two is the benefit of publicity."

The question of exactly why Waksal would tip off his family members and leave a trail of dots for prosecutors to connect may never be answered. But Bromberg said not everyone realizes how strong the chances are of being caught.

"People think if I only trade 1,000 shares I won't get caught. Maybe people feel they're so important that no one can catch them. There may be ego factors involved," he said.