The Digital Skeptic: Insider Trading? Why Even Bother?

NEW YORK ( TheStreet) -- My buddy Alec Foege has this to say to Mathew Martoma, Raj Rajaratnam, Martha Stewart or anybody else sucked into an insider-trading vortex in the digital age.

"I wonder sometimes why they even bother," he told me over the phone.

Foege is the founder and owner of Brookside Research, which since 2005 has provided customized, exclusive primary reports to hedge funds and those outfits usually looking to set up long-term investments. Foege cut his analytical teeth at so-called deep value shops including New York City-based Ruane, Cunniff & Goldfarb. Now working mostly from his home in Westport, Conn., he cares not a whit for complex quantitative models or gaining access to this or that bit of supposed insider information.

Rather, he takes a page from old-school, throwback, gumshoe investigative journalism. Which makes sense. Foege was a top-tier reporter for Rolling Stone, People magazine and others. He even worked at my shop several years back.

Foege relies on digging up 15 to 20 people with knowledge of the company or sector he's breaking down. Usually, he says it's former employees, referred experts or customers. He virtually never pays for information. Most folks are happy to talk to him. And he discloses all he learns immediately. "It is the aggregation of public information that creates the value," he said. "We are not looking for the scoop."

Which all gives Foege a fascinating take on insider trading in the information age.

"We live in an information-glutted world," he explained. "Anybody can do a Google ( GOOG) search." The trick, he says, is not focusing on the bits and pieces that can be material and nonpublic, but assembling the right public information to match a specific investment need.

"There is almost never a situation where a single person holds the key," he said.

And if you let Foege guide you through some insider trading scandals, he clearly has a point.

What's that information worth?
Take the by-now-infamous Raj Rajaratnam insider-trading scandal. The former manager of the Galleon Group was convicted of 14 counts of insider trading.

Foege confirms that specific information about upcoming earnings and coming deals were supplied by company experts, who acted as illegal tipsters to Rajaratnam, who was running a technology and health care fund. "I think people who participate in insider trading should be prosecuted," Foege says.

But he points out, the profits made were comparatively small. For all of Rajaratnam's skullduggery, he netted $63.8 million over the roughly seven-year period defined by the indictments -- about $9 million a year. Not that stellar a return, considering Rajaratnam managed a reported $7 billion in assets in 2008.

"A longer-term view probably would have netted more return," Foege argues."If there is one thing I have learned, it's that the real money is made in finding quality companies where there is an opportunity to realize value over the long haul."

What's a tipster know, anyway?
Foege also makes a powerful argument that insider information isn't as unique than as it seems. Take the red-hot case of Dr. Sidney Gilman, a recently retired University of Michigan professor, and Mathew Martoma, an ex-analyst with a shop called CR Intrinsic Investors.

SEC documents break down in grisly detail how Gilman was allegedly paid $1,000 an hour to feed Martoma insider data concerning details of an Alzheimer's drug trial from Elan ( ELN). Martoma was fed knowledge by Gilman of the looming failure of the trial before the larger market knew, the SEC said. Martoma restructured his company's investment in Elan, supposedly netting $276 million for the firm -- and a $9.3 million bonus for himself.

Foege agrees that while the specifics of trials are often secret, such medical research is often done in a near public, peer-reviewed fashion, putting a surprising amount of data in plain sight. What the supposed one-of-a-kind, expert tipster is offering as "insider information" is much more fluid -- and more visible -- than uneducated investors think, making the risks the company was running crystal clear, he said.

"I've done enough medical device research to tell you," Foege said. "This kind of work is not done in a vacuum,"

Why bother?
Which leads investors to the obvious question: If the digital age offers so much of the information investors need, why do the rich and powerful mess with what might be dangerous data?

"Analysts are under a huge amount of pressure to reach performance goals," Foege said. "And they are looking for an edge. So sometimes they miss the information forest for the trees."

The problem is, in the digital age, if you wander in that forest for too long, you may wind up stumbling into the woodshed.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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