If you’re an active investor who occasionally buys or sells a stock based on tips, you might be understandably nervous about the massive insider trading crackdown surrounding Galleon Group. The now-defunct hedge fund is linked to 22 guilty pleas and more than two dozen arrests involving an array of alleged conspirators, including lawyers, consultants and investment managers.
And Galleon is only the latest in a bevy of recent insider-trading prosecutions, including one case filed against a group of technology salespeople who traded Apple shares based, allegedly, on confidential information and another case that nabbed a doctor for blabbing about clinical trials for a new drug.Yet if people couldnt trade on tips, Jim Cramer, the host of CNBCs Mad Money program, would be out of work. In reality, it is perfectly legal (although potentially unwise) to trade on some tips that you hear or overhear. Illegal insider trading is all about facts and circumstances. Which situations constitute illegal insider trading and which dont?
TAKE OUR QUIZ: ARE YOU GUILTY OF INSIDER TRADING?
Situation #1: Coffee Talk
You are standing in line at Starbucks, and a well-dressed couple in front of you is talking about retiring to Majorca after they sell their company. You recognize them as the founders of a publicly traded company and figure out that the deal hasnt yet been announced. You snap up as many shares as you can afford and make a killing when the takeover is announced. Is this insider trading?
No. If this couple bought or sold shares — or called you and tipped you off in private — it would be a violation. But illegal insider trading requires that you not only trade on the basis of important nonpublic information but that you also have some sort of duty to keep the information confidential. Former football coach Barry Switzer was sued for insider trading following a similar scenario in 1981, but he won the case because he had no duty to ignore a conversation he overheard in a public place.
Situation #2: Office Eavesdrop
Youre a janitor at a major company. You hear members of the companys board convening outside the room youre cleaning and decide to hide in the closet. The board okays a deal to sell the company for a fat premium to the current share price. You load up on the shares. Illegal insider trading?
Definitely. This is not a public place, and youd be in a position to understand that confidential information was being disclosed, which changes the calculus, says Andrew Stoltmann, a Chicago-based securities lawyer.
Situation #3: Stranger Danger
You hop in a cab at JFK and are startled by the drivers Armani suit and solid-gold pinkie ring. You learn that the driver is merely taking this shift as a favor for a friend. The driver is now happily retired, living on his investment portfolio. When you whine about your own, he says: Look, Ill give you a break. Buy as much stock in Google as you can. You do. Insider trading?
No . It may be unwise — because the cab driver could as clueless as you — but you have no reason to believe hes telling you anything thats not public information.
Situation #4: Proud Papa
Once again a cab driver is offering stock tips, but this time he mentions that his son is an attorney at Skadden, Arps, Slate, Meagher Flom, a major law firm in the merger game. Insider trading?
This scenario could qualify as insider trading. Its all about whether you have reason to believe that youre receiving important, nonpublic information from a person who has a duty to keep that information private. The cab drivers trading would definitely be verboten. Yours is in a hard-to-defend gray area, says Stoltmann.
Situation #5: Mass Exodus
You read a few years back that executives at Countrywide Financial, the big mortgage lender, were unloading their stock. You decided that they must know something you didnt, so you followed suit and sold your shares, too. Now you worry that the Feds are going to come after you. Insider trading?
For you? No. For them? Maybe. Executives can sell their own companys stock without running afoul of the rules as long as theyre not trading based on information they havent shared with the public. The SEC sued Countrywides CEO, Angelo Mozilo, and several other insiders in 2009 (after the company had been acquired by Bank of America), alleging that they had improperly traded on undisclosed information about the evil lurking inside the companys loan portfolio. Mozilo, who netted some $140 million selling Countrywide stock before the company collapsed, eventually settled the suit without admitting or denying guilt by paying $67.5 million in fines and disgorging profits.
As for you: Mozilos trades were disclosed in SEC filings and in numerous news stories. Trading based on publicly available information is perfectly legal.
Situation #6: Disgruntled Employee
A woman in your Bunco group says shes about to quit her job because she cant stand the strain of working in a medical office where all the patients are dying. Because of previous casual conversations, you know that patients in this office are involved in early trials of a new drug. You know what the drug is and who makes it. You sell short shares of the drugs developer, betting that the stock will fall in value. Did you violate insider-trading rules?
This probably would not qualify as insider trading. Your playing partner is sharing information thats so general it cant be used to gauge whether the clinical trial will result in failure. Thus, the tip fails the materiality test. Its not significant enough to the companys stock price. And because the woman is just sharing information about the status of the offices patients and not the trial (including whether the ailing patients are taking the new drug or a placebo), no one appears to have a duty to keep quiet.
Situation #7: Disgruntled Employees Boss
Your friends boss calls and begs you to talk your friend out of quitting. The boss tells you confidentially that the drug trial your friend is upset about will soon be terminated because the drug is probably responsible for the deaths of those in the trial. You sell the developers stock short. Are you violating insider-trading rules now?
Yes. Youve been fed important information from an insider, who has said that the information was confidential. The SEC recently filed an insider-trading case against two individuals — a hedge fund manager named Joseph Chip Skowron and a medical researcher, named Yves Benhamou, who was overseeing a drug trial. The SEC alleges that Skowron paid Benhamou with envelopes stuffed with cash for confidential information about the results, which he then used to avoid tens of millions in stock losses on his holdings in Human Genome Sciences. Benhamou pled guilty; the case against Skowron is pending. The hedge fund Skowron worked for settled without admitting or denying guilt.
Situation #8: Shared Broker
Your broker calls and says you need to get out of ImClone Systems now because the CEO, who is also his client, is selling all his shares. Insider trading?
Maybe. The SEC filed suit against homemaking personality Martha Stewart in 2003 with these exact facts. Stewart did end up going to prison — but not for insider trading. She was convicted of obstructing justice and lying to prosecutors. Stewart settled the SECs insider-trading case, paying a fine and agreeing to never violate securities laws in the future. The settlement eliminated the need for a trial as well as a definitive answer about whether she had a duty to ignore the tip. But the case was complicated by the fact that Stewart had once been a stockbroker. The SEC contended that she should have known better.
Situation #9: Gordon Gekko
Youre a hedge fund manager, buying and selling stocks constantly. You pay a series of experts to feed you hush-hush information about pending mergers, and you earn millions in profits by buying shares of takeover targets before deals are announced. Insider trading?
Absolutely. If you bribed or bought insider information and traded on it, youre going to prison.
Situation #10: Information Seeker
Youre a hedge fund manager, and you pay dozens of analysts and consultants to provide seasoned advice about stocks to buy and sell. Some of those consultants may have access to secret information, but you trade based on a wide array of factors, including examination of public documents and detailed analysis about industries and companies operating within them. Insider trading?
This situation probably would not be considered insider trading. The key to the case against Galleon CEO Raj Rajaratnam hinges, says Stoltmann, on whether his lawyers were able to establish that his trading was based on assembling a mosaic of information or whether he paid consulants to feed him insider tips. The former, says Stoltmann, is perfectly legal. The latter is not.
ALEXANDRIA, Va. – The young man stood before the judge, his usually neatly trimmed hair now long enough to brush the collar of his prison jumpsuit. Glenn Duffie Shriver had confessed his transgressions and was here, in a federal courtroom, with his mother watching, to receive his sentence and to try, somehow, to explain it all.
When the time came for him to address the court, he spoke of the many dreams he had had to serve his country.
“Mine was to be a life of service,” he said. “I could have been very valuable. That was originally my plan.”
He had been a seemingly all-American, clean-cut guy: No criminal record. A job teaching English overseas. In letters to the judge, loved ones described the 29-year-old Midwesterner as honest and caring; a good citizen. His fiancee called him “Mr. Patriot.”
Such descriptions make the one that culminated in the courtroom all the more baffling: Glenn Shriver also was a spy recruit for China. He took $70,000 from individuals he knew to be Chinese intelligence officers to try to land a job with a U.S. government agency, first the State Department, later the CIA.
Shriver is just one of at least 57 defendants in federal prosecutions since 2008 charged with espionage conspiracies with China or efforts to pass classified information, sensitive technology or trade secrets to intelligence operatives, state-sponsored entities, private individuals or businesses in China, according to an Associated Press review of U.S. Justice Department cases. Of those, nine are awaiting trial, and two are considered fugitives. The other defendants have been convicted, though some are yet to be sentenced.
Most of these prosecutions have received little public attention, especially compared with the headline splash that followed last year’s arrest of 10 Russian “sleeper agents” who had been living in suburban America for more than a decade but, according to Attorney General Eric Holder, passed no secrets.
Contrast that with this snapshot:
—In Honolulu, Hawaii, a former B-2 bomber engineer gets 32 years in prison for working with the Chinese to develop a vital part for a cruise missile in a case that a high-ranking Justice Department official said resulted in the leak of “some of our country’s most sensitive weapons-related designs.”
—In Boston, Massachusetts, a Harvard-educated businessman is sent to prison, along with his ex-wife, for conspiring for a decade to export illegally parts used in military radar and electronic warfare systems to research institutes that manufacture items for the Chinese military. The Department of Defence concluded the illegal exports “represented a serious threat to U.S. national and regional defence security interests.”
—In Los Angeles, California, a man goes to jail for selling Raytheon-manufactured thermal imaging cameras to a buyer in Shanghai whose company develops infrared technology. The cameras are supposed to be restricted for export to China because of “their potential use in a wide variety of military and civilian applications,” according to court documents.
—And in Alexandra, Virginia, there is Shriver, who told the judge quite simply: “Somewhere along the way, I climbed into bed with the wrong people.”
All five of these defendants were sentenced over just an 11-day span early this year.
In Shriver’s case, when once he asked his Chinese handlers, “What, exactly, do you guys want?” the response, as detailed in court documents, was straightforward: “If it’s possible, we want you to get us some secrets or classified information.”
Despite denials from Beijing, counterintelligence experts say the cases reveal the Chinese are among the most active espionage offenders in America today, paying more money and going to greater lengths to glean whatever information they can from the United States.
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For years, U.S. counterintelligence experts have cited a growing espionage threat from China, the product of an ever-more competitive world in which technology is as vital as political intelligence, but a sign, too, of China’s increasing prosperity, persistence and patience.
Recent cases reveal not only a high level of activity but also signs of changing tactics and emboldened efforts. In one case, a convicted spy managed to persuade not one but two U.S. government officials to pass him secret information, telling them it was going to Taiwan when he instead passed it to a Chinese official.
The recruitment of more non-Chinese, such as Shriver, also represents a shift, said Larry Wortzel, who serves on the U.S.-China Economic and Security Review Commission.
Then there are the so-called “espionage entrepreneurs,” motivated simply by money.
When asked about the recent cases, the Chinese Foreign Ministry questioned the statistics, responding in a statement: “To speak of the Chinese side’s so-called ‘espionage activities’ in the United States is pure nonsense with ulterior motives.”
However, Joel Brenner, who served as the U.S. National Counterintelligence Executive from 2006 to 2009, said: “The Chinese espionage threat has been relentless recently. … We’ve never seen anything like it. Some of it is public. Some of it is private. And some of it lies in that ambiguous area in between.”
Today’s “agents” are professors and engineers, businessmen exporting legitimate products while also shipping restricted technology and munitions, criminal capitalists who see only dollar signs. While some may be acting at the direction of a government handler, others supply information to firms for private enterprise, state-sponsored research or both.
Driving all of this, U.S. officials said, are China’s desire to develop a modernized military and its expanding wealth; last year China surpassed Japan as the world’s second-largest economy, behind only the United States.
“They have more money to pay for things,” said Steve Pelak, a deputy chief of the Justice Department’s counterespionage section who points to the amounts given to Shriver before he was ever in a position to access, much less pass, secrets.
Still more money is going to private firms to help develop and build China’s military technology, sometimes through parts obtained illegally from U.S. manufacturers.
Indeed most of the Justice Department cases reviewed by the AP involve the illegal export of restricted defence-related parts or so-called “dual-use” technology, which can have commercial or military applications. These are items such as integrated circuits for radar systems, high-power amplifiers designed for use in early-warning radar and missile target acquisition systems, and military grade night-vision technology.
That only scratches the surface. Other cases involve the theft of trade secrets by individuals once employed at major U.S. corporations, including Boeing, Motorola and Dow. In some instances, the secrets were computer source codes or, in cases still awaiting trial, related to the development of organic pesticides and telephone communications technology.
Stolen information about the space shuttle and technical data about the capabilities of the U.S. Navy’s nuclear-powered submarines have also been passed along.
While export cases and economic espionage comprise most of the China-related intelligence prosecutions in recent years, there have been a few notable instances of traditional espionage, among them the Shriver case and that of Tai Shen Kuo, a Louisiana businessman who obtained information from two federal government employees that he passed to China.
It all fits into what some experts call China’s “vacuum cleaner” approach to information-collection: Catch whatever you can.
“It’s a little like … the cancer that you don’t know your body has,” said Michelle Van Cleave, another former National Counterintelligence Executive. “You don’t know that you’re in trouble until it manifests itself in ways that really, really hurt you.”
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“If you have customers in mainland China, please let us know if we could be of any help. In China, it seems impossible for most companies to buy directly from US. We can act as middlemen for you.”
It was 1996 and Zhen Zhou “Alex” Wu, a one-time schoolteacher in his native China who later studied at Harvard, was emailing a pitch for his business: A company dedicated to selling electronics components to Chinese customers. Based in Shenzhen, China, the company, Chitron, opened a single U.S. office in Waltham, Massachusetts, to acquire desired technology.
The Massachusetts firm, federal authorities now say, was merely a front to facilitate the export of defence technology from U.S. manufacturers to Chinese institutes related to the military. Wu now sits in a federal prison after being sentenced in January to eight years for conspiring to export restricted technologies illegally.
According to the Department of Defence, the exported items are “vital for Chinese military electronic warfare, military radar, fire control, military guidance and control equipment, and satellite communications.” Also included: parts “that the People’s Liberation Army actively seeks to acquire.”
The use of front companies, or private firms that may also do legitimate business, is a common way that China seeks information, said Pelak, who in 2007 was appointed the Justice Department’s first national export control co-ordinator, focusing on illegal export of munitions and sensitive technology. Prosecutions have since gone up, and today two-thirds of federal illegal export cases involve either China or Iran.
Take the case of William Chi-Wai Tsu, an electrical engineer serving a three-year prison sentence for illegally shipping several hundred thumbnail-size integrated circuits to a Beijing company called Dimagit Science Technology. Investigators said the circuits have a variety of applications, including use in sophisticated communications and military radar systems.
Among Dimagit’s clients: a research institute affiliated with the state-owned China Aerospace Science and Technology Corp. Dimagit’s catalogue, according to court records, promised: “We unswervingly take providing the motherland with … electronic technical support to revitalize the national defence industry as our mission.”
Court records describe how Tsu went about acquiring restricted parts: He created a fictitious company and used the California address of a friend for shipping. He then provided false end-user statements to American electronics distributors, promising that the parts he sought were not for export but for domestic use, specifically a project with Cisco Systems. If a distributor pressed Tsu, he would claim that nondisclosure agreements prevented him from providing more detail.
Similar tactics were used in a case still awaiting sentencing in Seattle, Washington. Lian Yang, a former software engineer at Microsoft, pleaded guilty in late March to attempting to buy restricted technology for a “partner” in China — specifically 300 radiation-hardened programmable semiconductor devices that are used in satellites. In conversations with a confidential FBI source, Yang suggested creating a fake U.S. company to list as the end-user.
Yang was arrested last Dec. 3 after he handed $20,000 to undercover agents in exchange for five of the devices. His sentencing is set for June 30.
Prosecutors argued in court papers that the offence “amounted to a form of espionage on behalf of” China.
However, some defence attorneys counter that these export cases are not espionage at all or even deliberate attempts to circumvent U.S. laws, but rather an outgrowth of confusing policies and, perhaps, overzealous prosecutors.
In the Chitron case, appeals lawyers for Alex Wu insist U.S. export regulations do not make clear enough what can and cannot be exported legally.
“Wu and others at his firm were not equipped and did not have the training needed to understand this country’s extremely complicated export control laws,” said his lawyer, Michael Schneider.
Stephanie Siegmann, the assistant U.S. attorney who prosecuted the case, responded that evidence clearly showed that Wu did understand the restrictions. One spreadsheet found on his computer was titled, “GP (Gross Profit) for USA Restricted Military Parts.” Among the parts exported: phase shifters used in military radar systems.
“With such equipment,” the Defence Department’s Defence Technology Security Administration concluded, “China could defeat U.S. weapon systems.”
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This year, retired FBI agent I.C. Smith gave a speech called “China’s Mole” at the International Spy Museum in Washington, D.C. It was about a man who landed a job with the Central Intelligence Agency and later turned out to be a spy for China.
He was referring to one of the most damaging Chinese espionage cases of all time: the infiltration of Larry Chin, who in 1986 admitted to spying for China during his almost three decades with the CIA. As a former Chinese counterintelligence supervisor, Smith helped investigate Chin, and he was stunned to learn of the 5 1/2-year recruitment of Glenn Shriver and China’s “run at the front door” of America’s pre-eminent intelligence agency.
“The Chinese,” Smith said, “still have the capacity to surprise.”
How did they do it in Shriver’s case? Standing before a federal judge on a blustery day in January, Shriver tried to explain how he went down the path to betrayal.
“It started out fairly innocuous,” he recalled. During a college study-abroad program in Shanghai, he was taken with Chinese culture and became proficient in Mandarin. After graduating from Grand Valley State University in Michigan in 2004, he returned to China to look for work.
Shriver was just 22 years old when, in October 2004, he first met a woman in Shanghai called “Amanda.” According to court documents, he had responded to an English-language ad looking for scholars of East Asian studies to write political papers. He wrote one about U.S.-China relations regarding North Korea and Taiwan, and was paid $120.
“Amanda” later asked Shriver if he would be interested in meeting some other people, two men he came to know as “Mr. Wu” and “Mr. Tang.”
As outlined in court documents and Shriver’s own statements, their conversations, at first, focused on developing a “friendship.” The men asked Shriver what type of work he was interested in and said that if he planned to seek a job with a U.S. government agency, “we can be close friends.” Had he ever thought about working for the U.S. State Department or, perhaps, the CIA? “That would be pretty good,” they told him.
“Only one time was I told that they would like secrets,” Shriver told the judge.
Six months after first meeting “Amanda,” Shriver applied for a job with the U.S. State Department. Although he failed the foreign service exam, the intelligence officers paid him $10,000. A year later, in April 2006, he took the exam a second time but again failed. He was nevertheless paid $20,000.
Then, in June 2007, Shriver applied for a position in the clandestine branch of the CIA. A few months later, he asked the Chinese intelligence officers for $40,000 for his efforts.
During all this time, friends and family, Shriver’s mother, especially, thought he was just trying to figure out what to do with his life. He talked about becoming a police officer or joining the Peace Corps. Eventually he returned overseas, this time to Korea, where he taught English and got engaged.
No one knew he was continuing to communicate with his Chinese handler, “Amanda.”
In June 2010, Shriver underwent a series of final security screening interviews at the CIA in Virginia. A week later, he was arrested — U.S. officials would not disclose what led them to him — and his clandestine life unraveled.
“Nobody knew. Nobody,” said his mother, Karen Chavez. “He was a good kid. … I don’t know what he was thinking.”
The closest her son came to an explanation was when he told the sentencing judge: “I think I was motivated by greed.”
In a telephone interview from prison in April, Shriver tried to expand on that.
“When you’re 23 years old living in a very fun city, you almost get addicted to money,” he told the AP. “After a while it’s kind of like: OK, I’m kind of up on what these guys are doing. But by then it’s just money getting thrown at you. I’m just like … I can apply to this, get some money and then just continue on with my life.”
Shriver pleaded guilty to conspiracy to communicate national defence information and is serving a four-year prison term.
It is true that he was, after all, never in a position to do any real spying. No harm done? That may depend on how you look at it.
“This case shows an aggressive attempt by (China) to recruit an American citizen and attempt to place him in one of the nation’s premier intelligence agencies,” said Neil MacBride, the U.S. attorney for the Eastern District of Virginia, whose office has handled a number of China-related intelligence cases.
“Foreign intelligence services are watching,” he said, “and they’re looking for any weakness they can identify and exploit.”
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Pauline Arrillaga, a Phoenix-based national writer for The Associated Press, can be reached at features(at)ap.org.
