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Insider trading may be easy to define, but it’s really hard to prove. Yet a sharp stock-price jump on low trading volume is sure to draw some regulatory attention, innocent or not. A recent case in point: Shares of VoiceStream Wireless Corp. and Powertel Inc. suddenly spiked just before the Aug. 27 announcement of a three-way merger involving the two companies and Deutsche Telekom AG. The rise has all the signs of the kind of activity that attracts the attention of the two principal regulators of insider trading police on U.S. stock markets: the Securities and Exchange Commission and the National Association of Securities Dealers Inc. Regulators routinely decline to comment on specific incidents before a case is filed. But in general terms, an unaccountable increase in share price, especially on low volume, will automatically attract notice, said Cameron Funkhouser, vice president of market regulation for NASD Regulation. NASDR is an independent subsidiary of the National Association of Securities Dealers charged with regulating the securities industry and the Nasdaq. NASDR has 12 investigators working full time on insider trading. If NASDR’s inquiries show insider trading may have taken place, the agency refers the case to the SEC or other authorities. From there, the process can take months or years. The VoiceStream acquisition of Powertel was rumored for more than a month before the $5.9 million deal was announced, with plenty of speculation on the Yahoo! and Raging Bull bulletin boards. The international edition of Newsweek in early August even mentioned a possible deal. But trading charts suggest only a few investors anticipated the exact timing of the deal. The Powertel bulletin boards on both Yahoo! and Raging Bull were silent during the four days immediately preceding the merger announcement. The VoiceStream boards carried only a few messages on other topics. And there were no news reports of important developments relating to Powertel in August. The only major news about VoiceStream was its reported drop in earnings in early August. Then, Powertel’s price shot up nearly ten percent, past $88 on Aug. 25, on trading volume of only 161,200 compared with the average volume of 235,000. The first leap in trading volume occurred on Aug. 28, the day after the announcement. about 4,316,500 Powertel shares traded that day with the price dropping to $80 early in the morning, which, after some fluctuation, is where it is now. In the week before the announcement, VoiceStream’s share price also moved up on low volume, though not as dramatically. The company’s stock price had dropped from more than $130 on Aug. 13 to around $106 on Aug. 22. It began to climb on Aug. 23 and passed $118 on Aug. 25 on a trading volume of 1,332,500, half the average. The price rose slightly on Aug. 28 before a drop on an above-average volume of 3,909,800 shares. As with Powertel, the share price has continued to fluctuate, and it is currently trading around $115. Did someone with inside information buy VoiceStream and Powertel shares before the merger announcement? A Powertel spokesman said the company doesn’t comment on stock price swings. VoiceStream did not explain the price rise. According to Funkhouser, its investigators review the trading activity of every Nasdaq and over-the-counter stock involved in M&A as soon as a deal is announced. “The trades are captured and displayed, and they’re retained and stored, along with the quotes. Every trade report is a footprint,” he said. Funkhouser said in most cases it’s obvious quickly whether a full probe is necessary. If something appears amiss, NASDR personnel reconstruct the circumstances surrounding the deal by interviewing everyone involved. “Once we’ve established a chronology, we identify the periods of time to look at,” he said. “Then we get all trading activity in an electronic form covering the trades during those periods, and begin to slice and dice.” “I can’t give away trade secrets, but generally we look for patterns in things like names, ZIP codes, new accounts, unusual pockets of trades,” Funkhouser added. If the trading takes place with human brokers, the NASDR will interview them, seeking to pin down who placed the trade and the conditions under which the transaction occurred – did the purchaser register, for instance, his name under his spouse’s name. “We ask how the shares were paid for,” Funkhouser said. “If someone with an annual income of $40,000 suddenly buys $500,000 worth of stock, we want to know where the money came from. We also check out the Internet message boards to see if anyone was giving out information before the deal was announced.” NASDR strives to complete its inquiries within 90 days after a deal is announced to ensure fresh memories. “But in any case, the footprint is always there, and we can always follow the money,” he added. If NASDR’s probes reveal possible insider trading, it refers the case to the authorities. Certain inquiries, such as identifying a writer on an Internet bulletin board, can only be carried out under subpoena. Funkhouser said NASDR conducts 200 to 400 insider trading investigations per year. It refers an average of 120 to the SEC or to law enforcement. And NASDR isn’t the only organization passing on suspected cases to authorities. The New York Stock Exchange, American Stock Exchange, and Nasdaq routinely monitor trades in real time through work stations programmed with algorithms that detect anomalous trading patterns. Cases that can’t be explained right away go to regulators for further action. “We want to level the playing field,” Funkhouser said. “We’re not perfect, but we’re really good, and we’re vigilant. We’re like the cop on the street – we’re on the front line.” NASDR’s evidence does not necessarily result in a conviction or administrative action. Funkhouser had no figures indicating how many cases NASDR refers are even prosecuted, much less how many result in convictions or settlements. Available information suggests the number is relatively low. The SEC filed 288 cases between 1994 and 1999 involving insider trading as either a primary or secondary charge in civil court proceedings or as administrative proceedings. That includes 57 cases in 1997, 49 in 1998, and 50 in 1999. The SEC has no figures on the outcomes of these proceedings. The Department of Justice’s Southern District of New York initiated dockets for 23 court cases involving insider trading in the first half of this year, compared with only two in 1999 and 11 in 1998. A review of press reports for the year identified 26 cases of insider trading processed at various stages, from arrest to settlement or conviction. The actual dates during which the alleged insider trading took place ranged from 2000 to as far back as 1992, and one case, imposing a fine for a previous conviction, dated to the late 1980s. “Insider trading is very hard to prove,” Funkhouser said. “Typically there are no confessions, and the investigations are resource-intensive. Investigators have to do things like collect phone records and interview people, and the element of proof required to support a violation is extensive.” In one notable example in April, a federal judge in San Jose, Calif., threw out most of an SEC lawsuit against an employee of Molecular Dynamics Inc., who, with family and friends, traded heavily in the company shares around the time it reported sales and earnings shortfalls. The SEC alleged computer engineer Hanh Truong could have gained access to the financial information because of the company’s open office plan, but the judge ruled the SEC failed to show Truong had, in fact, obtained the information, and that the suspicious timing of his trades was not in itself adequate evidence of guilt. Valerie Caproni, director of the SEC’s Pacific Regional Office, “respectfully disagrees” with court findings in that particular case, but she has found that not all suspicious trading patterns involve illegal activity. “Often a case referred to us through market surveillance appears suspicious, but it turns out that there are credible explanations for trades at that particular time,” she said. It’s a mistake to think of insider trading as only occurring in the 1980s. “Insider trading is not a very sophisticated crime,” Caproni said. “Recently we’ve been seeing more of what we saw ten or 15 years ago, with analysts providing information to outsiders and splitting the profits. “It’s like a new generation has come up that has to be taught the same lessons over again.” Copyright (c)2000 TDD, LLC. All rights reserved.

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