Inside Traders or Astute Observers
Case 10.3 Inside Traders or Astute Observers?
in 2009, federal authorities broke up the biggest insider- trading ring ever. Originally focused on the
Galleon Group hedge fund, the investigation soon unraveled a complicated network of nearly two dozen
traders, analysts, and lawyers at several different companies who were engaged in a criminal
conspiracy to buy insider information, usually about pending corporate acquisitions. Using throw-away
cellphones to avoid detection, they had netted $ 20 million in illegal profits. Allegedly at the center of it
all was ringmaster Zvi Goffer of the Schottenfeld Group and later Galleon, nicknamed “ Octopussy”
because his arms reached out to so many sources of information. Among those caught up in the federal
dragnet was a senior vice- president at IBM, Robert Moffat, who had been induced by his lover into
divulg-ing confidential information, which she then passed on to the head of Galleon Group. Since that
case, the Securities and Exchange Commission ( SEC) has been pushing hard against securities fraud in
gen-eral and insider trading in particular, using informants, wire-taps, and sophisticated software tools
to make a number of prominent arrests. “ Illegal insider trading is rampant and may even be on the rise,”
says Preet Bharara, the U. S. attorney in Manhattan. A main target of recent investigations has been the
so- called “ expert network firms” that arose in response to an SEC rule in 2000 that banned companies
from selectively divulging significant information, such as upcoming earnings reports, to favored
analysts. These firms purport to offer “ independent investment research” but routinely deliver inside
information on revenue numbers and sales forecasts. In Bharara’s view, however, it’s not just about the
prosecuting the big fish on Wall Street: “ The people cheating the system include bad actors not only at
Wall Street firms, but also at Main Street companies.” However, some think the SEC is now pushing too
hard and too far. Take the case of Gary Griffiths and Cliff Steffes, who worked in a rail yard owned by
Florida East Coast Railways in Jacksonville, Florida. The SEC has charged them with making more than $ 1
million by trading on inside informa-tion, specifically, on the information that their company was going
to be sold. How did they do it? After all, one of them is a mechanical engineer, the other a trainman—
not your usual corporate insiders. The answer is simply that they were observant. According to the SEC,
the two noticed that “ there were an unusual number of daytime tours” of the rail yard with “ people
dressed in business attire.” Although they were not told anything, officially or unofficially, Griffiths and
Steffes had a hunch that something was up. Along with members of their families, they bet that a deal
was in the works by buying tens of thousands of call options on the company’s stocks. That gave them
the right to buy the stock at its current price at some future date. ( Purchasers of call options make
money if the stock increases in value because they can then buy it at its earlier, lower price. If the stock
decreases in value, then the buyers simply don’t exercise the options; they’re out only whatever they
paid for the options.) In this case, when Fortress Investment Group acquired Florida East Coast Railways,
the value of the lat-ter’s stock shot up, and Griffiths, Steffes, and their families were able to cash in big-
time. Critics of the SEC say that it is going beyond making sure that insiders are not abusing their
positions or violating their fiduciary duties. Joel M. Cohen, a partner at the law firm of Gibson, Dunn &
Crutcher, has written that the SEC is moving from “ deterring and punishing those who abuse special
relationships at the expense of shareholders into a murkier area . . . [ of] policing general financial
unfairness.” Other business observers agree with him that the SEC shouldn’t focus on trying to make the
markets “ feel” fair to everyone. For its part, the SEC contends that Gary Griffiths and Cliff Steffes were
more than just observant. After the tours began, they had heard “ rail yard employees… expressing
concerns that [ it] was being sold, and that their jobs could be affected by the sale.” It also claims that
Griffiths was asked to make a list of all the locomotives, freight cars, trailers, and containers owned by
the company, along with their current value, some-thing he had never been asked to do before. “ Is all of
that material information?” asks New York Times business col-umnist Andrew Ross Sorkin. “ Clearly, it is
nonpublic. But without being told directly that a deal was in the works, did the men actually have inside
information? What would have happened if there had been no deal? Or if the company was later sold for
a price below its prevailing stock market value?” And as Joel Gibson points out, in most cases, “ if you
overhear something and divine from the conversation that Party A is about to buy Party B, and you buy
Party B, that’s fine. You can do that.” On the other hand, both Griffiths and Steffes had signed the
company’s code of conduct, which states that employees cannot trade on or disseminate material
nonpublic information. So maybe they breached a fiduciary duty after all. Or maybe they were just alert
employees, who happened to be good guessers and— until the SEC showed up, anyway— very lucky.
Discussion Questions
1. Did Griffiths and Steffes violate any legal or moral duties toward their employer? Did they act unfairly
in some way?
2. Were they “ insiders”? If so, explain why. If not, does that imply that they cannot be guilty of insider
trading or that what they did was morally permissible?
3. Should the law prohibit employees acting as Griffiths and Steffes did? Explain why or why not. If
actions like theirs are tolerated, will it diminish people’s faith in the fairness of the stock market? Would
permitting it set a bad precedent in other cases?
4.Putting legal technicalities aside, did Griffiths and Steffes act unethically? Explain the facts and moral
principles that support your answer
. 5. In your view, is insider trading a serious moral problem? Explain why or why not. Should we legalize
insider trading, as some argue, and simply let different companies decide how they want to deal with
the issue?
6. Suppose Griffiths and Steffes were not employees of Florida East Coast Railways, but merely lived
across the street and guessed what was going on. Could they still be guilty of insider trading?
7. Assuming that insider trading should remain outlawed, does prosecuting Griffiths and Steffes
represent a wise use of the SEC’s resources, or should it ignore cases like this?
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