Is the Stock Market Rigged? (Many Believe So)

Most Americans today think the stock market is rigged, and they’re probably right. New findings reveal that people with special information are trading unfairly. But strangely, no one is paying much attention to this.

Meet Jimmy Filler. He made a lot of money by buying and selling scrap metal in Birmingham, Ala. Now he’s almost 80 years old and mostly retired. He likes collecting old cars and stuff from casinos. He also got a huge 20,000-square-foot mansion on a hill near the city.

Plus, he gave $1 million to help the University of Alabama at Birmingham’s football team build a practice place. Because of all this, people in his hometown think he’s a big shot. But what’s even more interesting is that he’s a really important person among a certain group of stock traders.

➤ Here’s Why Filler Seems to Always Make Money

Filler’s like a stock market wizard. He’s really good at picking the right companies to invest in.

Let me give you an example: Out of the 496 times he bought and sold shares in two companies, ServisFirst Bancshares Inc. in Alabama (where he’s on the board) and Century Bancorp Inc. in Massachusetts (where he’s a big owner), he made a profit 372 times.

That’s 75%! It’s like hitting the final table in the World Series of Poker two years in a row.

Experts say Filler is the best at this kind of thing in the whole U.S. TipRanks, a company that rates how good executives are at timing their stock trades, even calls him the most successful insider.

When Filler buys shares in those companies, 2,699 TipRanks subscribers get a message. Some of them copy him and buy the same stocks, hoping to make money too.

You know, an insider is someone high up in a company or who owns a big chunk of it. There are about 82,000 of these folks in the U.S. When they buy or sell company stock, they have to tell everyone about it within two days.

But not all of their moves mean the same thing. Sometimes, they’re just cashing in old stock options, which doesn’t tell us much. Other times, they might be selling for personal reasons, like buying a boat. But when they use their own money to buy stock on the regular market, that’s when it’s interesting.

TipRanks has a clever way to figure this all out. They use a computer program to look through all these insider disclosures. They throw out the ones that don’t seem important. Then, they make a list of the top 25 insiders who are really good at this game.

They check how often they make money and how much they make each time. People with a long history of success, like Filler, get extra points.

Other stock market stars in this list are folks like Steve Mihaylo, who runs a phone company and owns a bunch of its stock. He’s made money on 83% of his trades in the last five years, even when his company’s stock was going up and down.

Then there’s Snehal Patel, who runs a pharmaceutical company. He’s made only five trades, but four of them were before his company announced good results for a cancer drug test. These guys know how to make the right moves.

Filler says he’s in it for the long haul with Century and he’s never been officially connected to the company. He’s never sold any of his shares in Century or ServisFirst. Patel points out that the good news about his company’s drug trial was already out there before he traded. Mihaylo didn’t want to say anything about it.

➤ Even Regular Executives Can Outsmart the Market

Here’s something interesting: Between 2015 and 2020, people in charge of big American companies who bought company stock did better than the S&P 500 index. On average, they made five percent more over the next year, according to TipRanks.

Now, this might sound kind of sneaky to those who don’t know much about the rules for insiders trading in the U.S. You see, it’s against the rules for insiders to trade based on secret, important information.

But here’s the thing: it’s been a not-so-secret secret on Wall Street that insiders often use their inside knowledge to trade. Way back in 1962, a guy named Perry Wysong started a newsletter about trading based on what insiders were doing.

A young stockbroker named George Muzea later gave advice to big shots like George Soros and Stanley Druckenmiller. They used to call the best opportunities “studs.” And in 2008, some math experts at Citigroup found out that copying insider trades could make you around 23.5% a year—more than most super-rich hedge funds.

Now, let’s be clear: We don’t know for sure if Filler or the other stars from TipRanks are using secret info. It’s like the poker legend Doyle “Texas Dolly” Brunson making a bunch of lucky final tables. Sometimes you can flip a coin and get heads a lot. And, well, insiders do have a better idea about how their own company is doing.

But here’s the thing: More and more research is showing that many insiders are making smart trades not just because of luck or guessing. There’s a strong sign that a lot of executives are trading so well because they know things before others do.

It’s like they’re playing a game with loaded dice. And you know what’s surprising? Nobody—neither the regulators, nor the Department of Justice, not even the companies themselves—is really trying to stop this.

Daniel Taylor, who’s really smart about this stuff, says there’s a big problem. He’s a professor and runs the Wharton Forensic Analytics Lab. He thinks there’s a lot of unfairness happening in the stock market. He says, “Most Americans today think the stock market is unfair, and they’re right.”

➤ Insider Trading

Think about it like this: Insider trading is like a top-tier white-collar crime. It’s the sneaky stuff Bobby Axelrod pulls in the TV show Billions and what Gordon Gekko in Wall Street did when he famously said, “Greed is good.”

In real life, too, insider trading shows how the market seems to favor rich corporate bigwigs. This feeling is behind both the recent meme-stock craze and the popularity of cryptocurrencies.

Here’s the deal: When a big-shot executive learns secret info and uses it to sell shares to an unsuspecting retirement fund, or a board member gets wind of a possible company takeover and starts buying stock, they’re making money at the expense of regular folks.

Going after insider trading is like making sure everyone gets a fair shot, says Preet Bharara, who used to be a big lawyer in New York. He wrote in a newspaper in 2018 that it’s not right for well-connected people to have unfair advantages over regular citizens.

Now, on paper, the law against insider trading is pretty simple. It’s in the Securities Exchange Act from way back in 1934. Basically, if a bigwig uses secret info to trade or tells someone else to trade, they can be charged with fraud and even end up in jail. But catching and punishing them is way trickier than it sounds.

Even smart regulators and lawyers have a tough time with it. Some politicians, like Elizabeth Warren from Massachusetts and Elise Stefanik from New York, want to fix the rules. They’re getting pushed by people like Daniel Taylor, who’s a researcher in this stuff.

Taylor started digging into this topic in 2016, not long after he got to Wharton. He wrote a draft paper that showed employees at banks who used to work for places like the Federal Reserve did way better in the stock market during the 2008 financial crisis. This was when the government was giving out bailouts. Someone from the enforcement agencies wanted to meet up and talk about how he did it.

With help from friends at Stanford and other places, Taylor has done about six papers. He uses math to look through big piles of info from the SEC and other sources to find clues about insider trading. He hopes their work will shine a light on this behavior, and maybe the big institutions will finally start doing something about it.

➤ Uncovering Insider Actions

One area Daniel Taylor delves into is how insiders behave when their companies are facing tough times. Every year, the SEC investigates lots of companies, but not all these investigations lead to anything.

Plus, companies don’t have to tell their shareholders anything about these investigations. It’s also up to the companies to decide if their employees should stop trading. Most put a pause on trading before they announce their earnings, but beyond that, they’re pretty lenient about letting their bigwigs trade.

After a lot of effort, Taylor convinced the SEC to give him a super long list of investigations from 2000 to 2017. He compared this list with the Form 4 disclosures. What he found was that insiders, as a group, managed to avoid losses by selling shares before their companies’ legal troubles affected the stock price.

Taylor got the idea after he saw the stock of Under Armour Inc. drop by 18% when the Wall Street Journal reported that the company’s financial practices were being investigated. Before that, insiders had been selling shares to unsuspecting buyers. This kind of story is more common than you’d think.

For instance, at CBS, shareholders are suing because board members sold shares before the company revealed its CEO was under investigation for sexual harassment. An executive at Boeing sold $5 million in stock after managers were told that a software issue might have caused a plane crash.

But the company didn’t tell the public until five months later, after a second crash. These examples show how insiders can make money while regular people take the hit. Boeing said its officers can only trade during specific times, while Under Armour didn’t comment. CBS said all their execs’ transactions were either planned or approved.

In another paper, Taylor looked into what insiders do when their companies are being checked by auditors. He found that insiders bought and sold more stock in the weeks right after the audit report was shared with the board but before it was made public.

These insiders could avoid losing money, especially when a company had to change its financial results. Over and over again, Taylor’s research showed that “insiders appear to exploit private information” to make extra money. In short, cheating seemed to be happening everywhere.

This all points to a problem with how the U.S. handles this stuff. The rules about disclosing information are not so clear. In the U.S., companies can decide a lot about what’s important to tell everyone.

This makes a gray area between what’s worth sharing and what directors want to trade on. Lawyers have to make decisions all the time about when to tell the world about things like mergers, investigations, or cyberattacks. Taylor says, “If something can change the stock price, insiders shouldn’t be allowed to trade it. Sadly, not all lawyers see it that way.”

At the start of the pandemic, some pharmaceutical company executives got in trouble for making trades that seemed to benefit from good vaccine news. This revealed another problem with the system.

These trades were made using something called 10b5-1 plans. These are schedules for trading that insiders set up ahead of time and have someone else execute. These plans were made in 2000 to let insiders sell shares without getting accused of anything, even if their trades ended up being lucky.

However, Taylor says these plans can be abused. There’s no rule that insiders have to wait after making a plan to start trading. Just three days before Moderna Inc. announced that its Covid-19 vaccine was ready for human testing, its chief medical officer set up a plan to sell shares.

The program matched with Moderna’s stock price going way up, and the officer made $3.4 million.

Moderna said the sales were part of plans set up “well in advance”. This kind of thing happens a lot. A recent study by the Rock Center for Corporate Governance found that 14% of executives set up plans to trade within 30 days and 39% within 60 days. This means they probably knew things others didn’t.

The study also found that about half of these plans involved just one trade, not a series like the SEC wanted. These single trades saved insiders from losing up to 4%, which suggests they used these plans to avoid bad news.

The biggest problem with the 10b5-1 plans is that insiders can change their minds. They can cancel and redo their plans whenever they want. This means insiders could make a new plan every few months and decide to keep it based on how the next earnings report looks.

Gary Gensler, the SEC’s new chairperson, said he’s looking into making a “cooling off” time between setting up these plans and making the first trades. He’s also thinking about stopping insiders from canceling planned trades to make a profit. Gensler thinks these plans have problems that need fixing.

➤ The Challenge of Holding Insiders Accountable

Gary Gensler’s view might not be telling the full story. In the past 20 years, the SEC hasn’t brought even one insider trading case involving trades made under a 10b5-1 plan. And lately, there haven’t been many charges against individuals or companies for this violation either. In 2019, the agency only took action against 32 cases of insider trading, the lowest number in more than two decades.

Last year, that number slightly rose to 33. The cases that do get brought forward usually revolve around insiders sharing tips with accomplices, often called “tipper-tippee” cases, like what landed Martha Stewart in jail for five months.

These cases differ from the opportunistic trading by executives highlighted by Taylor’s research. Taylor finds this to be a significant blind spot. The SEC declined to comment or provide an interview.

➤ The Insider’s Comfort Zone

So, why isn’t the government doing more? Part of the answer is how insider trading laws have evolved. Oddly enough, there isn’t a specific law for insider trading like there is for most federal crimes.

The concept that it’s illegal only gained widespread acceptance in 1961, when the SEC charged a stockbroker named Robert Gintel with securities fraud for selling aviation company shares after learning about an upcoming dividend cut.

The Gintel case set a tough standard. To prove securities fraud, it’s not enough to show someone made money from nonpublic information; prosecutors must prove the person knew they had such information and intended to deceive.

This makes it one of the trickiest white-collar crimes to prosecute. “Insider trading is tough to prove without direct evidence,” says Russ Ryan, a former SEC assistant director now working at the law firm King & Spalding. “And because there’s no clear law, the rules are vague and unpredictable. Jurors don’t like convicting when the law isn’t clear.”

Ankush Khardori, who worked at the Justice Department’s Fraud Section until 2020, says it’s even harder when the alleged tipper and tippee are the same person. “Most of the crime in insider cases happens in the executive’s mind,” he says.

“Evidence you’d hope to see in tipper-tippee cases, like emails or calls, isn’t likely.” He also points out that insiders do have a legitimate advantage over others. “Insiders have experience that lets them understand public information in ways others can’t. Defense lawyers can argue, ‘This wasn’t inside info. They were just better at reading public data.'”

The widespread use of trading plans adds another challenge for prosecutors. Khardori explains, “There’s this whole set of rules and conventions—10b5-1 plans, trading windows, compliance programs—that executives can use to say, ‘I did everything by the book. I followed the rules!'”

Prosecutors could argue that a plan wasn’t made in good faith, but that’s hard to prove in court, and they hardly ever do. As Lisa Braganca, a former SEC regulator, says, “Nobody wants to be in the news for failing.”

They also don’t want convictions overturned. Preet Bharara, the former U.S. attorney, was known for going after insider traders, including prominent hedge fund managers. But in 2014, some of his office’s convictions and guilty pleas were overturned by an appeals court, making it even harder to win cases.

After leaving his job, Bharara formed a group of academics and lawyers to discuss fixing things. They suggested creating a new law defining insider trading as its own offense, separate from fraud. They also proposed making insiders liable in cases where they should’ve known they were trading on important info, even if there’s no evidence they did.

But these major changes aren’t likely to become law. A less drastic proposal, the Insider Trading Prohibition Act, passed in the House of Representatives with 350 votes to 75. It doesn’t create a new offense but defines insider trading, clarifying the rules. The next step is getting it through the Senate, which has been tough for previous insider trading bills.

Taylor believes the government needs a more sophisticated approach to spot and prosecute insider trading. He suggests using data to model how much insiders would’ve made with different trades. This could be valuable evidence.

He’s shared this with regulators, and the SEC created an analytics unit to explore this approach. Convincing judges to accept new forms of evidence is another challenge. In 2019, a judge wouldn’t let a lawsuit alleging insider trading and accounting problems at Under Armour proceed based on data.

But maybe the government isn’t charging many executives because some officials don’t think it’s a big issue. Before the Gintel case, trading on sensitive info was seen as a perk for executives at public companies. This thinking still sticks, even among those supposed to prosecute the crime.

Former government lawyers wondered how much damage well-timed trading really causes, compared to say, a Ponzi scheme that rips off elderly investors or Enron-style fraud that brings down a company. Selling stock to a CEO before the price jumps might mean missing out on a few dollars per share at most.

One former prosecutor remembered being asked during his interview what he thought of the argument that insider trading helps spread information quickly, making markets efficient. He replied, “I’ll follow the law as it stands to the best of my ability.” He didn’t mention he sympathized with the idea.

That some officials are unsure about enforcing the laws isn’t surprising to John Anderson, a professor at Mississippi College School of Law. He’s written many papers defending insider trading. He says it’s up to companies, not the government, to decide if employees can trade based on the organization’s intellectual property.

This way, insiders, once approved, can trade freely, knowing they’re helping the markets work better. Anderson says, “If investors don’t like a company’s loose controls, they can invest somewhere else.” Just like with legalizing drugs, the government could stop fighting a losing battle.

Viewed this way, services like TipRanks could be seen as helping information move faster from a few people to the masses, making markets more efficient. You don’t need to be a big-shot scrap metal mogul like Jimmy Filler; you can trade like him with a $29 TipRanks subscription.

The company raised $80 million from investors and is expanding its reach to Canada and the U.K. Even Eliot Spitzer, once a tough-on-Wall Street attorney general, is on the board. “Retail traders want this a lot,” says CEO Gruenbaum.

Revamping insider trading rules is challenging. We want executives to care about their companies, but when they own shares, they should be allowed to sell them. When they do, they’ll always have an advantage. Philip Moustakis, who left the SEC to work at the law firm Seward & Kissel, says, “No one believes insiders are ever truly free of inside info.

Trading windows, 10b5-1 plans—they’re part of the useful illusion we have. To completely stop insiders from using superior knowledge, we’d need to change how we handle corporate governance. Insiders would become more like trustees, and that won’t happen.”

Taylor refuses to accept this idea. He points to various proposals in the works, from adjusting 10b5-1 plans to redoing the entire insider trading framework. He says, “It’s not easy to fix anything important in society, but that’s not a reason to avoid doing it.” —With Matt Robinson.

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