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Insider Traders Who Push Too Far Can Pay Dearly

Exactly what made Tsao's trade stand out, NASDR officials won't say, but they do say that they began their investigation the day after MedImmune's acquisition of Aviron was announced. Within a few weeks, Tsao's name was on a list of accounts that were under investigation.

The electronic trading trail showed that Tsao bought 10,000 shares of Aviron the day after Thanksgiving 2001. A few days later, MedImmune announced plans to buy Aviron in a $1.6 billion stock swap and the shares jumped from about $35 apiece to more than $50.

U.S. Attorney Thomas DiBiagio, right, prosecuted Eric Tsao after the case grew from a civil to a criminal proceeding. (Dennis Cook -- AP)

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As the computer searching technology known as "data mining" has become more sophisticated, it has gotten better at spotting suspicious trading, said Cameron K. Funkhouser, senior vice president for market regulation at the NASDR.

"History has shown certain scenarios where there is traditionally insider trading," he said. "Our technology is looking for patterns of behavior in the stocks that suggests to us, under different scenarios, potential insider trading or potential fraud."

Mergers and acquisitions are at the top of the list of situations in which insider trading can occur, so every merger triggers a review of the action in the stocks of the companies involved, Funkhouser said.

Obviously, big trades just before a deal is announced will set off the alarms. How big is one question Funkhouser won't answer. "People try to stay under the radar screen," he said. "It doesn't work."

The investigation begins with gathering basic data. From brokerage, the NASDR gets lists of accounts that were trading the stock. From the companies involved, the regulators get detailed timelines of when merger talks began and who, at each step of the process, knew what was going on. Company executives, lawyers, investment bankers, even the clerks who type documents are looked at, their names and addresses checked against stock trading records. Meanwhile, names that turn up on lists of suspicious trades are taken to the companies, to see if any of them are recognized.

Funkhouser's team of regulators has dozens of these insider trading investigations going on every day. Most of them don't turn up anything. But they score two or three times a week, referring about 150 cases a year to the Securities and Exchange Commission.

It's the SEC that actually prosecutes insider trading cases. When they become a criminal matter, as they did in Tsao's case, the SEC turns them over to the Justice Department.

Most of the time, insider trading is not treated as a crime. It is a civil violation of securities laws, handled by a civil lawsuit against the violator. The vast majority of those cases are settled by plea bargaining. The typical punishment in a civil insider trading case is a fine and repayment of any ill-gotten gain. People who work in the securities business are often banned from the industry, temporarily or permanently, for insider trading. People who are officers or directors of public companies are usually barred from serving in such posts.

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