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Insider Traders Who Push Too Far Can Pay Dearly

But basically, first offenders who get caught doing insider trading are forced to give back the money and to promise to never do it again. Rarely do they go to jail.

Martha Stewart and Eric Tsao made themselves exceptions to that rule.

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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Stewart was convicted of lying to federal agents who were investigating whether she had inside information when she sold shares of the biotech firm ImClone Systems Inc. just before the announcement that the company's new cancer drug had not been approved by the Food and Drug Administration. Stewart was never actually charged with insider trading, but is facing five months in prison for obstructing justice.

Tsao eventually pleaded guilty to insider trading and perjury. He tried to tell government agents that his wife had made one of the trades, coming into his MedImmune office, signing on to his company computer and placing the order. Later he admitted that was false.

Court documents reveal that when Tsao learned that he was under suspicion, he tried to cover his tracks. He called Schwab, pretending to be his father, to ask whether the firm kept e-mails and records of trades. The firm not only keeps them, it routinely records phone calls from customers to provide a backup record of a transaction. Investigators got not only the trading records, but the phone calls.

When they began studying Tsao's trading records, investigators uncovered two other instances of insider trading.

In 1999, Tsao bought 6,000 shares of U.S. BioScience Inc. after learning that MedImmune was in merger talks with that Pennsylvania company, which was developing drugs to treat AIDS and cancer. The $400 million acquisition was announced about a week after Tsao bought the stock. Within two weeks, Tsao sold the shares for an $18,000 profit.

In 2000, Tsao found out that MedImmune was negotiating to manufacture a cancer drug for ImClone -- the very same company involved in the Martha Stewart case. Counting on the deal to buy both stocks, Tsao bought 2,000 shares of ImClone and 2,000 shares of MedImmune. The drug manufacturing deal eventually fell through, but Tsao sold his ImClone stock several months later for a $50,000 profit.

Those two transactions radically revised the context of the case that originally brought Tsao to the attention of NASDR and the SEC. He wasn't just a scientist who couldn't resist one chance to make some quick money. He was a three-time insider trader who had lied to investigators.

Do it once and there's a good chance you'll walk away with a fine and a slap on the wrist. Three times plus perjury and you're referred to the Justice Department for a criminal prosecution. Criminal insider trading means jail time, a sentence of up to 10 years in federal prison. The perjury count, which parallels the crime of which Martha Stewart was convicted, carries a maximum five-year sentence, though Stewart got only five months.

Tsao's lawyer did not return calls and e-mail requests for comment.

Stewart is expected to surrender within the next few days to begin serving her sentence.

Tsao won't be sentenced until January.

The federal prison system is segregated by sex, so Stewart and Tsao won't have an opportunity to meet while they're serving their time. Too bad; they'd have a lot to talk about and a lot of lessons to teach anyone else who is tempted by an insider stock tip.

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