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Associated Press
Pro golfer Phil Mickelson is under investigation for insider trading because of a purchase of Clorox stock.

Insider trading: It’s all about who you know

– Few crimes on Wall Street generate more headlines than insider trading.

The definition is straightforward: An investor profits on nonpublic information at the expense of others. But proving that someone did it can be complicated without direct proof that he cheated.

Difficulties have dogged investigations surrounding high-profile individuals over the years, including Michael Milken, Martha Stewart and SAC Capital’s Steven Cohen. That’s worth keeping in mind amid the swirl of news about a federal investigation into trades by Hall of Fame golfer Phil Mickelson.

A federal official briefed on the investigation told The Associated Press that the FBI and Securities and Exchange Commission are looking at stock trades that Mickelson and Las Vegas gambler Billy Walters made involving Clorox when activist investor Carl Icahn was attempting to take over the company.

There have been no charges filed against the three men, and the investigation could lead to nothing.

Here are the basics on insider trading and the Mickelson case:

Q. What is insider trading?

A. It’s when investors use confidential or advanced information that is not available to the market as a whole to make a profit or avoid a loss. People with inside information – such as company officers, directors or employees – can legally buy or sell their company’s stock, but only after significant information becomes publicly known. They must report their purchases or sales to the SEC, the government agency that oversees Wall Street.

Government regulators take insider trading allegations seriously and often investigate even if there’s just a hint of illegal trades.

Q. What’s the legal way to get information out?

A. Every publicly traded company in the U.S. is required by law to disclose aspects of its business, so the public can decide whether to invest. This information can be as simple as how much profit a company earned, who was elected to its board of directors, or who made significant purchases of company stock. Companies disclose these important events by filing forms with the SEC.

Q. How about an example?

A. Let’s say ABC Drug Co. is working on a new drug that it believes could bring in big profits. But the drug is discovered to have life-threatening side effects when it’s under review by the Food and Drug Administration.

ABC Drug decides this is “material information” that investors should have. It files a document with the SEC detailing the side effects. It also issues a press release so the information is spread quickly through the media.

The drug’s side effects are now public information instead of insider information, and investors can sell ABC stock. That’s how the process is supposed to work.

But let’s say in the days leading up to ABC’s announcement, the company’s CEO sells his stock and tells his family and friends to do the same.

The CEO, his family and friends could be investigated for insider trading. All of them likely knew that ABC’s drug had problems, and all were able to sell ABC shares at a higher price than if they had no insider information.

If this sounds familiar, it is. Federal officials accused Stewart of selling ImClone Systems stock on the eve of bad news about one of the company’s key drugs in 2001.

Q. Why is there an investigation into Mickelson?

A. A federal official told the AP that Mickelson and gambler Walters bought shares of Clorox about the same time in 2011. Federal investigators are looking into whether Carl Icahn shared information of his takeover attempt of Clorox with Walters, and whether Walters passed that information to Mickelson.

Why would information from Icahn be important? He is one of Wall Street’s biggest and most influential investors, someone who pushes for changes at companies he deems badly managed or underperforming. As an “activist shareholder,” Icahn has successfully pressured companies for decades. Whenever he makes a move against a company, its stock can rise.

In this case, Icahn decided to go after Clorox in July 2011, offering to buy the company. Icahn’s campaign was not successful, and he withdrew his bid in September of that year.

Q. Did Icahn break any laws?

A. One question is whether Icahn should be considered an “insider” in this case. It is not necessarily illegal for one investor to tell another investor how he plans to trade, under insider trading laws. But one could make the argument that Icahn’s activities, in themselves, should be considered material information.