Anatomy of a Scandal: How Alleged Insider Trading Operated : Four Cases Illustrate Prosecutors’ Far-Ranging Charges of Wrongdoing

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Federal prosecutors this week have weighed in with a new round of insider trading charges, rounding up high-level officials at some of Wall Street’s most prestigious firms. Four of the allegations of insider trading are detailed here.

It was in April, 1985, that Robert M. Freeman, head of the risk-arbitrage department at Goldman, Sachs, had an important telephone conversation with Martin A. Siegel, then a takeover specialist for the rival investment banking firm of Kidder, Peabody.

It was a conversation that ultimately would prove damning for the 44-year-old Freeman, who was arrested this week for criminal violation of federal securities laws.


According to documents released in connection with Freeman’s arrest, here’s what happened:

Freeman told Siegel that Unocal, the Los Angeles-based oil company, was about to announce a partial buyback of its common stock in an attempt to thwart a pending hostile takeover bid by corporate raider T. Boone Pickens Jr.

Freeman obtained this inside information “in the course of his professional employment” at Goldman, Sachs, which was acting as investment adviser to Unocal in the takeover fight.

Among the key bits of information relayed to Siegel were how many shares Unocal was willing to buy and the fact that Unocal intended to exclude from the offer any shares owned by Pickens. This kind of news was valuable to Siegel because Kidder had a large chunk of Unocal’s stock of its own that it had acquired after Pickens announced his hostile takeover bid.

Armed with this information, Siegel relayed the news to the department at Kidder that speculated in the stock of possible takeover targets. Siegel discussed with these arbitrageurs--as the stock speculators are called--how they “could maximize Kidder’s profit on the situation,” prosecutors charge.

If Unocal’s partial buyback was successful, they reasoned, the price of Unocal’s remaining stock would fall. And that would hurt Kidder because the buyback offer would be prorated among the tendering shareholders.

That meant that Kidder would be able to get the buyback price for only some of its shares. The value of its other stock would probably drop.


What was eventually decided was a strategy that would allow Kidder to profit from a drop in Unocal’s stock. To do that, the investment firm bought what are known as put options.

Their reasoning was as follows:

Buying put options allows shareholders to sell a particular stock at a fixed price within a specified period of time, usually three to five months. If the value of the stock goes down, the investor exercises his option to sell at the higher exercise price. If the stock goes up, the investor allows the option to expire unused.

“By buying enough puts to cover Kidder’s probable remaining position in Unocal stock after the buyback, which they could closely estimate based upon the non-public information disclosed by . . . Freeman, Kidder would subsequently be able to make a large profit on that stock as well, by selling it at the exercise price,” prosecutors said.

Pickens announced his bid for Unocal on April 8, and it was on April 16 that Unocal announced its first buyback plan. After a court ruled a later plan legal, Pickens withdrew his takeover bid on May 20. On May 21, Unocal’s stock fell more than $10 a share.