Insidious rise of the insider dealer

THE parasites are back and they are getting fat. A flurry of company takeovers has given the stock market a much-needed boost, but it has also seen the unwelcome return of the insider dealer.

Though regulators claim to be tougher than ever and electronic trading can be tracked, many share trades in the City still appear to be inspired by whispers and mutual back-scratching, inspiring the imaginary QT - 'quiet' - Index.

Analysis of recent takeovers shows that a small army of Square Mile professionals always seems to be ahead of the game - buying up shares just ahead of official announcements and pocketing huge profits.

The pattern can be seen in almost every major bid. Take Aggregate Industries. At 7am on 12 January, it was announced that German cement giant Holcim had approached the British sand and gravel group about a possible bid. In the week before the announcement, the shares jumped 8% and rose a further 4% on the day before the news.

Health club group LA Fitness announced on Monday, 13 December, that it had received several approaches. The previous week its shares had risen 5%, jumping 2.5% on the Friday alone.

The pattern even extends to the London Stock Exchange, which announced a takeover approach from Germany's Deutsche Borse, also on 13 December. The LSE has been an obvious takeover target for years and the only question was when it would happen.

But some investors appear to have guessed the timing with uncanny accuracy. In the week before the bid was announced, its shares rose 5% to their highest level since 2002.

Henk Potts, equity strategist at Barclays Stockbrokers, said: 'What gives some investors an opportunity is advance knowledge of a takeover situation. Things leak out and those in the know take advantage. That is when levels of dealing rise rapidly.'

One partner at a top accountancy firm dealing in corporate takeovers said it was well known in his profession where the leaks came from. 'As soon as a stockbroker or investment bank becomes involved in a transaction, the shares price goes mental,' he said. 'They do not care about insider trading - they just want to make as much money as possible. It happens every time.'

The main authority responsible for policing insider dealing is the Financial Services Authority. Its head of market monitoring, Dilwyn Griffiths, says some apparent cases of insider dealing have innocent explanations.

'Sometimes people will look at a company and may decide on the basis of their experience that it is likely to receive a takeover bid - and sometimes they will be right,' he said. 'But of course we do find cases of very timely trading which we then pursue. At any one time we have up to 100 cases on the go, sometimes more.'

Trading shares on the basis of inside knowledge has been illegal since 1980. Until then it was widespread and an accepted part of City culture.

'You do meet old-timers in this industry who will openly tell you that trading on inside information for your own benefit was considered one of the perks of the job,' said Potts.

Another broker echoed the view of others in the City. 'You can't say it publicly, but really, insider dealing is a victimless crime.'

But Potts, whose customers include many ordinary private investors, disagrees strongly. 'Insider dealing is not a victimless crime. Every aspect of our society is linked to the stock market, not least pensions. Insider dealing means taking away someone else's rightful gains in a stock they own. If the integrity of the stock market can't be trusted, people will lose confidence in the whole system.'

Potts highlights trading in Woolworths shares as looking suspicious. On Monday, venture capital group Apax said it was considering a bid. That was enough to pump shares in Woolies to almost 50p from 40½p.

The rise had already been under way - the previous week saw the price rise 5%. But equally significant was the number of shares traded - 76m on Thursday and 38m on Friday. Yet the average daily volume over the past year has been 13m shares.

Spencer Crooks at City firm Winterflood Securities also highlighted Woolworths as an example of where some investors appear to have had reliable knowledge of what was going on long before the wider public.

'You hear so many whispers and 90% are nonsense,' he said. 'What the market now looks at is the volume traded. That is often an indication of whether someone really knows something or not.'

The FSA's market monitoring division depends on the London Stock Exchange to alert it to suspicious trades, but it also depends on tip-offs from traders.

Griffiths said: 'We get tips from City firms when they think they've spotted something interesting at one of their clients or at another firm. The City is as concerned as we are to preserve its reputation as a safe place to trade.'

The pressure on the City to root out insider dealers will increase this summer as the European Market Abuse Directive becomes law here. Under the new rules, brokers will be legally obliged to inform the authorities if they suspect a client is involved in insider dealing.

But many believe the constant pattern of insider dealing might prove almost impossible to stop. Crooks said: 'It's like trying to plug a hole in a dam with a finger. However far back you want to go and whatever markets you want to look at, it has always gone on.'

Griffiths admits the system is not perfect: 'I can't say that we catch everyone. I can say that we have a lot of ongoing investigations.'

Additional reporting: Lucinda Kemeny