Martha's Lesson: Be Careful with Tips

There's a popular expression aboutgetting ahead in the businessworld that goes something like,"It's not what you know, but whom youknow." When it comes to investing andchasing or acting on hot stock tips, theexpression is more aptly stated, "It's whatyou know and whom you know." ConsiderMartha Stewart's situation.

Wall Street Journal

According to a report, Stewart herself wasn't chargedwith insider trading, although that wasthe basis of the original investigation.Because of that investigation, many ofStewart's friends and acquaintances foundthemselves under the microscope. In theend, Stewart was tried and convicted forconspiracy, obstruction, and lying to prosecutors.That's because according to thelaw, it is illegal to trade stock based onmaterial, nonpublic information.

Understanding what constitutes nonpublicinformation is critical if you want tostay out of hot water. Securities law professorAlan Bromberg explains that mostcases hinge on whether a person knows, orshould know, that a tip they received wasinside information. But that out-of-boundslegal marker is often very gray.

Follow the Rules

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Still, if you want to avoid having yourinvestment life turned upside down, considerthese scenarios offered by the article:

• Investigators consider family membersfirst. Whether the family member is aspouse or distant cousin, as long as theinformation being passed on is not public,it is illegal to trade on. Last year, SamWaksal, CEO of ImClone, pleaded guilty tocharges that he tipped his daughter to sellthe company's stock just prior to its crash.His reward for being such a concerned parent:7 years in jail.

• In an old TV commercial, twowomen explained how they told twofriends about a product, who then toldtwo more friends, who then told twomore. You might be way down the foodchain from where a stock tip originated,but according to the article, regulatorsare not averse to moving their investigationalong that chain.

For example, a secretary at a major corporationonce passed a tip along to herhusband about a pending acquisition. Thetip began to spread like wildfire, andeventually the Securities and ExchangeCommission (SEC) charged 25 individuals,including friends, teachers, and repairmen.

• What happens if you overhear informationnot meant for you? Again, as longas you know, or should know, that whatyou heard was inside information, youcan't trade on it. Former Dallas CowboysCoach Barry Switzer found that out.According to the article, Switzer overheardexecutives talking about a pendingliquidation of an Oklahoma company.Switzer bought the stock, made $98,000when the liquidation was announced,and then was charged with insider trading.He was fortunate, however, that afederal judge dismissed the case.

When is it okay to take a chance? Thatall depends on how much of a risk you'rewilling to take. You might want to firstconsider that the securities cops arewatching closely, and regulators arebeing very aggressive.

Take a Prudent Chance

According to the article, the NationalAssociation of Securities Dealers (NASD)uses a sophisticated surveillance systemthat looks for unusual trading patternsprior to major announcements beingmade public, such as mergers. If odd activityis uncovered, an in-depth probe begins.Credible cases are then passed on to theSEC. NASD officials say they refer morethan 100 cases each year.

Consider all the potential consequencesof taking a chance and ask yourself, "Is itreally worth it?" In the case of the mediadiva and near billionaire, Stewart savedabout $50,000 by selling her shares inImClone. That's a drop in the bucket comparedwith how badly her reputation andcompanies have been damaged. If she hadto act on that hot tip again, she mightthink twice this time. You might want todo the same.