What I Learned About Investing From an Ex-Con

Marc Lichtenfeld By Marc Lichtenfeld, Chief Income Strategist, The Oxford Club

Market Trends

I’ve talked to a fair share of convicted felons in my life.

Years ago, I was on a baseball team that went into San Quentin State Prison to play the inmates.

Not surprisingly, investing did not come up in my conversations with the various murderers, armed robbers and drug dealers.

A few weeks ago, I had a very different experience when I spoke with a former inmate of the Lewisburg federal penitentiary in Pennsylvania…

Michael Kimelman served 21 months for insider trading.

But I’m convinced he was innocent.

I got in touch with Michael after reading his new book, Confessions of a Wall Street Insider: A Cautionary Tale of Rats, Feds, and Banksters.

It was a fascinating and entertaining read. But I wanted to know how prevalent insider trading really is on Wall Street and what individual investors should know about it.

I asked Michael to walk me through the process of receiving a stock tip that may be inside information.

I shared most of our conversation with my Oxford Income Letter subscribers last week. But what Michael told me was so shocking… I wanted to share a bit of the unpublished conversation with my Wealthy Retirement readers.

Below is an excerpt from our interview.

Michael Kimelman: In 2007 for example, as a very active trader, I would trade somewhere between 50 and 100 million shares a year. I would be in stocks, see them moving (and not know why), and either try to piggyback the momentum or trade to fade it.

And then I would find out, a minute, day or week later that there was some big news around the stock. Clearly there were multiple people who knew that earlier… It was obvious that there was a lot of that out there.

So that I knew. But what really occurred was on two different tiers. There was a top tier of guys like Raj (billionaire hedge fund manager Raj Rajaratnam, currently serving an 11-year sentence for insider trading) or my former partner, Zvi Goffer, and others who were arrested for having a level of access that was clearly illegal and illicit.

Raj talking to a Goldman Sachs board member right after a Buffett investment meeting (getting that information or allegedly getting that information) is yards different [from anything I did]. There’s a whale of difference between that and what I used to do on a trading desk at a hedge fund…

We would hear eight to 10 rumors a week, sometimes many more, but we didn’t have actual information. It would be couched or phrased differently. It would be like “a smart guy at this fund said…” or “an analyst just heard this…” It would be more of a rumor.

And I hoped that the rumors were true. I hoped whoever was spreading the rumors – or whoever we had gotten the rumors from – had inside information. Nobody’s obviously in the game to lose money, but there was no way for me to verify the rumors. There was no way to determine the credibility of the intermediaries. There was no way to determine the credibility of the information. So it was a much different tier.

And probably nine out of 10 times, the rumor would be patently untrue, probably disinformation spread by a hedge fund that was trying to get out of a position because it knew (or anticipated) bad news.

Marc Lichtenfeld: That’s interesting. I was going to ask you about how often they were true. When you heard a rumor, was there any way you could discount it or say, “This one sounds like it could be legit”?

Michael Kimelman: There was nothing I could put into a programmable matrix and say, “Here’s how it works, and we know because of X then Y.”

It was much more a gut feel from years of desk trading. The rumor would typically be – and this is something obviously the feds don’t understand – “Hey, he got tipped,” in my case, “to buy 3Com,” and I did.

Somebody told me to buy 3Com. He heard there was good news coming, smart money guys were buying it, and he was going to buy it. So I bought it.

But what you have then is the beginning of the trade. That’s not the end of the trade.

Once you get that rumor, call or tip, that’s when you actually start doing your homework and legwork. So you type up the stock, you look at the charts, you see who the holders are, you see if you know any of them, you try to call some people who are well-versed in the space and get their opinions.

You do a lot of other primary research once you have that call to determine whether or not you think it has some credibility to it. Or whether it’s just misinformation or disinformation for somebody trying to get out of a stock without crushing it. They do this by suckering guys like me and other fast-money guys into the name so our buying momentum takes the stock up, and they can sell into it without crushing the name.

So it’s more of a gut feel. And the only thing I could say is if you know a space or you know a company, you usually have a pretty good idea of whether or not there is something to the rumor. But that still means it could be very tough sledding if you’re going to try to state it, because you never know how long the momentum will take it up until somebody declines to comment or sort of puts the rumor out.

So even if you think you’re right and are going to take the other side of the trade, it’s still a tough trade. And if you’re going to momentum and piggyback it, there’s nothing easy about that either, because if somebody comes out and says, “No, nothing to that,” then the stock gets hit pretty hard.

And getting rumors or even passing them on to people is sort of “swim at your own risk,” which is a good motto for the individual investors and everybody out there… you really can’t believe anything you hear.

You have to try to do your own work. But in the end, you’re going to be right a decent amount, and you’re going to be wrong quite a bit too. So that’s where money management and discipline becomes critical.

Kimelman turned down a plea deal that would have resulted in no prison time. He has maintained his innocence since his arrest.

You can read more of my interview with Michael Kimelman in the May issue of The Oxford Income Letter. If you’re not already a subscriber, click here now.

Like me, you may learn something valuable from an ex-con.

Good investing,