A New Kind Of StrippingThis is quite ingenious:
The Securities and Exchange Commission is investigating whether Wall Street traders are using exchange-traded funds as a means of disguising insider trading.
Here's what's happening. Exchange-traded funds, or ETFs, are traded like stocks, but they're made up of a "basket" of underlying securities, commodities, etc. ETF's have similarities to mutual funds, but they can be traded throughout the trading day, which makes them more flexible
Insider trading happens when someone who has access to non-public information about a company buys the stock to profit from the information. So if someone who worked in accounting for Corporation ABC told me the week before their quarterly earnings release that their profit was going to be triple the analyst's expectations, and I bought stock after receiving that information (because I knew the stock would go up after the earnings were publicly disclosed), then I would be guilty of insider trading.
You can see why that should be illegal. Otherwise, the stock market would essentially be a rigged game.
Because insider trading can be extremely profitable, though, there's always someone trying to disguise insider trading as legitimate trading activity.
That's where "stripping" comes in.
Here's how it works. Let's say that you buy a technology ETF that has fifteen stocks in it, and you find out (via insider information) that one of those stocks is going to announce a new technology that is going to make the stock explode. If you buy large numbers of shares of the stock just before the announcement, the SEC could see that and start an investigation that could lead to bad, bad things for you.
However, there's another way you could essentially do the same thing. Just buy the ETF and short every other stock in the ETF except the company that's going to announce the new technology. In essence, that's being long the stock without ever actually buying the stock.
It's not easy, because you would be long an ETF and short fourteen individual stocks (a total of fifteen separate transactions), but if you're going to make millions, transaction costs aren't going to bother you much.
The SEC (remarkably) has apparently figured all this out, and bad, bad things are going to happen to those traders anyway, but what a clever ruse.