Claire buttered a piece of Irish soda bread. “A new type of bad guy has arrived on the New York scene.”
“You’ve got my attention.”
“As you are aware, Frank, the SEC has been investigating stock market fraud since 1934. The crimes are wide-ranging: embezzlements of investor funds by unscrupulous brokers and financial advisors, insider-trading, short-selling abuses, Ponzi schemes, companies deliberately misstating their financial reports, price gouging on commissions, the churning of retail customer accounts, to name a few. The list of wrongdoing is a long one and new scams pop up all the time.”
He nodded. “The SEC took a lot of heat on the Madoff situation but your agency does a decent job, given your limited resources.”
“We try our best.”
At that juncture the salads were served.
She continued after the waiter left. “Thanks to Roxy and her colleagues at the CIA, an old scam with a new wrinkle has been uncovered. Only this time, it’s not just about the money, Frank, the bad guys also have a political agenda.”
“Hmm.”
“Roxy, tell Frank what’s happening on at your end.”
She put down her fork. “Our agents in Pakistan are focusing on the major terror groups and where they get their funding. The prevailing thinking at Langley is that if this flow of funds can be interdicted, then the level of violence will be significantly reduced.”
“It seems logical.”
“Lately, however, the flow of funds to these groups has increased noticeably and they are becoming better armed as a result. Our troop casualties in Afghanistan are on the rise again.”
“Where’s the new money coming from?”
“From the good old USA.”
“Arab-American sympathizers?”
“No, it’s more complicated. An informant tells us a spying operation is being aimed at investment banks here in New York. The goal is to obtain confidential data on pending corporate mergers and takeovers.”
He scratched his head. “I’ve never heard of anything like that before.”
Claire nodded. “We’ve never seen the likes of it either.”
“Who is doing the actual spying for them, Roxy?”
“Great question, Frank, but we don’t have an answer.”
“I’m guessing it’s an American firm that is plugged into the Wall Street community and knows where to get their mitts on sensitive stuff.”
“They might be bribing analysts and bankers,” Claire offered.
“Yes, or else they’re stealing it.”
“Help me out here, guys,” Roxy said, “I never went to business school, I majored in Islamic Studies at the University of Chicago. How exactly are the terrorists making their profits and, more importantly, how much money could they be making off this scam?”
The entrees were served and Claire ordered a bottle of the red house wine for the table. “Ok, Roxy, the typical corporate acquisition deal works as follows. When company A wants to acquire company B, they must offer the shareholders of company B a premium price for their stock to induce them to go along with the deal. The premium paid is generally 20% - 40% over and above what the stock of company B is currently selling for on the stock exchange.”
“I see.”
“In cases where two or more companies are competing with each other to take over company B, the premium paid can go to 60% or much higher.”
“Hmm.”
“Recently, for example, Dell Computer and Hewlett-Packard got into a heated bidding war over a company named 3PAR. The eventual premium paid by HP, the winning bidder, exceeded 300%.”
“Wow!”
“Yes. If you had possessed confidential info on that deal, Roxy, you could’ve bought the stock of 3PAR at a relatively cheap price in the open market before the deal went public and made a killing when you sold it later on.”
“But it takes money to make money, Claire, wouldn’t they have to purchase millions of dollars in stock in order to make a large profit?”
“No,” Frank interjected, “they don’t even have to buy the stock of company B at all; they could purchase ‘call options’ instead at a fraction of the share price.”
“What’s a call option?”
“A call option is a financial contract between two parties in the market -- a buyer and a seller. In exchange for the payment of a fee to the seller, a call option gives the buyer the right, but not the obligation, to buy a set number of shares of a company’s stock from the seller at a certain date in the future at a fixed price.”
“Hmm.”
“If the price of the stock later rises substantially in value, as it would if the company became the target in a takeover, then the option is said to be in the money and the buyer can exercise it and make the large profit.”
“I see.”
“With options, Roxy, you get a much bigger bang for your buck. That is financial leverage, a way to multiply your gains without having to put any significant cash down to buy the stock upfront.”
“Nice.”
“And your downside risk is also limited. If the acquisition deal doesn’t go through for some reason and the stock price of the target drops like a rock, the maximum you can lose is the relatively small fee you paid for the option.”
“That’s even better.”
“The terrorists might also use derivatives or engage in risk arbitrage. They can sell the stock of company A short and …”
“Frank, I don’t think Roxy needs to be aware of all the possible twists and turns,” Claire interjected, “it’d only confuse her.”
“Right.”
“Suffice it to say, Roxy, there are a number of ways for a sophisticated investor to make many millions of dollars on just a single takeover deal without ever having to put much cash down.”
“So the terrorists could be making a fortune.”
Claire nodded. “Possibly hundreds of millions or more. It all depends on how much sensitive info on pending deals they can get their hands on.”
She finished off her wine. “That kind of money buys a lot of roadside bombs and grenade launchers.”
“Yes, Roxy, it sure does.”
“I get the picture, Claire, possessing knowledge is the same as having money in the bank. It’s practically a sure thing.”
“It is, Roxy, and that’s why people are willing to risk going to jail in order to obtain it.”
She sat back. “I can understand the temptation; a person could retire in style from doing just one deal.”
“But human nature being what it is, Roxy, they rarely stop at just a single deal. Greed leads to their eventual arrest and downfall.”
He placed his napkin on the table. “I’ve got to say I’m impressed at the ingenuity of the terrorists. On 9/11 they hijacked our own planes and used them to attack us; now they’re hijacking our capitalist system and using it to attack us.”
“Yes, Frank, it’s as if they are mocking our culture.”
“The Devil must be given his due, Claire.”
“I wouldn’t go that far.”
He looked from one woman