Insider trading: In Silicon Valley, you can be worth billions and it’s not enough

Buying options in your own company right before a merger is announced is a red flag for regulators, and relatively easy for them to discover. Trading in another’s account, as Bechtolsheim was accused of doing, or in a company that is not directly involved in the deal but is likely to benefit from it, must seem less risky.

Insider trading prosecutions are relatively infrequent, so it is difficult to determine just what really goes on in the home offices, executive suites and office parks. But researchers who analyse trading data say corporate executives broadly profit from confidential information. These executives try to avoid traditional insider trading restrictions by buying shares in economically linked firms, a phenomenon called “shadow trading”.

‘I’m invincible’

“There appears to be significant profits being made from shadow trading,” said Mihir N. Mehta, an assistant professor of accounting at the University of Michigan and an author of a 2021 study in The Accounting Review that found “robust evidence” of the behaviour. “The people doing it have a sense of entitlement or maybe just think, ‘I’m invincible.’”

Another recent Bay Area insider trading case shows how shadow trading works. Matthew Panuwat, an executive at the San Francisco biopharmaceutical company Medivation, was informed in August 2016 that Pfizer was acquiring his company. Minutes later, he bought shares in a third drug firm. When the deal for Medivation was announced, the third company became a hot prospect, and its shares soared, too. Panuwat’s profit: $US107,066.

At his trial earlier this year, Panuwat said the timing was a coincidence. A jury didn’t buy it, and after only a brief deliberation on April 5 found him guilty of insider trading.

White-collar defence firms anticipate an explosion of new cases. “The successful prosecution of Mr Panuwat has armed the federal government with a powerful new precedent,” Gibson Dunn, a law firm, told clients. 

The SEC issued a brief statement after Panuwat’s verdict, saying that “there was nothing novel” about the case: “This was insider trading, pure and simple.” A lawyer for Panuwat didn’t return a request for comment.

The agency also considers Bechtolsheim’s case straightforward, though it was higher profile than usual. It was one of the few cases of wealthy company founders being charged since 2001, when lifestyle guru Martha Stewart was tipped to sell her shares in a medical company before it announced bad news. Stewart was sentenced to five months in jail for obstruction of justice.

Bechtolsheim grew up in rural West Germany, developing an interest at a very early age in how things worked. “I spent all my free time just building stuff,” he once said.

He went to Stanford as a doctoral student in the mid-1970s and got to know the then-small programming community around the university. In the early 1980s, he, along with McNealy, Vinod Khosla and Bill Joy, started Sun Microsystems as an outgrowth of a Stanford project. When Sun initially raised money, Bechtolsheim put his entire life savings — about $US100,000 — into the company.

‘Zero risk’

“You could end up losing all your money,” he was warned by the venture capitalists financing Sun. His response: “I see zero risk here.”

Asked in a 2015 oral history what his social life was like during Sun’s early years, Bechtolsheim replied: “Social life? I didn’t have any social life. I was working day and night on designing new workstations and building the company. That was the only thing that mattered to me at the time.”

The wager paid off. Sun workstations filled a niche between the rudimentary personal computers of the era and high-end mainframes from IBM and others. Later, Sun expanded into computers that manage other computers called servers. At its peak in the late 1990s dot-com bubble, Sun had a stock market valuation of $US200 billion.

It was Bechtolsheim’s funding of Google in 1998 that made him a permanent part of Silicon Valley lore. The deal happened at a moment when Google’s founders, Sergey Brin and Larry Page, weren’t even sure they wanted to build a company around their homemade search technology. They were focused on getting their Stanford doctorates.

The investment happened like this, according to Steven Levy’s 2011 history of Google, “In the Plex”: Brin emailed Bechtolsheim one evening around midnight. Bechtolsheim immediately replied, suggesting a meeting the next morning.

An impromptu demonstration was hastily arranged for 8am, which Bechtolsheim cut short. He had seen enough, and besides, he had to get to the office. He gave them a cheque, and the deal was sealed, Levy wrote, “with as little fanfare as if he were grabbing a latte on the way to work”. The founders celebrated at Burger King.

Page and Brin couldn’t deposit Bechtolsheim’s cheque for a month because Google did not have a bank account. When Google went public in 2004, that $US100,000 investment was worth at least $US1 billion.

It wasn’t the money that made the story famous, however. It was the way it confirmed one of Silicon Valley’s most cherished beliefs about itself: that its genius is so blindingly obvious, questions are superfluous.

The dot-com boom was a disorienting period for longtime Valley leaders whose interest in money was muted. Bechtolsheim’s Sun colleague Joy left Silicon Valley.

“There’s so much money around, it’s clouding a lot of people’s ethics,” Joy said in a 1999 oral history with Bechtolsheim.

Bechtolsheim didn’t leave. In 2008, he co-founded Arista, a Silicon Valley computer networking company that went public and now has 4,000 employees and a stock market value of $US100 billion.

Bechtolsheim was chair of Arista’s board when an executive from another company called in 2019, according to the SEC. Arista and the other company, which was not named in court documents, had a history of sharing confidential information under nondisclosure agreements.

This executive told Bechtolsheim that a smaller networking company, Acacia, was in play, according to the SEC. The executive’s company had been thinking of acquiring Acacia, but now another firm was making a bid. What to do?

Whatever counsel Bechtolsheim supplied was not mentioned in the SEC complaint. But immediately after hanging up, the government said, he bought Acacia option contracts in the accounts of a close relative and a colleague. The next day, the deal was announced. Acacia shares jumped 35 per cent.

Arista’s code of conduct states that “employees who possess material, nonpublic information gained through their work at Arista may not trade in Arista securities or the securities of another company to which the information pertains.”

Levy, the “In the Plex” author, said there were plenty of legal ways to make money in Silicon Valley. “Someone who is regarded as an influential funder and is very well-connected gets nearly unlimited opportunities to make very desirable early investments,” he said.

Bechtolsheim is no longer chair of Arista’s board but has the title of “chief architect.” Arista issued a statement saying it “will respond appropriately to the situation,” but declined to say what that meant.

McNealy, the former Sun CEO, said he did not know the details but that Bechtolsheim’s overall career should be taken into account.

“While Andy may have knowingly or accidentally made a mistake,” he said, “he will always be able to say he did real good.“

This article originally appeared in The New York Times.

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