American Airlines and United Airlines, the operators of the four flights that were hijacked on 9/11, are public companies whose stock is traded on the New York Stock Exchange. In 2001 American Airlines traded with the ticker symbol AMR, and United Airlines with the ticker UAL.
An investigator looking for evidence of insider trading usually starts with the options markets, closely linked to the stock market. Decades of insider trading cases have shown that options are the insider trader’s tool of choice. The reason is obvious: options offer much greater leverage for the same amount of cash than regular stock trading. What makes sense for Wall Street crooks also makes sense for terrorists. When one is betting on a sure thing, leverage amplifies the expected profits, and the terrorists were betting on a sure thing—the panic that would follow their attack.
While the operational details of the 9/11 terror attacks were known in advance to only a small cadre of operatives, the coming of an attack on September 11, 2001, was known to a larger circle. This group included immediate associates of the hijackers, housemates, and financial backers, as well as family and friends. Those who learned of the coming attacks from the terrorists told others, and the information spread through a social network in much the same way a video goes viral.
Advance knowledge of an attack communicated in social networks does not help intelligence agencies unless the messages are intercepted. Interception presents challenges both in directing collection resources at the right channels and in separating signals from noise. But at least one channel was blinking red before 9/11, telling the world that disastrous events involving airlines were imminent. That channel was the pinnacle of the U.S. financial establishment—the New York Stock Exchange.
As the terror clock ticked away, market signals rolled in like a tsunami. A normal ratio of bets that a stock will fall to bets it will rise is 1 to 1. On September 6 and 7, option bets that United Airlines stock would fall outnumbered bets it would rise by 12 to 1. Exchanges were closed on September 8 and 9 for the weekend. The last trading session before the attack was September 10, and that day option bets that American Airlines stock would fall outnumbered bets it would rise by 6 to 1. On September 11, 2001, United Airlines and American Airlines flights struck the World Trade Center and Pentagon. The first trading day after the attacks, United Airlines stock fell 43 percent and American Airlines stock fell 40 percent from where they had last closed. Thousands of Americans were dead. The options traders had made millions.
One-sided trading, involving more bearish than bullish bets of the kind seen just prior to 9/11, would not be unusual if there were negative news about the stocks. But there was no news on airlines on those days. The stocks of other major airlines, such as Southwest and US Airways, did not exhibit the massively bearish trading that affected American and United.
All that appeared was a huge one-way bet on a decline in the stock prices of American and United Airlines in the last four trading days before 9/11. Seasoned traders and sophisticated computer programs recognize this pattern for what it is—insider trading in advance of adverse news. Only the terrorists themselves and their social network knew that the news would be the most deadly terrorist attack in U.S. history.
The trading records are not the only evidence of a terrorist connection to insider trading in advance of the attacks. Yet notwithstanding such evidence, the official 9/11 Commission concluded:
Exhaustive investigations by the Securities and Exchange Commission, FBI, and other agencies have uncovered no evidence that anyone with advance knowledge of the attacks profited through securities transactions.
This language used in the 9/11 Commission Report is a lawyer’s dodge. Saying that agencies uncovered no evidence does not mean there is no evidence, merely that they failed to find it. The conclusion that no one profited does not mean that transactions did not take place, merely that the profits could not be ascertained. Perhaps the perpetrators failed to collect their winnings, like a bank robber who drops a satchel of stolen cash in flight. The inside terrorist traders may not have known the exchange would be closed for days after the attack, making it impossible to settle trades and collect winnings.
Despite the official denial, proof of the terrorist trading connection is found through a deeper dive into the world of forensics and the phenomenon of signal amplification. The unusual options trading in advance of 9/11 has been closely studied by academics. The literature, most of it published after the 9/11 Commission completed its work, is emphatically of the view that the pre-9/11 options trading was based on inside information.
The leading academic study of terrorist insider trading connected to 9/11 was done over four years, from 2002 to 2006, by Allen M. Poteshman, then at the University of Illinois at Urbana-Champaign. His conclusions were published by the University of Chicago in 2006.
These conclusions were based on strong statistical techniques. This is like using DNA to prove a crime when there was no eyewitness. In murder cases, prosecutors compare a defendant’s DNA to samples found at the crime scene. A DNA match might implicate a defendant in error, but the chance is so slight, so exceedingly remote, that juries routinely convict. Certain statistical correlations are so strong that the obvious conclusion must be drawn despite a microscopic chance of error.
Academics like Poteshman take large sets of data and establish the normal behavior of stocks, called the baseline. Researchers then compare actual trading in a target period to the baseline to see if the target period represents normal or extreme activity. Explanatory variables are tested to account for extreme activity. These techniques have proved reliable in many investigatory and enforcement contexts. During the dot-com bubble, for example, they were used to uncover widespread illegal backdating of options by technology companies.
Poteshman’s data for the purposes of establishing a baseline included a daily record of options trades on all stocks in the S&P Index from 1990 through September 20, 2001, shortly after the 9/11 attacks. He focused on several relevant ratios before turning to the one most likely to be used by terrorists—the simple purchase of put options on AMR and UAL. A put option on a stock is a bet that the stock’s price will fall.
He arranged the data in decimal brackets from 0.0 to 1.0, with 0.0 representing extremely low activity in put options and 1.0 representing extremely high activity. He discovered that in the four trading days prior to 9/11, the maximum daily value for either hijacked airline was 0.99 and the maximum value over the entire four-day window was 0.96. In the absence of any news that would explain such an extreme skew, the inescapable conclusion is that this activity represents insider trading. Poteshman writes:
There is evidence of unusual option market activity in the days leading up to September 11 that is consistent with investors trading on advance knowledge of the attacks.
Another leading study, conducted by the Swiss Finance Institute, reached the same conclusion. This study covered the period 1996 to 2009 and analyzed over 9.6 million options trades in thirty-one selected companies, including American Airlines. With respect to 9/11, the study concluded:
Companies like American Airlines, United Airlines, Boeing and to a lesser extent Delta Air Lines and KLM seem to have been targets for informed trading activities in the period leading up to the attacks. The number of new put options issued during that period is statistically high and the total gains . . . realized by exercising these options amount to more than $16 million. These findings support the evidence in Poteshman (2006) who also documents unusual activities in the option market before the terrorist attacks.
The 9/11 Commission was aware of the trading records used by subsequent scholars, and it was familiar with media reports that insider trading by terrorists had taken place. Yet the 9/11 Commission denied any connection between the options trading and terrorists. Its failure to conclude that terrorist insider trading took place is due to its failure to understand signal amplification.
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Signal amplification in stock trading describes a situation where a small amount of illegal trading based on inside information leads to a much greater amount of legal trading based on the view that “someone knows something I don’t.” It is a case of legitimate traders piggybacking on the initial illegal trade without knowing of the illegality.
Again, no one can trade in isolation. For every buyer of put options, there is a seller who sees the transaction take place. Each trade is entered on price reporting systems available to professional traders. A small purchase of put options by a terrorist would not go unnoticed by those professionals. There was no news of any importance on American or United Airlines in the days before 9/11. Anyone seeing a small trade would ask herself why a trader would make a bet that the stock was going down. She would not know who was doing the trading, but would assume the trader knew what he was doing and must have a basis for a bear bet. This pro might buy a much larger amount of put options for her personal account as a piggyback bet on the stranger’s informed trade.
Soon other traders begin to notice the activity and also buy put options. Each trade adds to the total and amplifies the original signal a little more. In extreme cases, the dynamic resembles the chaotic climax of the film Wall Street, in which initial insider trading in Blue Star Airlines by Charlie Sheen’s character cascades out of control amid shouts of “Dump it all!” and “We’re getting out now!”
In the event, 4,516 put options, equivalent to 451,600 shares of American Airlines, were traded on September 10, 2001, the day before the attack. The vast majority of those trades were legitimate. Yet it only takes a small amount of terrorist insider trading to start the ball rolling on a much larger volume of legitimate piggyback trading. The piggyback traders had no inside information about an attack; they were betting that other traders knew negative news on AMR that had not been made public.
They were right.
A standard rejoinder, by many in the intelligence community, to suggestions of terrorist insider trading is that terrorists would never compromise their own operational security by recklessly engaging in insider trading because of the risks of detection. This reasoning is easily rebutted. No one suggests that terrorist hijacker Mohamed Atta bought put options on AMR through an E*Trade account on his way to hijack American Airlines Flight 11 from Logan Airport, Boston. The insider trading was done not by the terrorists themselves but by parties in their social network.
As for operational security, those imperatives are easily overridden by old-fashioned greed. A case in point is home decorating maven Martha Stewart. In 2001 Stewart was one of the richest women in the world due to the success of her publishing and media ventures related to cooking and home decorating. That year she sold stock in ImClone Systems based on a tip from her broker and avoided a loss of about $45,000; that sum was a pittance relative to her fortune. In 2004, however, she was convicted of conspiracy, obstruction of justice, and making false statements in connection with the trade and was sent to prison.
When it comes to betting on a sure thing, greed trumps common sense and makes the bet irresistible. The record of insider trading is replete with such cases. A terrorist associate is not likely to show better judgment than a superrich celebrity when the opportunity arises.
Given the weight of the social network analysis, statistical methods, signal amplification, and expert opinion, why did the 9/11 Commission fail to conclude that terrorists traded in AMR and UAL in advance of the attack? The answer lies in the 9/11 Commission Report itself, in footnote 130 of chapter 5.
Footnote 130 admits that activity in AMR and UAL before 9/11 was “highly suspicious.” It also says, “Some unusual trading did in fact occur, but each such trade proved to have an innocuous explanation.” A closer look at these “innocuous” explanations reveals the flaws in the commission’s reasoning.
For example, the report finds “a single U.S.-based institutional investor with no conceivable ties to al Qaeda purchased 95 percent of the UAL puts on September 6 as part of a trading strategy that also included buying 115,000 shares of American.” This explanation falls down in two ways. First, the fact that a high percentage of the trades were found to be innocent is completely consistent with signal amplification. Only the small initial trade is done by terrorists. The 9/11 Commission Report presented no evidence that it had made any effort to drill down to the small initial signal. Instead, the staff were beguiled by the innocent noise.
Second, the 9/11 Commission relies on the fact that the investor it interviewed said he bought UAL puts as part of a strategy involving the purchase of AMR shares, a kind of long-short trade. This shows naïveté on the part of the commission staff. Large institutional investors have numerous positions that have nothing to do with one another but that can be selected post facto to show innocent motives to investigators. On its face, this investor’s AMR position says nothing about why it so heavily shorted UAL.
The report goes on to say that “much of the seemingly suspicious trading in American on September 10 was traced to a specific U.S.-based options trading newsletter, faxed to its subscribers on Sunday, September 9, which recommended these trades.” This analysis shows that the commission staff had a limited understanding of how Wall Street research works.
There are thousands of trading tip sheets in circulation. On any given day, it is possible to find at least one recommending the purchase or sale of most major companies listed on the New York Stock Exchange. Going back after the fact to find a newsletter that recommended buying puts on American Airlines is a trivial exercise. No doubt there were other newsletters in circulation recommending the opposite. Selecting evidence that fits a theory while ignoring other evidence is an example of confirmation bias, a leading cause of erroneous intelligence analysis.
Another problem with the newsletter rationale is the belief that the recommendation arose independently of the insider trading already going on in AMR. Why treat the newsletter as a signal when it was actually part of the noise? For example, on September 7, trading volume in AMR doubled from the previous day and reached a near three-month high with a declining stock price. This pattern is consistent with insider trading ahead of an attack on September 11. It is more likely that the September 7 put volume caused the September 9 newsletter recommendation than it is that the newsletter caused the September 10 put buying.
The more likely explanation is that the entire sequence from September 6 through 10 was a signal amplification caused by a small initial insider trade. To isolate a single event like the newsletter and give it explanatory power without reference to prior events is poor forensic technique. It is better to take a step back and look at the big picture, to separate signal and noise.
Insider traders and those piggybacking are notorious for retaining research reports to support their activities in case the SEC comes calling. SEC after-the-fact inquiries are routine whenever the SEC identifies suspicious trading related to a market-moving event. Waving a research report at SEC investigators is a standard technique to make them go away. Stock trading criminals have gone so far as to prepare their own research reports for the sole purpose of having a cover story in case their insider trading is ever questioned. Given this well-known technique for foiling investigations, it is unfortunate that the 9/11 Commission Report gave weight to a single newsletter.
Viewed through the lens of signal amplification, the 9/11 Commission’s “large buyer theory” and the “newsletter theory” contained in footnote 130 are more consistent with terrorist trading than a refutation. Moreover, these theories never address the put buying in United Airlines on September 7 and the other suspicious trades.
It is important to disassociate this insider trading analysis from the so-called 9/11 Truth Movement, a collective name for groups and individuals who assert conspiracy theories related to the 9/11 attacks. Many of these theorists claim that agencies and officials of the U.S. gov
ernment were involved in planning the attacks and that the twin towers collapsed from prepositioned explosives and not from the impact of the hijacked planes. This nonsense is a disservice to the memory of those killed or injured in the attack and in subsequent military responses. The hard evidence that the attacks were planned and executed by Al Qaeda is irrefutable. The 9/11 Commission Report is a monumental and excellent summary, a brilliant work of history despite the inevitable flaws that arise in such a wide-ranging effort. Furthermore, there is nothing inconsistent between the widely accepted narrative of 9/11 and terrorist insider trading. Given the magnitude of the attack and the imperatives of human nature, such trading should have been expected. The statistical, behavioral, and anecdotal evidence for insider trading are overwhelming.
Terrorist insider trading was not a U.S. government plot but a simple extension of the main terrorist plot. It was despicable yet, in the end, banal. Small-time terrorist associates could not resist betting on a sure thing, and signal amplification took care of the rest. Still, the signal was not hidden. On trading screens all over the world, evidence of the coming attacks was visible by watching options trading in American and United Airlines.
In the chilling words of CIA director George Tenet, “The system was blinking red.”
■ Project Prophesy
If the 9/11 Commission was finished with the topic of terrorist insider trading, one government agency was still willing—though initially ill equipped—to dig deeper.
The Central Intelligence Agency had been mobilized before 9/11, based on the volume of reporting that indicated a spectacular attack might be in the works. A body of intelligence concerning reports of unusual trading in airline and other stocks in the days before the attack came to the CIA’s attention immediately after 9/11. But it had a problem pursuing those leads because it had almost no expertise in capital markets and options trading.
The Death of Money Page 3
