The Death of Money (4 page)

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
.

*  *  *

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. government 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.

This gap in intelligence capabilities at the time is not surprising. Prior to globalization,
capital markets were not part of the national security arena. Markets were mostly
local, controlled by national champions in each country. Some banks, such as Citibank,
were international, but they conducted traditional lending businesses and were not
involved in stock trading. The CIA did not have capital markets expertise because
it had not been required during the Cold War; markets were not part of the battlespace.

As a result, when reports of possible terrorist insider trading rolled in after 9/11,
practically no one at the agency had the experience necessary to evaluate how it might
have occurred and its implications for national security. Fortunately, one senior
intelligence analyst understood the implications quite well.

Randy Tauss lives quietly in the upscale Washington, D.C., suburb of McLean, Virginia,
not far from CIA headquarters. He retired from the CIA in 2008 after a thirty-seven-year
career, mostly in the agency’s Directorate of Intelligence, the analytic branch. He
is a brilliant physicist
and mathematician who won numerous medals from the agency for his technical and deductive
work. Although most of his work involved complex weapons systems, he won fame both
inside and outside the agency for his role in solving the mystery of the 1996 midair
explosion of TWA Flight 800.

Tauss had another avocation, one not required in his day job but to which he applied
the same passion he showed while working with weapons and technology. He was an avid
stock and options trader who used his mathematics skills to look for small anomalies
in options prices that could be traded to advantage in his personal accounts. He pursued
this options trading with such vigor and over such a long period of time that he was
almost as well known for it among his colleagues as he was for his intelligence analyses.
When the story of insider trading surfaced in the aftermath of 9/11, it was no surprise
that Tauss’s name came to the attention of CIA senior management.

In October 2001, just weeks after the attacks, the CIA’s Office of Terrorism Analysis
asked Tauss to serve as director of a project to consider whether terrorists might
use advance knowledge of their actions to profit in financial markets, and whether
the intelligence community could identify such efforts and possibly thwart the attack.
Thus began one of the longest and most unusual analytic projects in CIA history.

The effort was dubbed “Project Prophesy.” By the time the project wound down in 2004,
almost two hundred finance professionals—including stock exchange executives, hedge
fund managers, Nobel Prize winners, and floor traders, along with technologists and
systems analysts—would be tapped to contribute their time and effort. Tauss led a
massive undertaking that simultaneously modeled the mind of the terrorist and the
mind of the Wall Street trader. He found that the two domains had more than a few
things in common.

Project Prophesy was formally launched in April 2002, and the core team assembled
by the end of May. The first task was to create a threat board of potential targets
for terrorist attacks and link those targets to publicly traded stocks that might
provide advance warning through unusual price activity. These stocks included a broad
list of airlines, cruise lines, utilities, theme parks, and other companies with symbolically
important assets.