How Financial Markets Finance Terrorism

by Hugh McDermott

The securities industry is no stranger to terrorists.  While criminals use the markets to launder their funds, terrorists make money by speculating.  If terrorists had ‘inside information’ about an imminent attack, they could purchase financial derivatives before the attack and make millions from the subsequent market movements.

What happens to financial markets after a terrorist attack and how terrorists make money from these market movements if they knew the attacks were about to occur is illustrated by the  suspicious trading that occurred immediately before the successful New York, Madrid and London attacks.

Global financial markets reacted swiftly to the news of the New York, London and Madrid terrorist attacks, with a general flight to quality. Gold, bonds and defence stock strengthened and investors flocked to highly liquid, developed markets.

In contrast, less mature markets suffer as do stocks such as reinsurance and aviation. American Airlines’ share price dropped 39% after the 9/11 attacks and United Airlines dropped 42%. Even a novice trader can see the windfall that could be achieved in shorting these stocks before a terrorist attack.

The German Stock Market Commission reported that in the days before 9/11, derivatives traded on underwriter Munchener Ruck were twice normal volumes.  Munchener Ruck’s share price dropped 22% after the attacks.

On 7 September, the number of put options on British Airways was four times normal volumes. BA shares dropped 42% over the following week.

Between 6-7 September, 4744 put options were bought on United Airlines; six times normal volumes. Assuming that 4000 of these options were bought by terrorists with advance knowledge of the imminent attacks, these ‘insiders’ would have profited by almost $5 million.

On 10 September, 4516 put options were bought on American Airlines; 285 times normal volumes. Assuming that 4,000 of these options trades were purchased by ‘terrorist insiders’ they would net a gain of about $4 million.

Financial stocks also declined after the attacks due to the disruption to trading and the operation of the financial system. The World Trade Centre was the nerve centre of the global financial system, so the attacks were a major disruption to business. Seventy four per cent of the civilian deaths in the attacks were people employed in the financial industry, and many investment banks had head offices in or around the World Trade Centre.

Morgan Stanley occupied 22 floors of the World Trade Centre and was severely affected by the attacks. Trading of put options on Morgan Stanley stock averaged 27 contracts per day before 6 September, but from 6-10 September , 2157 October $45 put options were purchased.  Morgan Stanley’s share price fell from $48.90 to $42.50 in the aftermath of the attacks. Assuming that 2,000 of these contracts were bought with knowledge of the approaching attacks, these purchasers could have profited by at least $1.2 million.

Merrill Lynch had headquarters near the Twin Towers and averaged 252 contracts per day before 6 September.  The period 5-10 September saw 12 215 October $45 put options bought.   When trading resumed after the attacks, Merrill’s shares fell from $46.88 to $41.50.  Assuming that 11,000 option contracts were bought by ‘terrorist insiders’ their profit would have been about $5.5 million.

The International Organisation of Securities Commissions has stated that the financial maneuvers that had taken place in the days prior to 9/11 amounted to several hundred million dollars, constituting “the most important crime of insider trading ever committed”. Massive market irregularities in the days preceding the attacks delivered huge profits to “someone”, somewhere.

However, tracing these profits to terrorist insiders has allegedly proved futile.

The US Government’s 9/11 Commission Report stated that the “investigation has found no evidence that anyone with advance knowledge of the terrorist attacks profited through securities transactions”.  The report puts the irregularities down to a general downturn in the airline industry and the release of a newsletter from a broker the weekend before the attacks which downgraded airline stock.  This seems implausible.

This explanation overlooks some important facts.  Short selling was up 11% on airlines due to the global downturn following the dot com bust, but it was up around 40% on United and American Airlines. Surges in call options on gold and oil were also not explained.

The 9/11 Commission Report has been widely criticized and academic quantitative studies have confirmed that there is evidence of unusual option market activity in the days leading up to 9/11 that is consistent with investors trading on advance knowledge of the attacks.

But while ‘terrorist insiders’ may be elusive after the fact, law enforcement can take advantage of market movements as a source of financial intelligence to track terrorists and forecast attacks.

When it comes to assessing risk, the markets never lie. Spikes in the trading of put options on infrastructure stocks could indicate a heightened risk of a terrorist attack on critical infrastructure. Unexplained spikes in trading on commodities could indicate a heightened risk of a bio-terrorist attack.

While this information in isolation isn’t sufficient to counter an attack, it could add a critical piece to the intelligence puzzle about the imminence of planned terrorist violence.

In its new market supervision role, ASIC monitors for unusual trading patterns to detect insider trading. While this monitoring focuses on insider trading offences under the Corporations Act 2001, these capabilities could be leveraged to detect potential terrorist insiders.

These types of irregular trading patterns could be used as a ‘seismograph’ to indicate that a terrorist attack may be about to occur. By working with Australia’s counter-terrorism agencies, ASIC could provide critical information to our law enforcement teams charged with fighting extremists. Combining the specialist skill of market operators with that of law enforcement will provide another element to protect our society.

Dr Hugh McDermott is the editor of .

He was the Senior Manager, Major Fraud & International Enforcement, with the Australian Securities & Investments Commission, Sydney from 2010-11.