The law and theater of insider trading

By Felix Salmon
November 23, 2010
complete with photographs of unidentified "law enforcement officials" in decidedly casual clothes walking cardboard boxes full of "Evidence" out of a Boston hedge fund's offices.

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Pull up a chair, folks, the show has already begun, complete with photographs of unidentified “law enforcement officials” in decidedly casual clothes walking cardboard boxes full of “Evidence” out of a Boston hedge fund’s offices. There’s a lot of theater here:

At the Diamondback offices, the FBI agents were interested in information stored on computer servers, the employee at the firm who described the raid said…

“They could have just as easily come in before hours and gotten what they wanted,” the employee said. “Why did this have to be in a dramatic, Hollywood manner?”

The NYT explains what might be going on:

Taking the aggressive tack of using search warrants to raid the firms’ offices, rather than issuing grand jury subpoenas demanding the production of documents, suggests that federal prosecutors are concerned about the destruction of evidence related to possible crimes, lawyers say.

It is also possible that the government has already served these firms with subpoenas, and it is looking to scoop up any remaining documents.

“This guarantees that the government can quickly and securely get its hand on evidence,” said Fernando L. Aenlle-Rocha, a lawyer at White & Case and former federal prosecutor who is not involved in the investigation. “Tactics such as this tend to make people at the targets very nervous and may even prompt some employees to speak to government agents.”

In other words, the theater has a very specific target audience: the employees of any banks or hedge funds which are being investigated. It’s a sign that they can’t kid themselves that this is any kind of routine investigation, and that they should seriously consider turning witness against their bosses.

Part of the problem is that insider trading is a hard crime to nail, as the man in charge of this investigation, Preet Bharara of the Southern District of New York, has said quite openly.

Speaking last month to the New York City Bar Association, Bharara called insider trading a “rampant” problem that prosecutors need more tools to fight.

He said the increased speed and volume of trading makes it harder to pinpoint specific illegal trades and that a “veritable explosion of newsletters, websites, blogs, tweets, and feeds” can make it easier for the accused to argue that they traded based on information obtained legally.

Another part of the problem is that the net here is being cast so broadly—it includes not only traders and bankers but also “expert network” firms that connect hedge funds with industry specialists—virtually anybody trading on non-public information should probably reasonably be very worried right now.

It’s worth emphasizing that—at least up until now—trading on non-public information is not, in and of itself, illegal. Neither is disseminating that information, if you’re not an insider. (To take just one obvious example: disseminating non-public information is what journalists do every day.)

But, as Integrity Research points out, this is an area of jurisprudence which is constantly evolving:

Insider trading is a broad topic which is mostly defined by case law rather than clear regulatory statutes. Because of the gray areas surrounding the definition of insider trading, it is easy to be swept up in the emotion surrounding what the WSJ is billing as the mother of all insider trading cases.

One company which seems to have got swept up in the emotion is Big Lots, which has retained Cravath, Swaine, and Moore, no less, in a lawsuit against Retail Intelligence Group, a small Tampa, research firm. That, in and of itself, looks like bullying to me. The researchers went out and got intelligence on individual store sales and pieced those datapoints into a picture of a company which was about to disappoint the stock market. They were right. And now, for their pains, they’re being sued by Big Lots, which—given its earnings and stock price—really ought to have bigger things to worry about.

In a short video accompanying the story, the WSJ‘s Dennis Berman—a former Deal Journal blogger—tells viewers that “I suggest people go read this lawsuit because it really speaks a lot about where insider trading law is headed.” I’d love to, Dennis, but you didn’t post it. Come on, Dennis, there’s no copyright in lawsuits. Post it. That’s your job. And more generally, it would be good to have some well-reported explanations of what is and isn’t illegal when it comes to trading, and whether Bharara’s investigation might move the needle on that front.

Update: The WSJ has now posted the complaint.

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