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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Felix – you would have no problem then, if I paid currently-employed Reuters middle-managers to give me confidential information about the inner strategic planning and financial forecasts of Reuters business units, and then sell that information to competitors or investors?

You have no problem with that? Really? That is what the Big Lots lawsuit is about.

Kid Dynamite has a good article about expert networks and insider trading in general, with a link to a very informative background article on expert networks in detail. Asking a former Sprint executive about the impact of the iPhone becoming available on Verizon’s network – that is a good use of expert networks. Paying current employees to divulge proprietary corporate information is not, and should not be allowable simply because you call it ‘expert networking’ as opposed to corporate espionage or tortious interference with business contracts.

Simply because you might not be legally prohibited from trading on previously non-public information that has been leaked does not mean that you can do anything you want to get that non-public information in the first place. Make sense?


BTW, from the article, here is what the Big Lots lawsuit alleges. You’re fine with all of this?

“Big Lots alleges the firm pried information out of store managers, in effect stealing trade secrets and aiding and abetting employees’ breach of fiduciary duty. It has asked the court for an injunction to immediately stop what it calls “wrongfully induced” snooping.”

“It claims it suffered in the wake of Retail Intelligence’s disclosures, which show details on inventories, payroll and margins. In the highly competitive business of discount retail, this kind of disclosure can harm a company and its share price, Big Lots claims.”

“It accuses the group of illegally pinching information out of store managers, inducing them to disclose trade secrets about the discount chain’s sales, inventory and foot traffic.”

“Deploying a 21-question survey of 72 store managers, it concludes the company’s sales growth was beginning to falter. The managers even were asked to estimate the chain’s year-over-year performance, pegging it at a sluggish 1.8% gain.”

I see no problem with firing those employees, suing them for all gains they derived from their actions as well as for costs & damages, and suing Retail Intelligence Group for conspiracy to violate trade secrets and tortiously interfering with, at least, Big Lots employment agreements.

Posted by SteveHamlin | Report as abusive

Links to articles above (HTML didn’t go thru):

Kid Dynamite article about expert networks and insider trading: 1/insider-trading-or-not.html

Detailed background article on expert networks: 839-28.stm

Posted by SteveHamlin | Report as abusive

Steve, I haven’t seen the suit, as noted, but I suspect that there were no payments involved in the Big Lots case.

Generally, you don’t need to pay a leaking employee in order for you to be civilly liable for misappropriation & misuse of trade secrets. This case has very little to do with insider trading, and a lot to do with corporate espionage.

I agree that the specifics of what is inside information, and to whom the surrounding legal duties apply, are increasingly hard to apply in the modern, internet-enabled world of financial information.

However, Big Lots v. Retail Intelligence Group isn’t a case of “insider trading”, it is being pursued as a case of misappropriation of trade secrets and tortious interference with business relationships. Who wound up using the information to make investment decisions is not the point, rather the point is HOW the information was obtained.

Some selected quotes from the complaint ( documents/BigLots.htm):

“The Report consists largely of trade secrets and/or confidential and proprietary information obtained wrongfully from Big Lots’ managers and other employees. As set forth in more detail below, RIG has committed torts in connection with obtaining Big Lots’ confidential business information and selling it for profit in its Report, including (a) violations of Florida’s Uniform Trade Secrets Act, (b) interference with Big Lots’ business relationships, and (c) inducing Big Lots’ managers to breach their fiduciary duties to Big Lots by disclosing trade secrets and/or confidential and proprietary information about the Company.”

“RIG prides itself on its unique ability to dupe store managers into revealing trade secrets and confidential and proprietary information that it can then sell for a profit. On its website, RIG states that it is especially successful at obtaining confidential information because it hires former store managers, which allows RIG to better induce current managers to disclose such information.”

“Big Lots’ Confidential Information Policy states that its employees may not disclose to third parties (a) business, financial, and product development plans, forecasts, sales, and earnings data, (b) information related to customers, price lists, pricing policies, and financial information, (c) marketing techniques and materials, (d) marketing and development plans or (e) strategies, business policies, or practices.”

“Without Big Lots’ permission, RIG has improperly obtained the Company’s trade secrets and proprietary and confidential information from its employees, has disclosed such information, directly and indirectly, and has used Big Lots’ proprietary and confidential information to benefit itself and its customers.”

Posted by SteveHamlin | Report as abusive

I think the thing that the government and most people not within the financial services industry forgets is, risk.

Risk occurs in all insider trading cases, especially in the the cases with Big Lots. At the end of the day Retail Intelligence is expressing an opinion, not a fact. There is no guarantee that you’ll profit by following Retail Intelligence’s opinion.

Even if the case was that Big Lots CEO is giving non-public information to an analyst, such as an extraordinary dividend. The information is still not guaranteed. How do you know that the CEO isn’t just trying to ramp his stock? Or that perhaps the CEO doesn’t like the analyst and is trying to send them on a wild goose chase. Or even if the CEO is telling the truth, how do you know it’s not going to be rejected at the last minute by the board? At the end of the day the analyst is still taking risk from the information.

Is it less risky? Only if the analyst is sure of himself. But then is that any different to the analyst deciding that Big Lot’s sales are directly correlated to the number of lizards in his back yard? What happens if they were, would the analyst have an unfair advantage?

As you can see there is a fallacy in claiming that insider trading effects people.

If insider trading is based on having an “unfair advantage” over the “public” then basically everyone in the financial services industry has an unfair advantage over the public. Heck just having a Bloomberg terminal should be considered unfair, not everyone can afford one. Not to mention it most likely DOES give “non-public” information. Information usually distributed faster on financial networks than via public media.

Or even going further, the Australian Securities Exchange releases pricing data on its websites on a 20 minute delay. If I was to rely on that, then I am severely disadvantaged and someone with real-time-pricing would have “non-public” information.

Or what happens if my coworker has a faster computer than me? Is he getting price data faster than me? Is he getting news releases faster than me? Yes. Could that be considered non-public?

Where does it end?

Posted by bulllmktcowboy | Report as abusive