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Portfolio Manager's First Mistake Was Hiring Guy Whose Hobbies Included Insider Trading Club

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If you've been really closely following the SAC-Diamondback-expert-network-etc.-etc. insider trading investigations you might be able to keep the players straight but it's beyond me. I have a hard enough time keeping one list of their prison sentences. The SEC's new case against Whittier Trust and Victor Dosti really ought to come with a flowchart:

During at least 2008, a Dell employee (the "Dell Insider") passed material nonpublic information regarding Dell to Sandeep Goyal ("Goyal"), an analyst at a New York-based investment adviser who had previously worked at Dell. ... Goyal, in turn, passed this material nonpublic information to Jesse Tortora ("Tortora"), who at the time was an analyst at the investment adviser firm Diamondback Capital Management, LLC ("Diamondback"). ... Tortora, who was a member of a group of hedge fund analysts who regularly shared material nonpublic information regarding technology companies, passed the material nonpublic information that he received from Goyal to other members of the group, including [Whittier Trust employee Danny] Kuo. ... Shortly after receiving the Dell inside information from Tortora, Kuo communicated the information to Dosti.

Oh what the heck here's a flowchart:

I guess that wasn't so hard. I mean, for me to draw; it was one imagines difficult for the SEC to keep moving along the links of the chain and catching more and more insider traders. Dogged investigating and all that, plus like once you've got a fight club you'll have no shortage of idiots.

Anyway "Whittier Trust and Dosti agreed to pay nearly $1.7 million to settle the charges," versus around $724,000 in gains that the SEC claims they made on their insider trading. Dosti seems no longer to be employedat Whittier; it's not immediately clear to me how much of that $1.7 million he's paying, or if he'll face any other consequences. Seems like a no; I don't see a criminal complaint, and the SEC's suit doesn't ask for him to be banned or anything, just enjoined from violating the law again, which, y'know, nobody's supposed to violate the law.

While I guess it's impressive for the SEC to follow the chain so far, it's kind of embarrassing for Dosti. I mean, he's all the way over there on one end, why is he getting dinged for insider trading? The SEC's complaint suggests that he got multiple emails from Danny Kuo, who worked for him, saying "hi here's some illegal information I got":

On Monday, May 4, 2009, Kuo emailed Dosti to advise him that he had spoken to his Nvidia source over the weekend, and that his source had stated that the company would report first quarter revenues of "around $668 million," and that the company was still planning to report a worse-than-expected gross profit margin of 30 percent. Dosti responded, "[L]et's look at this some more after close today." ...

On the morning of May 12,2009, Kuo emailed Dosti the information that he had obtained from the Intel Insider concerning Intel's negotiations to acquire Wind River, including details of the monetary terms each company was proposing for the deal. Kuo wrote: "Update on WIND: [Wind River] wanted $12-13 and [Intel] wanted only up to $10 .... After further discussions between the two companies, [Intel] has submitted a revised term sheet to [Wind River] mgmt./board at close to $11, something around $10.80; [Wind River] board will review the revised term sheet this week; Sounds like the deal might go through after all."

I tell you this: if I were gonna do a lot of insider trading on the basis of tips received from my junior colleague, I would tell him to keep them to himself. "I got a good feeling about WIND, boss": great! "I got an email from a Wind insider containing details of board-level merger negotiations": pass! Wink with your eyes, not with a ;) at the end of your email full of federal felonies.

You can contrast the equivalent information flow at SAC Capital which looks like this:

The chain here is much shorter: instead of a bunch of dopes and a fight club, the inside information went directly from drug trial doctor Sidney Gilman to SAC analyst Mathew Martoma, and Martoma then went directly to a room with Steve Cohen where they talked about golf or whatever, and then SAC sold a bunch of shares based on that inside information. And SAC paid like $600 million in fines for that, but Cohen is still untouched. Because of that impenetrable wall.

What is it made out of? Oh, I don't know, possibilities include

  • not using email for that decisive conversation;
  • Mathew Martoma's loyalty in not turning on Cohen (versus Danny Kuo, who was only too happy to work with the feds); and/or
  • A culture at SAC that, whether or not it encouraged analysts and portfolio managers to seek out illegal inside information, definitely encouraged them not to tell Steve Cohen about it.

As a guy who really doesn't want to go to jail I sometimes wonder why more people don't replicate that structure. What were you doing, Victor Dosti, trading on emails from your analyst saying "hey boss here's some illegal inside information!"? Just look horrified, fire him, and forego the $700K in profits that you could have made for your $220mm investment funds. Go hire a new analyst who is either good at analyzing stocks or whatever, or good at getting inside information and not telling you about it.

I guess that's hard though? Lots of people have good feelings about stocks, and as far as I can tell those feelings tend to come more from idiocy than from insider tips. If you're some PM at a sleepy $3bn AUM wealth manager1 in South Pasadena it's harder to screen for the informed ones based on performance. If you're SAC it's easier. I guess that helps explain the SEC's relentless focus on SAC, rather than other parts of the expert-network web. And its greater success with those other parts.

SEC Charges Whittier Trust and Fund Manager in Insider Trading Investigation Into Expert Networks [SEC, and complaint (pdf)]

1.The SEC says "During the relevant period ... the total value of Whittier's assets under management was approximately $3 billion." It claims $8bn now, and to be "the largest, independently owned family office headquartered on the West Coast."