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


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."


After The STOCK Act It Will Still Be Legal To Trade On Congressional Inside Information*

Here's a sort of touching monologue from David Einhorn's call with Punch: If you’ve done the analysis, and come to the conclusion that on it’s own, the company is not going to make it, it makes all of the sense in the world to raise equity at whatever the price is, so that you can know that the company, you know, is – is going to make it. Now, what that brings to my mind though is, you know, obviously we haven’t done your analysis, we haven’t done -- signed an NDA; I don’t know that we’re going to sign an NDA, because we prefer to just remain investors, but from my perspective, and I’ll be just straight up with you, is that gives a lot of signalling value. And the signalling value that comes from figuring out the company has figured out that it’s not going to make it on it’s own is that we’ve just grossly misassessed the -- you know what’s going on here. And -- and that, that will cause us to have to just reconsider what we’re doing, which is not the end of the world to you. You will continue on even if we don’t continue on with you. You could sort of see why the FSA read that to mean that he was insider trading. Like ... (1) You have told me something with signalling value. Sorry - "a lot of signalling value." (2) I will now act on that signal. (3) Don't be mad. "Signalling value" sure sounds like it means "material nonpublic information," doesn't it? Now as we've discussed before, trading on that information would not be enough to make Einhorn guilty of insider trading in the US, though maybe it wouldn't be exactly a great idea here either. Why? Because in our weird but sort of sensible insider trading laws, it's just not illegal to trade on material nonpublic information. It's only illegal to trade based on material nonpublic information that was obtained in violation of some sort of duty of confidence. Since Einhorn didn't sign an NDA, he had no duty of confidence. And since the Punch CEO and bankers weren't tipping him for nefarious purposes, but were instead sounding him out on the company's behalf as a shareholder and potential investor in a new capital raise, they weren't breaching their duty of confidence. You could quibble with the details of that but it's basically the law here. In England not so much. That also seems to be the law for our friends in Congress, who recently passed a law making it illegal for them to insider trade, which is worrying some people who make their living from trading on Congressional inside information: