Tears for insider traders

My name is Jay Robert Guy, III. I was one of the most successful hedge fund managers on Wall Street until I was sentenced to three years in federal prison on 10 counts of securities fraud, along with the usual seven-figure fines for engaging in insider trading.

The judge called me a white-collar sociopath, and that was one of the nicer things she said about me. My attorney objected and said it depended on how you define sociopath. The judge suggested, “A person who knows the difference between right and wrong but doesn’t care.”

Over-zealous prosecutors employed wiretaps, subpoenaed millions of documents, tried to flip former employees and used other heavy-handed methods to convict me of receiving material, non-public financial information from a network of highly paid independent experts my firm had retained. I was too busy to ever question them about the source of their research. How was I to know that the information was not public?

I paid a big chunk of the fines by selling our duplex on Manhattan’s Upper East Side, with its multiĀ­ million dollar art collection. I also sold the obligatory house in the Hamptons with the barn I had converted into a spa for my wife, Muffy. It was the only way to get her out of Manhattan, along with the custom Porsche in the three-car garage. Poor Muffy felt martyred by the whole business.

Then there’s the Caribbean island hideaway. We actually spent just half a dozen weekends during the years we owned it. And various condos in Miami Beach, San Francisco and a couple of other cities where I did enough business to justify having my own pad.

I bought the 110-foot Feadship yacht from the previous owner’s estate when it was sitting in a Miami repair yard. It was halfway through a full hull and engine overhaul that had been suspended when the owner’s money ran out. I have written enough checks to complete the overhaul and get it back into the water, where it was moored at a dock in the repair yard while ‘the interior was being re-done.

Question: What is the definition of a yacht? Answer: A big hole in the water into which you keep pouring money.

And of course there was the Lear Jet based at Teterboro airport in Jersey with the full-time pilot ready to fly me anywhere on a moment’s notice.

You get the idea. I lived a life too rarified for the average working stiff to even imagine. All the usual grown-up toys Wall Street money mavens tend to accumulate more or less automatically when the big dollars are rolling in.

I paid the rest of the penalties by liquidating most of my domestic investment accounts. So in a short period of time, I went from being ridiculously rich to merely “financially independent.” According to an article by some smart-aleck college professor, that is supposed to be the worst punishment society can inflict on a white-collar felon.

At least my numbered and password-protected offshore accounts are still intact. They will enable me to set up shop again once my high-priced attorneys get the court to vacate my original conviction.

Why am I so confident? Because of a decision by the 2nd U.S. Circuit Court of Appeals in New York that overturned the conviction of two hedge fund managers because prosecutors had not proved that the defendants knew the original source of the inside information and whether the source benefited from sharing the information. Thank God the court finally realized that these reckless trading prosecutions have gone too far. They hurt real people like Muffy and me.

We are in the process of making the same argument on appeal. After that it will be time to get back to business as usual. Actually, it should be even better now that insider trading has gotten a whole lot harder to prove.

originally published: January 24, 2015

The Rothschild legend’s legacy on insider trading

The convictions of two former hedge fund managers on insider trading charges were unanimously dismissed last month by the three-judge panel of the influential Second Circuit U.S. Court of Appeals. The ruling makes the charge tougher to prove, and illustrates why Congress needs to provide a clear definition of insider trading.

The court held that two Wall Street traders could not be convicted of insider trading by merely possessing and trading on privileged information leaked by corporate insiders and passed along to them through several levels of intermediaries. Instead, it found that the traders must have known the source of the inside information and that the person who provided material, nonpublic information must personally benefit from the leak.

This tougher standard puts pressure on the Securities and Exchange Commission (SEC) to better define what actually constitutes insider trading. Both the SEC and the Department of Justice prefer a broad rule against insider trading because they believe that it seriously erodes the public’s confidence in financial and capital markets, thereby reducing liquidity and investment.

The Second Circuit ruling marks a significant setback to U.S. Attorney for the Southern District of New York Preet Bharara, whose office patrols Wall Street. Until now, Bhahara had a near-perfect track record, gaining convictions or guilty pleas from about 90 people for insider trading since he became U.S. attorney in 2009.

SEC chairwoman Mary Jo White predictably complained that the ruling was “overly narrow.” Bharara said he fears it “interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information.” A key objective of the aggressive prosecutions was to leverage the ambiguity of what constitutes insider trading to deter illegal behavior, especially on Wall Street.

In the United States, insider trading is one of the most common offenses that usually falls under the general purview of securities fraud. Most insider trading cases are covered by Rule 1Ob-5 of the Securities Act of 1934, which prohibits fraudulent or manipulative conduct in connection with the purchase or sale of securities. While it is regarded as a serious crime, no statute specifically defines it.

The ultimate insider trade was when Nathan Rothschild learned that Napoleon had been defeated at the Battle of Waterloo in 1815 a full day before anyone else, allegedly thanks to carrier pigeons that made their way across the English Channel to London. This advance knowledge enabled him to make a killing by buying up the British bond market before the news of the British victory was more widely known.

The Rothschild legend identifies the value of inside information when it is applied to securities trading. For years, judges, prosecutors and the SEC have worked to expand what constitutes insider trading, yet there is little agreement as to exactly when trading on material nonpublic information should be prohibited. This lack of clear guidance on the parameters of the prohibition creates immense difficulties for prosecutors.

So an ever-changing cast of prosecutors, judges and SEC officials have interpreted the general law against “securities fraud” differently as it applies to insider trading, struggling to measure what conduct constitutes improper trading on material non-public information with the precision of a crystal meth cook.

Since insider trading is a crime punishable by harsh penalties, Congress needs to define it, perhaps by prohibiting any trading on material nonpublic information. It should be made clear that those possessing inside information must either make it public or forego trading. The Second Circuit’s recent ruling makes it clear that such an approach would be preferable to the current murky, fuzzy rules.

Until Congress unambiguously defines insider trading, we will continue to rely on the ability of presentĀ­ day Solomons to make the most delicate of judgments about what constitutes improper trading on material nonpublic information. 

originally published: January 10, 2015

So let’s talk about insider trading

So let’s talk about insider trading. A great American dream. Like having your own private copy of tomorrow’s Wall Street Journal delivered this afternoon, in time to place your trades before the markets close. Is it any wonder most people find the concept irresistible?

The Securities and Exchange Commission generally uses the term “insider” to identify those individuals – corporate officers, directors, employees, and other professional advisers -who have access to material information before it is available to the public. Insiders are permitted to trade as long as the trading does not take advantage of the confidential information and breach their fiduciary duty to the company. Such trades must also be disclosed to the SEC.

Illegal securities trading by an insider is a key Department of Justice and SEC enforcement priority. The SEC has initiated about one insider trading action a week since 2009 and the feds show no signs of slowing down. But what Congress should look at is changing the penalties for insider trading.

The government has won a number of high-profile cases, including one against the Galleon hedge fund manager Raj Rajaratnam, who was found guilty and given an 11-year prison term. Nearly two dozen people associated with Rajaratnam’ s insider trading scheme pleaded guilty or were convicted.

Rajat Gupta, the former chief of McKinsey and Co. who also served as a director for Goldman Sachs and Procter & Gamble, was the highest profile executive convicted of illegally passing confidential information to Rajaratnam. He was sentenced two years in Club Fed.

There has been extensive debate as to whether insider trading should be banned. The theory most often used by the SEC and the courts is that insider trading undermines investor confidence in the integrity of the markets. Shareholders and outside investors are at a disadvantage when they trade against insiders. If they aren’t protected, capital markets would be damaged as fear of trading with insiders might stop potential buyers from coming to the market.

On the other hand, some economists say insider trading benefits markets and improves the accuracy and efficiency of stock prices. Milton Friedman, for example, questioned whether insider trading is harmful and worthy of legal action. He was as decent a human being as you could find, regardless of whether  you agree with his support of unrestrained free-market capitalism.

Friedman believed that trading on material, non-public information benefits investors by more quickly introducing new information through prices into the securities market. And better information makes for more efficient markets.

Others argue the ethical questions raised by exploiting uninformed investors for personal gain are valid enough to justify prohibiting insider trading on material non-public information obtained in breach of a fiduciary duty.

For certain, these are difficult policy questions. But when it comes to meting out punishment for engaging in illegal insider trading for personal gain, the real punishment should be for the guilty to give up their lifestyle.

Instead of meting out prison terms that cost the American taxpayer $30,000 per person per year, guilty parties should be sentenced to live at the standard of the average American. That can be accomplished by imposing a fine equal to the perpetrator’s assets, then paying part of it back to them over their lifetime by giving them an amount equal to the median income.

Perpetrators could also spend the rest of their working lives performing community service. So bankers who profited from the housing crisis could work in homeless shelters. This would be a classic example of the punishment fitting the crime.

originally published: July 27, 2013