Levine on Wall Street: Do Nice Guys Do Insider Trading?

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Meet the insider in the big insider trading cases.

At the heart of many of the big recent insider trading prosecutions is Rob Ray, a (former) junior investor relations employee at Dell who told some hedge-fund analysts some stuff. Those analysts then told other analysts about the stuff, and then those other analysts' bosses were arrested and convicted of insider trading, because Ray's information was so radioactively illegal that even anyone who got it at three removes should have instantly been able to tell not only that it was nonpublic information but that it was obtained corruptly from Ray. Such, really, was the theory

But here is the story of Rob Ray and it is fascinating. Bloomberg News got the FBI's notes of its interviews with Ray, and with a Citadel analyst, Richard Farmer, who got information from Ray but was never charged. Here is how the FBI characterized the interviews with Ray:

“Ray stated that he knew what he did was wrong and that he wanted to do whatever he can to cooperate and help the government,” FBI agents wrote in a summary of that meeting. “Ray stated that he got caught up in getting into the buy-side and that he crossed the line.”

Sounds bad! Sounds like he confessed to criminal insider trading! Here's how his lawyer puts it:

“Ray told the agents he provided analysts with information and ‘color’ vetted by his supervisors, that he did not believe he had done anything wrong, and that he was unaware of insider trading by anyone,” Hendon said in a statement.

“Under pressure, he agreed with the suggestion -- advanced many times by the agents and rejected as many by Ray -- that it was ‘possible’ he had ‘crossed a line’ when speaking to analysts. (Getting to the buy side was another of the agents’ suggestions.) The next day, Ray told the agents he wanted to recant that statement, because it was not true,” Hendon said.

Who's right? Well, a useful hint is that Ray was never charged with insider trading. This might just be because the FBI and federal prosecutors thought he was a nice guy and wanted to cut him a break. But that doesn't sound like them; after all, they charged a lot of people who received Ray's information thirdhand, presumably some of whom were nice. Also, they didn't charge Farmer, who made millions of dollars for Citadel trading based on his information, which doesn't sound especially sympathetic. 

One obvious conclusion is that Ray's lawyer is right: that Ray more or less did his job, providing investors with the sort of non-material "color" that investor relations people are supposed to provide to their investors, and that he wasn't doing it because he'd been corruptly bribed to give out Dell's secrets. He knew that, and the people who dealt with him directly knew that. So prosecutors went after people who dealt with him at many removes, who traded based on information that their analysts got from other analysts who got it from Ray. (Bloomberg News has a good chart of the people who were actually tried for insider trading, all of whom are quite far from Ray.) By leaving out the actual story of how the inside information got out -- Ray never testified -- they could make it look more sinister.

It's fun to get angry about stocks

Here's an INSEAD working paper about investing blogs:

In this paper, we address these questions by using a unique hand-collected database of blogs covering all S&P 1500 stocks over the 2006-2011 period from LexisNexis. We start by investigating whether bloggers are informed. We entertain two alternative hypotheses. The first posits that if the objective of bloggers is to become “gurus,” bloggers must release some non-public information to build a long-term reputation. Bloggers may be more informed than the public either because they are better able to process information or because they are privy to more private information. We label this hypothesis the informed guru hypothesis. The alternative hypothesis posits that bloggers are not more informed than public media; rather, they simply selectively rephrase what is already published in the public media to attract attention. We label this hypothesis the cheap-talk hypothesis.

Guess which is right? Ha you guessed wrong: A "one-standard-deviation increase in blog tone" (i.e. how nicely bloggers talk about a stock) "is related to a 3.3% higher annualized" excess return, which is "evidence in favor of the informed guru hypothesis." On the other hand, negativity sells, so "bloggers will have an incentive to take an extreme negative tone when they want to win the attention war against their competing peers," which will "inflate extreme and especially negative opinions among competing bloggers." The more competitive a blogger's area is -- that is, the more other popular bloggers write about the same stocks -- the more negative and extreme that blogger will be. "Our results suggest that social media may provide mixed incentives for its participants in terms of information efficiency," conclude the authors, and that understatement is now my Twitter bio.

Speaking of social media information efficiency.

Twitter-obsessed journalists tend to distrust Anthony Noto, the former investment banker who became Twitter's chief financial officer, because he's not really a natural Twitter user himself and seems to be leading the charge to turn Twitter into Facebook in order to attract new users. This won't help: Yesterday Noto tweeted (and then deleted) "I still think we should buy them. He is on your schedule for Dec 15 or 16 -- we will need to sell him. i have a plan." So if you're on Twitter's schedule for December 15 or 16, you can go ahead and pick out your yacht. Presumably Noto did not mean to publicize his acquisition plans, or maybe he did, and this is just a clever plot to convince everyone that Twitter is too difficult for new users and needs big changes. Elsewhere, a former Morgan Stanley banker settled a lawsuit with Google over "an exceptional case of Internet trolling." And Carl Icahn's investing advice is "become a Twitter follower and read my future tweets!"

How did Goldman do on its derivatives trades with Libya?

I don't know, but we're going to find out, and I for one am super excited:

Goldman will disclose its margin, profit and loss from the day the trades were booked as well as a month later. It will also disclose the reserves it set aside for each trade, the parties said during a case-management hearing at London’s High Court.

The disclosure will generate ample attention because complex derivatives trades are highly lucrative, in part because of the opacity of the market and the negotiations involved. The authority contends that a standard margin for trades like the ones in its suit would be 5 percent, compared with the 20 percent to 40 percent charged by Goldman.

I mean ... 5 percent seems a little rich? But not crazy? Obviously 20 percent is crazy. I mean, 5 or 20 percent of notional. I worry a little that Libya is talking about profit margins as a percentage of premium, which is not a useful way to think about profit margins on derivatives.  Goldman could have sold Libya some call options and bought back some put options and ended up charging Libya zero dollars in up-front premium. That is a trade that happens all the time. Goldman still makes money on those trades -- the put it gets is worth more than the call it gives up -- but it is not meaningful to say that its profit margin is infinity percent of the premium. Anyway, we'll find out.

Extraterritorial payday lending.

A bunch of states regulate payday lending, with particular attention to maximum interest rates. Native American tribes are sovereign nations who can probably make payday loans that are not subject to those regulations. And if those tribes outsource that payday lending to private companies -- that is, if "payday lenders are just using tribes and tribal land as puppets to perpetuate their attempts to lend into states where payday lending is illegal," as Benjamin Lawsky puts it -- well, then. Then I mean that's not good, but also I guess not that surprising? If you have a regulatory exemption, you might as well sell it to someone who wants to use it. The going rate for this exemption doesn't seem to be that high -- "The tribe keeps about 1 percent" in one deal -- but why would it be? There are a lot of tribes, so no one tribe has all that much bargaining power, plus there's competition from the option of just, like, locating in Belize and doing the payday lending illegally.

How do you solve a problem like Aubrey McClendon?

Here's the story of how John Raymond -- the head of generically named investment firm Energy & Minerals group and the son of former Exxon Mobil chief executive Lee Raymond -- is financing Aubrey McClendon's comeback at the similarly generically named American Energy Partners. McClendon is among the wildest of wildcatters, and my model of his work at Chesapeake Energy was basically that he was an independent businessman who happened to accept money from public stockholders but did not want much to do with them. Raymond's model is different, insofar as he "insisted his firm have final say over all decisions," though McClendon gets to "scout for drilling prospects, launch new companies and hire teams to run them." 

Things happen.

Whitney Tilson began a letter to a CEO: "I am among your smallest shareholders, but also perhaps among your best known thanks to my public profile (Google me)." Steve Cohen's divorce is pretty unpleasant even by billionaire-divorce standards. David Tepper is returning some money to investors. Somehow Universa is making money. Santander's CEO resigned. The Strand makes money by selling truckloads of books to rich people who need to fill their libraries, sometimes with all white books. Definancialization and oil prices. And If This Self-Effacing Blog Post Highlights My Appealing Quirks, So Be It.

  1. Now is high time for my usual disclosure that I used to sell derivatives at Goldman and still own a little restricted stock.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net