Salsa-Dancing Day Trader Not an Expert on Securities Law
Here is a little romantic comedy from the Securities and Exchange Commission. It features Shirmila Doddi and Vlad Spivak, and it starts with a meet-cute:
Doddi and Spivak met at a salsa dancing club in early 2011 and developed a romantic relationship that lasted at least through the end of 2011.
They get to know each other and bond over shared interests 1 :
Spivak described himself to Doddi as a “day trader,” and frequently talked to Doddi about the different stocks that he traded.
Spivak was aware that Doddi had access to material, nonpublic information through her job at the Bank.
Their relationship is tested:
On multiple occasions, Spivak asked Doddi to provide him with nonpublic information that she had acquired in the course of her employment. Spivak further told Doddi that insider trading was not a big deal and that individuals rarely get caught.
Between October 6, 2011, and October 13, 2011, and in violation of her duty to maintain the confidentiality of such information, Doddi knowingly provided Spivak with material, nonpublic information about the possibility of merger and acquisition activity involving ADPI. Doddi provided this information with the intention that Spivak use the information to purchase ADPI stock.
The SEC also prevails:
Without admitting or denying the allegations in the SEC’s complaint against her, Doddi has consented to the entry of a judgment that permanently enjoins her from future violations of Section 10(b) and Rules 10b-5 and orders further proceedings for the purposes of determining the appropriate amount of disgorgement, prejudgment interest thereon, and civil penalties.
I am just a guy typing words into a box on the Internet, and you should never take anything I say as legal advice, but on the other hand you definitely, definitely, definitely should never take legal advice about which crimes are "not a big deal" from a day-trader you meet at a salsa dancing club. 2
Doddi never traded or made money on this scheme, though, while Spivak, who allegedly "sold the shares of ADPI that he had purchased in his and his mother’s accounts for a profit of $222,357," does not seem to have settled. "Although Doddi did not trade on the information," says the SEC, "in tipping Spivak, she conferred a gift upon a romantic partner." And, really, what could be more romantic than the gift of material nonpublic information? The SEC is not mentioning the gift just for the sake of the story, though. It's also a key element of the insider trading charge. As I've mentioned before, the Second Circuit's Newman decision, which seemed to say that it's not illegal to trade on inside information from a tipper who did not receive a "personal benefit" in exchange for the tip, didn't really mean that. A gift of inside information to a romantic partner -- like a gift of inside information to a brother or golf buddy -- is probably still illegal, despite some ambiguous language in Newman. 3
I read a lot of SEC enforcement actions. (So should you! They are funny.) They tend to divide into two broad categories. 4 One is what I will affectionately call small-time crooks: penny-stock hucksters, stay-at-home spoofers, friends-and-family Ponzi schemers, "prime bank" true believers. These are usually the funnier ones. The defendants tend to be out of the financial mainstream, working at home or in strip malls, with limited access to high-powered lawyers or well-designed compliance programs. Their schemes tend to be rickety, their legal violations clear, their fraud obvious and intentional. "You running Ponzi scheme?" their clients text them.
The other category is what you might call industry clean-up. Here, the defendants are bigger companies with better lawyers, and the accusations are rarely (not never!) about blatant intentional fraud. These are cases about gray areas, where the defendants are accused of doing things that a lot of people in their industry thought were actually fine. And that's the point: The SEC brings these enforcement actions to change industry norms, to signal that things people thought were fine are no longer fine.
So today the SEC announced a $10.2 million settlement with Fenway Partners for what you might call aggressive private-equity fee practices, part of a series of similar private-equity fee cases that we've discussed here and here. 5 The story is basically: The private equity industry had evolved a pretty aggressive set of standards for what fees private equity firms could charge their limited partners, and then people decided that those standards were kind of icky, and the SEC agreed, and so people who did stuff that they could plausibly defend as industry-standard nonetheless got in trouble. Or there are the bond-trading cases, in which the SEC and prosecutors are wading into the disputed area of how much bond traders are allowed to lie to their customers. Market-structure enforcement is a mixed bag -- there are a surprising number of stay-at-home spoofers -- but a lot of it really does seem to be about making big high-frequency traders more careful and big dark pools more transparent. And don't forget the mortgage CDO cases!
Insider trading is just obviously in the first category. Classic insider traders eat Post-its, use golf-based codes, hand each other bags of cash in parking lots and reassure each other that insider trading is "not a big deal." They buy short-dated out-of-the-money call options. 6 They are -- and, again, I say this with great fondness -- small-time crooks. Even when they use massive hacking schemes to make hundred-million-dollar profits, they still have a certain scruffiness, trading in short-dated out-of-the-money options and itemizing invoices to "guys."
But there was a brief strange moment when it looked like it might be otherwise. From the time the SEC started looking into Steve Cohen, until the time the Supreme Court declined to hear the Newman case, insider trading law seemed like it might be a tool of industry crackdown. What if, in its efforts to gain "edge," the hedge fund industry as a whole had gone beyond the law? What if insider trading law regulated not just romantic gifts of merger news, but also earnings color provided by corporate investor-relations departments? What if that law could be used not just to prosecute goofballs on golf courses, but to fundamentally change how professional investors do research and interact with companies?
The results would be weird, is I think the answer, though it's hard to really know. If it were a crime to have better information than the average investor -- as prosecutors in Newman sometimes implied, 7 and as some people in Congress seem to want -- then professional investors would be afraid to seek out market-moving information or meet with corporate managers. Markets would be less informed, though also perhaps fairer. But it's hard to know. With the Newman decision, the hedge-fund insider trading crackdown seems to have ended, with inconclusive results. Some popular hedge fund practices have probably changed for good -- expert networks seem a lot riskier now than they did a few years ago -- but the fundamentals are still more or less the same. You still can aggressively hunt out information that gives you "edge." You still can't do it in obviously corrupt ways, like bribing company insiders for merger tips. You can adopt an industry-standard compliance program, and follow it, and never have to worry about the SEC or prosecutors coming after you for insider trading. 8
Which leaves insider trading enforcement for small-timers who don't know any better. Which is mostly fine! Cracking down on small-time, obvious crooks is an important part of the SEC's mission; penny-stock fraudsters, say, harm their victims even if they don't pose much systemic danger to the financial system. But insider trading does seem a little different. Big professional investors really do have informational advantages over the average investor: They can meet with management, share ideas with each other, even team up to buy stock ahead of an acquisition. Those advantages are, for the most part, entirely legal. They're normal and accepted and industry-standard. That doesn't mean that enforcement actions can't be used to change them. But right now that threat seems to have receded.
And so the poster children for insider trading are once again day-trading salsa dancers accused of making hundreds of thousands of dollars on merger tips. If the SEC's allegations against Spivak are true, his insider trading was blatant and obvious and far from any gray area. But it was also pretty small. If you want to punish blatant crooks, then this case makes sense. But if you want a level playing field for retail investors, Vlad Spivak is not who you worry about.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
"The Bank" is Wells Fargo, where Doddi was "a financial analyst in the commercial banking group."
To be fair, the consequences to Doddi don't seem to be an especially big deal? There seem to be no criminal charges, anyway, and no fine determined yet.
That's extremely not legal advice! You can distinguish this case from Newman in a bunch of ways: It is civil, not criminal, so the standards are lower; and it is in the First Circuit, not the Second, so Newman doesn't control. But all in all I think the right reading of Newman is that a pure "gift" of inside information, in a close enough personal relationship, can still be illegal. I have written about this more here and here and here and everywhere.
This is not super scientific. It leaves out, in particular, public-company accounting fraud, which kind of spans both categories. And there are mid-tier cases; what do you make of the charges against Lynn Tilton? And there are, like, Rule 105 cases and other pretty much administrative things.
Also here, but that wasn't an enforcement action, just a Wall Street Journal article about KKR. In fact, the Fenway case -- about charging portfolio companies consulting fees (not shared with limited partners) instead of management fees (shared with LPs) -- sounds a lot like the Journal's complaints about KKR, while the SEC's case against KKR was for entirely different fee-related stuff.
Which Spivak didn't, so that's something.
See this post, especially footnote 7.
Here is Patrick Radden Keefe with the negative view of this:
But, to anyone who is at all acquainted with the anthropology of the contemporary hedge fund, it also represented, unmistakably, a license to cheat. Company insiders share tips for many reasons, not just financial compensation: the person they share the information with may be a friend or a family member, someone they want to impress, someone they owe a favor. And once they pass the tip along it often circulates through a network of people in the investment community. At a large hedge fund, the senior investors are generally not out shaking the trees and doing primary market research themselves—they are relying on their analysts and portfolio managers to feed them data and hypotheses. These intermediaries were always a buffer against legal exposure, and the existence of that buffer may offer one explanation for why Bharara was never able to personally charge Cohen with criminal wrongdoing.
What the Second Circuit opinion does is fortify the buffer with Kevlar. Richard Holwell, a former federal judge who presided over several high-profile securities-fraud cases, told me that, when an illegal tip is passed up the chain at a hedge fund, senior traders often know better than to inquire about its origins.
I am not convinced that this anthropology is entirely right, or that it quite captures what went on in the Newman case itself.
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