Just a relief defendant.

Photographer: Andrew Redington/Getty Images.

Insider-Trading Law Comes for More Golf Buddies

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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In 2014, the U.S. Court of Appeals for the Second Circuit decided an important insider trading case, U.S. v. Newman, ruling that a person who trades on tips from a corporate insider isn't guilty of insider trading unless (1) the insider got some sort of quid pro quo for the tips and (2) the "tippee" knew about the quid pro quo. So the Second Circuit overturned the convictions of two hedge fund managers who traded based on inside information, but who got it fourth-hand and had no idea where it came from or why. I wrote at the time:

This renders a whole host of insider trading cases problematic. Even golf buddy cases. One of the Oakley Country Club cases featured a corporate executive who allegedly tipped his golf buddy with the goal of "currying favor" with him "and/or providing confidential information to a trading friend." Does that sound like the sort of personal benefit that the Second Circuit would find sufficient for criminal liability? It sounds to me more like "the mere fact of a friendship, particularly of a casual or social nature." And so it's not criminal insider trading.

I have since moderated my opinion somewhat, but Preet Bharara, the U.S. Attorney for the Southern District of New York, has not. He still seems to regret his inability to imprison people for trading based on hot tips from their golf buddies. A particularly galling Golf Buddy That Got Away is Phil Mickelson, the three-time Masters winner who is almost certainly the best golfer ever to be mentioned in connection with an insider trading case. Mentioned, but not charged:

During the question-and-answer portion of the press conference, a reporter asked Bharara whether the Newman decision was the reason why Mickelson hadn't been charged. 

"I will repeat what I’ve said many times: If the Newman decision stands, it has an impact on our investigations," Bharara said, somewhat grumpily. "Conduct we think is nefarious, and that undermines faith in the markets and the fairness of the markets, will not be able to be prosecuted because of the Newman decision."

Mickelson allegedly got a hot tip about Dean Foods from professional gambler Billy Walters, which Walters had allegedly gotten from Dean director Thomas C. Davis. Walters allegedly gave Davis money in exchange for his stock tips, but Mickelson didn't know that. It was a hot enough tip that "Mickelson bought, partially on margin, a total of 200,240 Dean Foods shares, a $2.4 million position," which "dwarfed the other holdings in the brokerage accounts, which collectively were valued at less than $250,000." The temperature of the tip might suggest -- just suggest -- that Mickelson may have had an inkling that Walters got it from inside the company. But there's no evidence at all that he knew that Walters had paid for it, or that any corporate insider got any "personal benefit" for providing the tip. So, after Newman, there's no case. Bharara at least implies that it's still "nefarious." Mickelson's lawyer disagrees ("Phil was an innocent bystander to alleged wrongdoing by others that he was unaware of"). The Securities and Exchange Commission will split the difference: Mickelson agreed with the SEC to pay back about a million dollars of trading profits, with interest, "because he should not be allowed to profit from Walters’s illegal conduct."  

The Mickelson situation is an interesting little window into the present and future of insider trading law. But the Walters and Davis situations ... kind of aren't? If you believe what's in the SEC's complaint, and the Justice Department charges against Davis (who pled guilty) and Walters (who did not, and whose lawyer says that the "accusations are based on erroneous assumptions, speculative theories and false finger-pointing"), then they are just simple mainstream insider trading. Davis, a former investment banker, was clearly an insider, serving as a director of Dean Foods. But "following his retirement from investment banking, Davis’s financial condition declined, as his spending and gambling habits did not change despite his lower income." I happen to know this feeling rather well.

Walters, meanwhile, was wealthy and a fantastically successful sports gambler who "started placing bets as a young boy and lost all his savings -- $75 -- betting on the New York Yankees against the Brooklyn Dodgers in the '55 World Series." (He got better.) And he happened to be Davis's -- oh yes -- golf buddy.  And so, according to the SEC complaint, they fell into a comfortable sort of quid-pro-quo based tipper/tippee insider-trading relationship:

In April 2010, Davis was desperate for money and turned to Walters. Davis asked Walters for a loan and, in the same meeting, provided Walters with confidential information regarding Dean Foods.

The information was about Dean's plans to spin off a subsidiary, and also about upcoming earnings information. The loan was for $625,000:

At that time, Davis needed money and he needed it fast. He owed the Internal Revenue Service (“IRS”) $78,000, was carrying tens of thousands of dollars in credit card debt, and had heavily margined his brokerage account. Davis also owed over $550,000 to an investment fund he managed. Not having the money to pay the IRS or maintain his lifestyle, Davis turned to Walters for help.

Walters allegedly got a friend to lend Davis the money, which Davis never paid back. (Walters did, making it distinctly more of a gift than a loan.) Things got seedier:

In November 2011, Davis returned to Walters for more money. This time, he needed an additional $350,000 to repay substantial personal debts. He owed $178,000 on a business venture to operate a private jet. He also owed $100,000 to a charitable organization he managed, having wrongfully taken that amount from the charity to cover a gambling debt owed to a Las Vegas casino.

That was the "charity he runs to raise money for a Dallas-based shelter for battered women and children" that he raided to pay his casino markers. I can see how insider trading might feel like a more honorable solution.

Meanwhile Walters was just putting oceans of money into Dean Foods:

Davis knew that Dean Foods was performing ahead of expectations and, in words or in substance, provided this information to Walters. The two spoke after the market had closed on June 18, 2008. Before the market opened the next day, Walters called his broker and placed a buy order and, over the next three trading days, bought 3,358,216 shares of Dean Foods common stock in The Walters Group account and 600,000 shares of Dean Foods common stock in the Nature Development account at a total cost of $73.5 million. Walters’s purchases ranged from approximately 29% to 37% of Dean Foods’s daily trading volume on those days.

Why would you insider trade with $73.5 million of your own money?  For one thing, buying a third of a stock's volume every day for three days is ... pretty noticeable. But also it is just so much money, for a person. Like, if you work at a hedge fund and want to impress your boss, I can understand putting $73.5 million of the fund's money on an insider trade. If you need money, I can understand -- though not condone -- putting $10,000 in short-dated out-of-the-money call options on an insider tip. But if I had $73.5 million, for myself, I would not insider trade with it. You know what I'd do? Live on it, in great comfort, for the rest of my life. It's so much money; why risk prison for more? I guess this is why I don't have $73.5 million. Or as "a longtime Vegas pal" and biographer of Walters put it in this ESPN profile:

"He has a work ethic that is just ridiculous. If you and I had $300 million, we might play golf five days a week. Or be on a beach with three gals in bikinis. Billy works as hard today as he did when he was a used-car salesman in Kentucky."

Ah, but if you play enough golf it might get you some inside information. 

There was some skulduggery. Walters allegedly gave Davis a prepaid phone, and "said that when either of them wanted to discuss Dean Foods, he should refer to the company as the 'Dallas Cowboys.'"  And at some point, when Davis was given confidential information about an activist campaign at Darden Restaurants, he allegedly "met with a representative of the shareholder group, called Walters, and then mailed the confidential presentation to Walters. Although Davis had an electronic version he could have forwarded by e-mail to Walters, Davis instead traveled to a postal center and used cash to pay for the mailing." Subtle.

But all in all it just seems so ... old-fashioned. And yet so big. I think of insider trading as either a subtle, careful, hard-to-prove, less-common-than-you-think practice among big connected hedge funds, or else dumb call-option purchases by small-time goofballs. (Or, now, hacking.) It's rare to see a timeline this straightforward where the parties are a director of a public company and a trader buying millions of dollars worth of stock :

It undermines Preet Bharara's complaints a bit. A world in which the big insider traders are subtle and sophisticated, and get their tips fourth-hand and in deniable ways, is a world where it really is difficult for prosecutors to punish insider trading. But if the prosecutors' allegations in this case are right, they haven't yet run out of opportunities to go after insider trading that is both big and dumb.

  1. This is where I mention: Nothing here is legal advice! Also: Don't insider trade! Come on!

  2. In broad strokes I think that, after Newman, prosecutors will have a harder time going after "professional" insider trading -- hedge fund managers getting information as part of a basically business relationship with corporate insiders -- and will instead focus on "amateur" insider trading, like, brothers-in-law and stuff. (See herehere, here, etc.) This makes me think that golf-buddy cases will work out a little better for prosecutors than I had originally thought. 

  3. Though not necessarily: Walters is a blindingly successful gambler, so if he gave me a tip I might trade on it without assuming that it came from an insider.

  4. Is that a thing? There are subtle and metaphysical differences between civil and criminal insider trading, but Mickelson was not charged with civil insider trading either. And there is no lesser category of insider trading that is, like, it's fine, you just have to give back the money. But I guess the "relief defendant" concept -- "a person or entity who has received ill-gotten funds or assets as a result of the illegal acts of the other named defendants" -- applies to insider trading too. Also, a settlement is all about splitting the difference. In any case, Mickelson was a "relief defendant" in the SEC case and will give back the money. 

  5. From the SEC: "Walters and Davis first met more than 20 years ago at a Southern California golf course. At the time, both owned homes in Southern California and met often to play golf."

  6. The SEC explains that "The Walters Group is a Nevada partnership owned by Walters and his wife and is based in Las Vegas, Nevada."

  7. If they are tapping your phones, you are kind of already sunk, no? In any case it doesn't seem like they were tapping anyone's phones: Davis pled guilty and will cooperate against Walters, and will presumably be the main evidence against him. 

  8. I have no idea why. The SEC says:

    During the summer of 2013, Davis was approached by a shareholder group that was buying stock of a certain code-named target company with the goal of pushing the company to make corporate changes. On or about July 31, 2013, Davis signed a Non-Disclosure Agreement (“NDA”) in which Davis agreed that he would keep confidential information he received from the shareholder group, including their plans for the company.

    That group was led by Barington Capital Group, and was pushing to split up Darden. (It's not the later, more amusing Starboard Capital proxy fight.) 

  9. The exception is the Rajat Gupta/Raj Rajaratnam trades. Man, those were weird.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net