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Hedge Fund Got Bananas Bonanza of Inside Information

And it ignited a money-printing machine.

Some guy who might be in finance.

Photographer: Jeff Hutchens/Getty Images

The rules of insider trading are complicated. You might think it's as simple as "don't trade on nonpublic information you got from an insider," but it isn't. There are strange and subtle rules about how you can get that information, about what sorts of benefits to the insider, or friendship between you and the insider, that make his tips and your trading illegal. The rules are even more complex for traders who get their tips indirectly; there, the inquiry involves not only what benefit the insider got, but also what the traders knew about it.

But there is a rough useful metarule, 1 which is that if your interactions with the insider look corrupt, that's bad. For instance if you hand him a sack of cash in a parking lot, you have to know you're going to prison. Similarly don't do this:

On or about April 27, 2012, BLASZCZAK wrote an email to HUBER, OLAN and Fogel to inform them that he had made contact with the CMS Contractor. BLASZCZAK  said, "The mystery man ... responds. Here's my chance ..." HUBER told BLASZCZAK, "Just tell him your doing god's work." Fogel chimed in, "That is huge dude ... don't blow it! You just turned my frown upside down so let us know if he bites. [The CMS Contractor] is the man with the keys to these companies' coffins. ..." In a separate email chain, HUBER, OLAN and Fogel discussed the possibility of BLASZCZAK's getting inside information from the CMS Contractor. Fogel said, "So you guys know, getting a useful input from [the CMS Contractor] would be way bigger than bonanza bananas bazooka in my book."

You could analyze that email chain -- in which "CMS Contractor" is an insider at the U.S. government's Center for Medicare & Medicaid Services, David Blaszczak is a political intelligence consultant, and Jordan Fogel, Theodore Huber and Robert Olan are partners at Deerfield Management, a hedge-fund firm that paid Blaszczak for consulting work -- in terms of the Supreme Court insider trading cases of Dirks v. SEC and Salman v. U.S., or the Second Circuit case of U.S. v. Newman. 2 You could ask questions like: If CMS Contractor passed inside information from the CMS to Blaszczak, did he do it as part of his job, 3 or as a breach of his duty of confidence to the CMS? Did he receive any personal benefit for passing the information to Blaszczak, or have a "meaningfully close personal relationship" with him? And if he did get such a benefit, or have such a relationship, did Fogel, Huber and Olan know about it? 

Or you could look at the phrase "way bigger than bonanza bananas bazooka" and figure there is something fishy going on there, and everyone on that email chain knew it, and they were all in trouble. 

As it happens, the CMS Contractor never ended up passing any information to anyone, so none of those questions matter. But Blaszczak knew someone else at CMS, an employee named Christopher Worrall, and allegedly got inside information from him and passed it along to Fogel, Huber and Olan. And that email chain is included in the federal criminal indictment for insider trading against Blaszczak, Huber, Olan and Worrall, even though they never got anywhere with CMS Contractor. It has no direct relevance to whatever they got up to with Worrall. But if you're on that email chain, and later you get inside information indirectly from a different CMS employee, and you bring up the technical legal defense that you had no way of knowing what personal benefit that CMS employee did or didn't get in exchange for passing on the information, the prosecutor can hand you that email, wait for a few tense seconds, and then say: "bonanza bananas bazooka, eh?"

It's not a good look. 4  In fact, Fogel -- the phrasemaker behind "bonanza bananas bazooka" -- isn't charged in that indictment; he was indicted separately, pleaded guilty and is cooperating with prosecutors. In a sense he was confessing his guilt and assisting the prosecutors from the minute he hit send on that email. He was pretty indiscreet generally; he sent Blaszczak another email saying that they should "catch up soon and figure out how we can re-ignite the Blaszczak-Fogel money printing machine." The phrase "money-printing machine" is high praise, in financial circles, but it's one that you really don't want in your federal criminal indictment. It does not sound good to a jury!

Anyway, the actual legal stuff. Worrall worked at CMS, where according to the Securities and Exchange Commission -- which also brought civil charges against Blaszczak, Worrall, Huber and Fogel -- he "had access to material, nonpublic CMS decisions concerning reimbursement amounts" that Medicare would pay to health-care companies. Before becoming a political consultant, Blaszczak had worked with Worrall at CMS, and they were friends who "met regularly for lunch, golf, baseball games, and drinks," as well as meeting at the CMS offices and texting each other a lot. Worrall allegedly passed nonpublic information to Blaszczak, which Blaszczak then passed to his clients, including the Deerfield guys. So for instance in July 2012, CMS announced that it was going to cut reimbursements for certain radiation oncology procedures. Worrall allegedly told Blaszczak about that before the public announcement, and Deerfield shorted the stocks of Varian Medical Systems Inc. and Elekta AB, two companies exposed to the price cuts. Their funds made about $2 million in profits from the trade. 5  

If that's true, it would meet the basic requirement for insider trading: Worrall was a CMS insider with an obligation to keep information confidential, and he allegedly leaked it to Blaszczak. 6  But then you still have the Newman/Salman question of: Did Worrall give the information to Blaszczak in exchange for a personal benefit, or as a gift as part of a close personal relationship, or what? And there again, the emails are ... not ... good:

In August 2014, Worrall and Blaszczak discussed in a series of text messages the possibility of Worrall leaving CMS to join the new policy firm that Blaszczak was establishing. Blaszczak asked Worrall, “When you going to join and be part owner?” Worrall replied, “you got time on Monday to talk?” Blaszczak responded that he did and then wrote, “Me and the two guys that work for me are on pace for 1.7 million total revenues for 2014. I bet we come close to 2 million by end of year. Things always pick up sept to dec.” Blaszczak also wrote, “We’d kill it working togethe[r].” Worrall responded, “You’re like a drunk whore to me. Hard to resist. Lol. Let’s talk.”

As a personal benefit, this is not as concrete as Blaszczak just handing Worrall a bag of cash in exchange for tips. For one thing, a job opportunity is not exactly a gift: Blaszczak wasn't offering money for nothing; he was offering money for work, and maybe he needed Worrall more than Worrall needed the job. For another thing, there was no explicit quid pro quo: He wasn't offering a job in exchange for tips, he was just suggesting that Worrall might be good at the job. 7 And yet! "You're like a drunk whore to me," again, is just not a quote you want to see in your federal criminal indictment. It sure sounds like a shady exchange! 8

Finally, there is the third and subtlest question, which is: Even if Worrall leaked inside information to Blaszczak, and Blaszczak passed it along to the Deerfield partners, and even if Worrall leaked the information illicitly in exchange for a personal benefit, still, did the Deerfield partners know about it? The Second Circuit held in Newman that, to be guilty of insider trading, an indirect tippee -- someone like Fogel, Huber or Olan, who got their information not from an insider but from an intermediary -- must know that the insider received a personal benefit. 9  Fogel, Huber and Olan seem to have known that Blaszczak had inside information, 10 sure, but that is not quite the same as knowing that he had inside information from an insider who received a personal benefit.

There is an extra level of deniability there. 11  If you took that requirement literally, then indirect tippees would be very well insulated from insider trading liability. You could even build a business model around it: Political consultants and expert networks would go out and find information from insiders, and then would sell that information to hedge funds without telling the funds how they got it. The hedge funds would pay the consultants for information, but that is perfectly legal; lots of advisers are paid for their advice and insights. The consultants would pay the insiders for information, 12 which is pretty illegal, sure, but they would shield the hedge funds from knowing about it. "Wow, our consultant is really good at innocently overhearing secret conversations in Washington," the funds could tell themselves. 

I am not suggesting that that would really work. 13 (Nor am I suggesting that it is an accurate description of the actual business model of expert networks and political consultants. 14 ) But I am pretty sure that it won't work if you gloat about it in email! Insider trading is not a crime that is defined objectively; it is not just about trading on inside information. Your state of mind is also important, and the more embarrassing your emails are, the harder it will be to convince anyone that your intentions were innocent. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
  1. Obviously none of this is legal advice, or illegal advice, or metalegal advice.

  2. We talked about Newman here and here and here, and Salman here

  3. It's possible? Regulators sometimes discuss regulatory decisions with the public in order to make better decisions, and the lines between "political consultants" (who try to get information about regulation for clients) and "lobbyists" (who try to influence regulation for clients) are not always clear.

  4. Huber's lawyer said that "his research was based on detailed and rigorous analysis as well as the type of information regularly and properly relied upon by institutional investors in evaluating health care and medical companies." Olan's said that he "is an innocent man and looks forward to clearing his name at trial." Blaszczak "told The Wall Street Journal in 2014 he used only 'public information in preparing all my reports,' adding that he 'if needed, will vigorously fight any false allegation.'" 

  5. There were two other alleged cases of tipping, in July and November 2013, both about kidney dialysis treatment reimbursement rates. The government alleges that the total profits were more than $3.9 million.

  6. Of course he was a government insider, not a corporate insider. So his obligation actually came from the STOCK Act -- the Stop Trading on Congressional Knowledge Act of 2012 -- which provides that "each executive branch employee, each judicial officer, and each judicial employee owes a duty arising from a relationship of trust and confidence to the United States Government and the citizens of the United States with respect to material, nonpublic information derived from such person's position as an executive branch employee, judicial officer, or judicial employee or gained from the performance of such person's official responsibilities."

  7. Also, logically, if you are relying on a CMS insider for inside information about CMS decisions, why hire him away to work for you? Then he can't give you inside information any more!

  8. Blaszczak also allegedly did other favors for Worrall that sound more political than financial. For instance:

    In September 2011, Blaszczak tried to interest Worrall in joining a healthcare policy firm. In a September 28, 2011 email to his wife, Worrall said that it was a “big opportunity,” stating, “[n]ote that these people have political links. If I ever do want to really get into politics, like run for Congress, these are the types of people I’d need to be around.” Worrall did not take the job, but he leveraged the opportunity to obtain a promotion at CMS, which he received in December 2012. He received a promotion to a position at the top of the agency’s pay scale, a $10,000 raise, and became a supervisor of other employees for the first time. 

    Or:

    On March 8, 2013, Blaszczak introduced Worrall via email to a staffer on the Senate Finance Committee, which oversees CMS. After Worrall separately asked Blaszczak why he thought it would be good for Worrall to meet the staffer, Blaszczak responded, “I am just a big believer in networking and [the staffer] is a guy that knows a lot of people in DC and will be in and out of positions affiliated w the [political] party. He probably will be leaving the hill soon but told me he will return again or work in a [political party] administration.” Blaszczak stressed to Worrall that Worrall’s “knowledge and experience is going to be extremely valuable,” and Worrall should “meet as many people as possible along the way.” 

    Of course the basic currency of politics is the exchange of introductions, connections, networks, influences like this. The basic trick is not to exchange any of those things for money. (That's bribery.) The secondary trick is not to exchange them for stock tips: At least after the STOCK Act, that's insider trading.

  9. Or must have "consciously avoided" knowing about it.

  10. The government spends a lot of time on this point. From the SEC:

    Indeed, Blaszczak bragged to others about his access to information from inside CMS. For example, Blaszczak told Fogel in an email that another analyst’s predictions differed from Blaszczak’s because his competitor “doesn’t know anyone at cms. His guesses are just wild random guesses.”

    That certainly at least implied that Blaszczak's own insights were based on talking to people at CMS. The SEC cites other emails in which, for instance, Fogel said that Blaszczak "has a guy there," or Huber told colleagues that Blaszczak "has high confidence, talked to CMS folks." 

  11. As the Second Circuit said in Newman, "even if detail and specificity could support an inference as to the nature of the source, it cannot, without more, permit an inference as to that source’s improper motive for disclosure." You could know that information is so good that it has to come from an insider, without thereby figuring out that the insider got a personal benefit in exchange for disclosing it. 

  12. Or schmooze it out of them, or get it in exchange for promises of jobs and connections, or whatever.

  13. The conscious avoidance problem is a real problem: If you did this a lot, then everyone would know it's what you're doing, and so eventually prosecutors would have a pretty good argument that hedge funds who hired you really did know that you were bribing insiders for information.

  14. But, you know. It's an interesting model!

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

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