Nice Guys, Naughty Information?

Nathaniel Popper of the LA Times reports, Major investment firms subpoenaed in insider trading probe:

A number of high-profile investment firms — including two that manage mutual funds owned by millions of Americans — have received subpoenas in a federal probe of alleged insider trading on Wall Street.

Janus Capital Group Inc., a Denver-based mutual fund family, reported in a regulatory filing Tuesday that it had "received an inquiry regarding the recently disclosed insider trading investigation on Wall Street calling for general information."

Boston-based Wellington Management, which invests money for a number of pension funds and mutual funds, also received a government request for information, Bloomberg News reported.

One of the biggest names in the hedge fund world, SAC Capital Advisors, wrote in a letter to clients Tuesday that it had received a government request for information, according to a person who saw the letter.

Another big hedge fund operator, Chicago-based Citadel Asset Management, and at least two smaller hedge fund firms also were reported to have been subpoenaed.

Shares of Janus slumped 2.8% on the news. SAC Capital and Wellington are privately held.

News of the subpoenas came a day after FBI agents raided the offices of three hedge fund firms as part of the insider trading probe. Although a raid requires a search warrant approved by a judge, a subpoena can be issued without judicial approval.

Wellington has $598 billion in assets under management. Janus manages $161 billion. SAC Capital and Citadel manage many fewer billions than Wellington or Janus, but charge much higher fees relative to the size of the portfolios they handle.

The government's interest in SAC Capital caused a buzz on Wall Street because of the firm's successful track record and an air of mystery surrounding its secretive founder, billionaire art collector Steven A. Cohen, who has been called the "hedge fund king" by the Wall Street Journal.

Two of the firms raided Monday were started by alumni of SAC Capital.

Yahoo's Tech Ticker said that according to initial reports, the investigation could ensnare Wall Street's biggest names: Goldman Sachs, SAC Capital, Wellington, Jennison, MFS Global, Maverick, Citadel, and others. (Here's a who's who of who might get nailed.)

For Rolling Stone contributor Matt Taibi, author of Griftopia, there's nothing shocking at all about revelations of possible widespread insider trading on Wall Street (see video below):

"Everybody is trading on the inside somehow or another; so this isn't particularly surprising," Taibbi says. "A lot of sources I talked to suggested this is endemic to the entire culture."

The current investigations center around alleged insider trading prior to merger announcements such as MedImmune's takeover by AstraZeneca in 2007 and Merck's buyout of Schering-Plough in 2009, The WSJ reports.

While gaming takeovers is a "classic" form of insider trading, Taibbi says it's also evident in high-frequency trading, where exchanges provide a millisecond sneak peak at buy and sell orders, or the practice of clients front-running big orders by institutions.

"The real issue here is that it's everywhere," he says. "And the fear is there's no end to it."

Taibbi, who became widely known in financial circles in 2009 when he dubbed Goldman Sachs "a vampire squid on the face of humanity," says he is not cynical by nature. "But this Wall Street stuff is overwhelming," he says. "The more you look into it, the less you see the way out. The government seems so completely helpless to do anything positive in this situation."

Finally, Holman Jenkins Jr. of the WSJ reports, Nice Guys, Naughty Information?:

Beating a dead horse in argument is frowned upon, but sometimes it takes a good thrashing to reveal the absurdity beneath the surface reasonability. So it has been with the evolution of insider trading law.

Once it was deemed that the person acting on the information was naughty because, however valuable and accurate the information, acting on it involved a betrayal. An executive who traded on inside information betrayed his shareholders. A lawyer who traded on advance word of his client's deal betrayed his client.

You could buy or not buy this theory, based on whether you think the benefit of having the information in the stock price outweighs using criminal law to improve the climate of trust between principals and agents. But it was not insane. Insane is what has happened to insider trading law over the past generation, and by all portents may reach its culmination in today's widely leaked FBI crackdown on hedge funds and research firms.

Insane is treating the information as the offender. Insane is seeking serially to expand the circle of people who can be criminalized for trading on it, as if it were desirable to keep accurate information out of stock prices.

The latest investigation has led to raids on hedge funds and people who run research shops being visited by the FBI and threatened with jail. That much we know. The papers delight in hinting between lines that the climatic target is hedge fund impresario Stephen A. Cohen, whose vast wealth and semi- colorful history you can read about on Wikipedia.

The probe may yet reveal something we can properly hold our noses over. Bribes were distributed to betray corporate confidences. Agents were induced to sell out those whom they were duty-bound not to sell out.

It may also turn out—many years hence, after careers and lives have been ruined—to be an instance of the dead-horsers at the FBI and SEC running amok.

We can already cite one considerable irony. The effort over many years to police "insider" information has made such information more valuable. From "your bunny has a good nose" (a line that got an investment banker charged with insider trading in the 1980s) to today's crackdown on what leaky investigators describe as an insider information "trading network," the government has injected fertility drugs into a sub-industry of specialists devoted to winkling out whatever corporate information is not yet in the share price.

Lately books have been written debunking the efficient markets hypothesis, claiming it does not account for all known human phenomena. But a hypothesis does not have to be comprehensive to be valuable. And the securities markets, whatever their vagaries, manifestly do finally deliver prices that accurately reflect what an investor can expect back on the money he puts in. Romantic as it may seem, some of us even believe the stock research industry is worth putting up with if it contributes to creating accurate, up-to-date stock prices. Society is served, after all, when investors and management get the best possible feedback on what products and services and business models are most demanded by the public.

The SEC has a different view. The logic of insider trading law, taken to its dead-horse extreme, is to keep good information out of stock prices. In the SEC's ideal world, any information originating inside a company will be reflected in stock prices only after the company has publicly announced it to the world's investors simultaneously.

As a colleague said of Stalin, there is no way to get the SEC's ideal world without mangling the real world beyond repair. A company cannot do business without revealing itself to its customers, its suppliers, the guy who drives by and sees a parking lot more full (or empty) than the day before. Yet under "misappropriation theory" anyone can be prosecuted for trading on information that the government decides they should have known they shouldn't have known.

More ridiculous is the claimed motive: because it's "fair" to small investors.

Huh? In a world where hedge funds spend millions so their computers can be a nanosecond closer to the stock exchange, the average small investor is supposed to secure his retirement by betting on his ability to beat the world to some market- moving bit of information? Let us suggest an ironic and contradictory theory: What really improves the small investor's confidence in the market's fairness is when he buys a stock, is blindsided by some corporate announcement, and yet notices the stock barely moves anyway thanks to the sharpies who made sure the information was already in the price.

The SEC touts on every possible occasion its political bona fides with blather about its devotion to small investors. But if the agency really had our interests at heart, it would preach daily the unwisdom of most us ever buying an individual stock. We should be free-riding on the efforts of the people the FBI is trying to criminalize. Let the pros do the work of keeping stock prices "right" (a problematic concept, we understand). Let the rest of us sit back on our index funds while this marvelous, greedy, roiling system keeps Corporate America's nose to the wheel.

Mr. Jenkins' argument has merits but he uses twisted logic. The stock market is rigged and it's ridiculous to hear the SEC is devoted to maintaining a level playing field between small investors and large banks and their large hedge fund clients. Joe and Jane Retail can never compete with the Goldmans, Citadels and SAC Capitals of this world. Not in their wildest dreams. To even suggest you can create a level playing field is a farce!

Keep in mind, however, this nonsense has been going on for years. Matt Taibbi is dead right, it's endemic and pervasive across the entire financial industry. Pension funds who invest in these mutual funds and hedge funds are probably very nervous, weighing the reputation risk of being linked to these funds, especially if criminal charges are laid. When the ship goes down, everyone is looking to cover themselves. Also, the prospect of major hedge funds and mutual funds getting redemption notices makes traders on Wall Street very nervous.

This is the type of stuff that makes me nervous too because you don't know how it's going to play out. It might turn out to be nothing and blow over, or it might snowball and wreak havoc in financial markets. Citadel and SAC Capital are two of the biggest and best multi-strategy hedge funds. I don't want to blow this up until I hear all the facts, but now might be a good time for pension funds to cut risk across the board and assess the implications of these investigations. I keep asking myself why is this happening now? What else is lurking out there? Is this the beginning of a series of investigations? If so, we're in for a long, tough slug ahead.