Views on improving the integrity of global capital markets
11 February 2011

Tipping Point

Posted In: Insider Trading

It was an especially late night at work for former portfolio manager Donald Longueuil — one that lasted into the wee hours of the morning of 20 November 2010, according to U.S. prosecutors. According to their criminal complaint against Longueuil, he had to dispose of some especially toxic assets that couldn’t wait for the trash man’s regular pickup — evidence of his trading on inside information. Security cameras allegedly confirm the activities he later described to his former colleague and, unbeknownst to Longueuil, federal investigators listening in on the conversation. He went on a late-night, “twenty block” jaunt in search of garbage trucks in which to dump the remains of the flash drive that contained information on which he based previous trading activity. Did Longueuil consider the information on the trashed flash drive “tiles” in a “mosaic” of research obtained through diligent, thorough — and perfectly legitimate — investigation and effort? Not likely, given the precautions he supposedly took to dispose of the records on which he based the trades. And neither does the SEC.

Longueuil’s recent arrest, along with two others, is only the latest round of charges in a federal crackdown of insider trading done under the guise of legitimate market research. Late last year, when federal prosecutors announced charges against “experts” employed by companies to provide industry insight in support of investment strategies, there was a lot of hand wringing in the analyst community about whether its legitimate research practices were under attack. The government’s aggressive tactics and focus on “expert networks,” the industry founded on providing investors with access to a network of experts with significant expertise in a particular industry in exchange for a fee, seemed to threaten the use of primary research tools — the very foundation of an analyst’s livelihood. 

But as the sordid details are revealed in a steady stream of charges and media news accounts, it turns out to be garden-variety misuse of material non-public information such as detailed earnings, gross margins, and other confidential information leaked by insiders that federal prosecutors are after. Not that the mosaic theory won’t be dragged into the mess. According to the government, one of the latest defendants, hedge fund manager Samir Barai, frantically texted his potential defense to any charges to a co-conspirator: “BTW – we did mosaic threoy” (sic). The SEC doesn’t seem to see it that way. It isn’t the mosaic theory that’s under attack — it’s the plain-vanilla tipping of financial data by insiders of the type used by Barai, Longueuil, and others, according to the government, that is the real conduct at the heart of these cases. 

Indeed, the SEC is taking pains to point out that the investigations are not an indictment of the expert network business model. In its release on the latest charges, the SEC states that its ongoing investigation “is focusing on the activities of expert networks that purportedly provide professional investment research to their clients. While it is legal to obtain expert advice and analysis through expert networking arrangements, it is illegal to trade on material nonpublic information obtained in violation of a duty to keep that information confidential” (italics are ours).

We remain confident that, as the investigation unfolds, honest research conducted under the mosaic theory will prevail.

About the Author(s)
Jon Stokes

Jon Stokes was the Director of Ethics and Standards Education at CFA Institute. His responsibilities included design and creation of on-line ethics education, development and maintenance of the CFA Institute Code of Ethics and Standards of Professional Conduct, and the design and management of the CFA Institute Ethical Decision-Making and Giving Voice to Values education programs. Stokes holds a JD degree.

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