01-12-2010, 07:43 AM
Business Times - 01 Dec 2010
At what point does scuttlebutt become insider information?
(NEW YORK) On Wall Street, it is called the 'mosaic theory'. Every day, professional investors and research analysts work the phones to ferret out information about companies that can't be found by simply reading news releases.
Some will walk through shopping malls interviewing Gap store managers, for example, to gauge how sales are going. Others might monitor sales of certain component parts in Asia to determine how many iPads Apple might sell this quarter.
Investors use multiple tidbits of non-public information from various sources to build a 'mosaic' to try to get an edge on other investors. For better or worse, that is what passes as 'research' in the finance world.
Amid a wide-ranging investigation by the Securities and Exchange Commission (SEC) and federal prosecutors into hedge funds and the 'expert networks' that supplied them information, some investors may be asking themselves if their 'mosaics' may soon be considered 'insider trading'.
'The SEC's recent enforcement docket reflects a belief that certain buy-side investors' investment activities were rife with insider trading violations, and that there are more to be found,' the law firm Fried Frank wrote in a note to its clients last week titled 'Avoiding Insider Trading Risks in Fundamental Investment Research'.
Indeed, the mosaic theory itself is one of the central defences in the insider trading investigation of Raj Rajaratnam, founder of the Galleon Group. 'Throughout his career, Mr Rajaratnam has worked tirelessly as permitted by the securities laws to build a mosaic of public information about the companies he follows,' his lawyer said.
In other words, Rajaratnam and many others who subscribe to the mosaic theory contend that none of the individual bits of scuttlebutt they pick up constitute material insider information; the edge they get, they say, comes from putting it all together. That's the 'value add', in Wall Street parlance.
(In the Galleon case, it must be noted, there is evidence that the information being passed was more than just various assembled data points; it included tips on pending mergers and earnings announcements - which fall in the traditional definition of insider trading.)
When young analysts are trained on Wall Street, they often read the CFA Institute's standards and practices handbook, which declares: 'The idea behind the mosaic theory is that each individual piece of information is non-material by itself: An individual piece of information would not move the price of the security if disseminated in a public press release. Taken together, however, the bits of information can form a meaningful mosaic. This practice is perfectly legitimate.'
But is it? While it has long been considered standard practice to ask the local Gap store manager how sales are going, the store manager's answer may actually fall into a grey area.
According to most white-collar lawyers, the ultimate test is whether the information is 'material'. (There's also a question of whether the manager is breaching his or her fiduciary duty to the company by providing such information.) In truth, knowing the sales at one Gap store isn't material because the company has some 3,100 stores around the globe. However, if you went store to store and managed to find out sales figures for 1,000 of them, you might have something closer to 'material' information. -- NYT
At what point does scuttlebutt become insider information?
(NEW YORK) On Wall Street, it is called the 'mosaic theory'. Every day, professional investors and research analysts work the phones to ferret out information about companies that can't be found by simply reading news releases.
Some will walk through shopping malls interviewing Gap store managers, for example, to gauge how sales are going. Others might monitor sales of certain component parts in Asia to determine how many iPads Apple might sell this quarter.
Investors use multiple tidbits of non-public information from various sources to build a 'mosaic' to try to get an edge on other investors. For better or worse, that is what passes as 'research' in the finance world.
Amid a wide-ranging investigation by the Securities and Exchange Commission (SEC) and federal prosecutors into hedge funds and the 'expert networks' that supplied them information, some investors may be asking themselves if their 'mosaics' may soon be considered 'insider trading'.
'The SEC's recent enforcement docket reflects a belief that certain buy-side investors' investment activities were rife with insider trading violations, and that there are more to be found,' the law firm Fried Frank wrote in a note to its clients last week titled 'Avoiding Insider Trading Risks in Fundamental Investment Research'.
Indeed, the mosaic theory itself is one of the central defences in the insider trading investigation of Raj Rajaratnam, founder of the Galleon Group. 'Throughout his career, Mr Rajaratnam has worked tirelessly as permitted by the securities laws to build a mosaic of public information about the companies he follows,' his lawyer said.
In other words, Rajaratnam and many others who subscribe to the mosaic theory contend that none of the individual bits of scuttlebutt they pick up constitute material insider information; the edge they get, they say, comes from putting it all together. That's the 'value add', in Wall Street parlance.
(In the Galleon case, it must be noted, there is evidence that the information being passed was more than just various assembled data points; it included tips on pending mergers and earnings announcements - which fall in the traditional definition of insider trading.)
When young analysts are trained on Wall Street, they often read the CFA Institute's standards and practices handbook, which declares: 'The idea behind the mosaic theory is that each individual piece of information is non-material by itself: An individual piece of information would not move the price of the security if disseminated in a public press release. Taken together, however, the bits of information can form a meaningful mosaic. This practice is perfectly legitimate.'
But is it? While it has long been considered standard practice to ask the local Gap store manager how sales are going, the store manager's answer may actually fall into a grey area.
According to most white-collar lawyers, the ultimate test is whether the information is 'material'. (There's also a question of whether the manager is breaching his or her fiduciary duty to the company by providing such information.) In truth, knowing the sales at one Gap store isn't material because the company has some 3,100 stores around the globe. However, if you went store to store and managed to find out sales figures for 1,000 of them, you might have something closer to 'material' information. -- NYT
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