by Tom Hardin
“It is one of the biggest mysteries on Wall Street: Who is Tipper X, the secret witness at the center of the biggest insider-trading case in a generation? The answer is Thomas Hardin — a young investment analyst who, the authorities claim, traded on inside information and may now lead prosecutors to other crucial players…” – New York Times, January 12, 2010
In 2007, while working at a small hedge fund as a 29-year-old technology stock analyst, I received material nonpublic information (MNPI) from another investor on four occasions; three tips regarding upcoming corporate M&A deals and one tip with information about a company’s quarterly earnings announcement. I placed four trades in those shares (in my mind “small” trades). I did not hesitate to make the trades as trading on MNPI seemed rampant within the technology and healthcare stock analyst communities at the time. One well-regarded tech stock focused hedge fund had several of their largest 2006 winning positions as targets of corporate takeovers. Ultimately, my faulty rationalizations led to a career ending, life-altering situation. In July 2008, I was approached by FBI agents on the street outside my apartment and given the chance to help them build larger cases. I became known as “Tipper X” and was credited with helping the FBI build over 20 of the 80+ cases in Operation Perfect Hedge, a Wall Street house cleaning campaign that morphed into the largest insider trading investigation of a generation.
Today, I have made it my life’s mission to assist compliance officers at registered investment advisers in the training of investment staff. More than just “scaring them straight,” my goal is to educate them on what exactly I was thinking as a young analyst, by exposing the extremely faulty rationalizations I made and then showing how compliance professionals can keep their investment staff and employers from suffering the same fate as I did. Below are some of the insights gathered from my own experience as a former analyst.
1) Investment staff who think they may be in possession of MNPI must always escalate their questions/concerns to compliance. They must never think they are wise enough to draw the line when they think they might have MNPI. You never want your analysts to be thinking about whether their relationship to the tipper is sufficiently close or whether the value received by the tipper was significant enough to form the basis of a claim. All of these facts will be assessed in hindsight in a political and judicial environment they can’t control. If it is determined that they are in possession of MNPI, trading in the particular security is restricted until the MNPI becomes public. It’s also important not to make an analyst feel guilty for going to compliance officials with their concerns regarding MNPI. You do not want the analyst to close down and avoid raising concerns in the future.
2) The “hot areas” of enforcement for investment managers are always changing. The market may appear to be three steps ahead of enforcement, but that is actually to the analyst’s detriment. Keep in mind that, regardless of the decisions in Newman, Salman or Martoma, the SEC has a much lower burden of proof than the DOJ.
3) It is important to stress that every member of your firm is on the compliance team. Compliance can’t be everywhere all of the time overseeing the investment team. Your traders and analysts are responsible for being vigilant. Also stress if they make a mistake, own it before it gets worse; the cover-up is always worse than the crime.
On the behavior side, making investment staff aware of some of the rationalizations and psychological traps that pull people over the line – into unethical or even illegal activity – can be helpful. Examples of psychological traps include (i) small steps, (ii) reduction words and (iii) the perception of faceless victims.
With me, I received MNPI from another investor and then placed four small trades where I told myself these positions were “immaterial” because of their size. The reduction word “immaterial” was my self-talk to try to minimize my illegal behavior. During training sessions, I believe a CCO should introduce the psychological traps that can ensnare even the most well-meaning employees.
4) The prohibition on trading while in possession of MNPI effectively shuts down the possibility of using the original analysis until after the MNPI has become public. At one speaking engagement, a client shared with me the story of a young analyst and his largest position in the portfolio. He had his five thesis points, airtight analysis and then received MNPI on an unchaperoned research call with an industry contact. Instead of going to the CCO, he chose to ignore the MNPI, as he rationalized it wasn’t part of his original thesis. This all came to light after an inquiry from a regulator and the analyst is now on leave from the firm.
I believe it is situations like these that are most common and of highest concern. The analyst most likely did not have any intent to break the law, but engaged here in “isolated decision making” and ultimately put the firm and himself in harm’s way. Analysts must own up if a mistake is made so that they are protected and the firm is protected.
Through the investment research process, a thorough analyst may come to possess MNPI multiple times in his or her career or at least be in situations where it’s not always clear. It is not time to panic, ignore, rationalize, or “cover up.” A well-trained analyst will know exactly what to do.
Thank you again for the opportunity to turn past career-ending decisions into an opportunity to add a voice to the behavioral aspects of a compliance discussion.
Tom Hardin, Tipper X LLC. Tom Hardin previously spent much of his career as a long-short hedge fund analyst focused on the technology sector. In 2008, as part of a cooperation agreement with the Department of Justice, Hardin assisted the U.S. government in understanding how insider trading occurred in the hedge fund industry. His former front-line perspective helps train hedge funds, private equity firms, law firms, investment banks, and university students in how to avoid insider trading.
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