New insider trading rules make it 'easier to cheat'

How the hedge fund trading game has changed
Getting 'the call' at Galleon   

Insider trading just got a whole lot easier.

The ambiguity of what constitutes insider trading has been the biggest deterrent of illegal practices over the last 6 years — that and watching all the perp walks down by City Hall on television. As soon as the crackdown began in 2009, fear has been running rampant on the Street. Nobody wanted to be next. Two days ago if you asked ten traders what exactly was considered trading on inside information —you would have gotten ten similar, but also very different answers because no one really knew exactly where the line was drawn in the sand. And that was terrifying.


With the decision to overturn the insider-trading convictions of Todd Newman and Anthony Chiasson, the idea of what's considered illegal has just been narrowed significantly. Insider trading has been clearly defined. The two cases were founded on not knowing where the inside information had come from and a lack of clear evidence that the two plaintiffs had any knowledge that the person giving the tip got any benefit from the trades. This is what an insider trader might call: plausible deniability. This has always been the scheme.

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And now people have a blueprint of how to operate within the letter of the law. The less you know the better. Why else have the Feds been unable to pin anything on Steve Cohen from Point72 Asset Management (formerly SAC)? He set up a system where he didn't want to know if something was illegal because that would make him guilty. Wall Street traders who've dipped their toes into the insider-trading pool have always operated on this premise. When I was on the trading desk at the Galleon Group trading for Raj Rajaratnam, I never wanted to know where his information came from. It was too good. My attitude was: Just give me the ticket to buy or sell and don't tell me anything else.

It helped me sleep at night thinking I could plead naiveté.

Here are the new rules:

1.You can't be convicted if you don't know where the insider information came from.

2.You can't be convicted if there isn't any evidence that you knew that the person giving the tip benefited from the trade.

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I spoke with a few of my friends who work at billion-dollar hedge funds after this news came out.

"It's a lot easier to cheat when you know what the rules are," my friend said. His firm has a very strict policy against insider trading. "We dot every i and cross every t," he said. He explained that whenever they're on a call or receive information that might even be considered in the universe of inside information, the protocol is to call and report it to their general counsel. "The stock immediately goes on the restricted list."

He's not sure how these new rules will affect the way his firm operates but he thinks it will certainly increase a trader's ability to get information.

"It’s a lot easier to cheat when you know what the rules are." -hedge-fund trader

Most of the traders and analysts I spoke with were in agreement: This is a win for Wall Street.

To be clear, in the history of Wall Street, no portfolio manager, trader or analyst has ever just blindly bought shares of a stock from a phone call from a stranger or acquaintance. The mentality is to assume the other person is wrong before even considering trading off of their information. The rule is to always know the person providing the information, know who their contacts are and most importantly, know HOW GOOD their information is. If someone gives you three bad ideas in a row their phone number is deleted from contacts. There are certain guys in your inner circle that all you need is a clearing of the throat and a recommendation to buy a stock. And you buy it. Because you know it's a good call.

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So now, the government has to prove that the person receiving the information knew exactly where it came from. This would never be discussed on a per-trade basis. It would just be known. Like six months ago at a bar, you heard that the tippee went to business school with an insider working at Dell. And then you never speak of it again.

File photo: Todd Newman (center) leaving court with his attorney last year.
Victor J. Blue | Bloomberg | Getty Images
File photo: Todd Newman (center) leaving court with his attorney last year.

Unless you are sending wire transfers or using Western Union to compensate your informants, it will be difficult to prove. And there are many more benefits than direct financial compensation. Perhaps the tippee needs help getting his nephew a job, an invite into a country club or to bypass the difficult admissions process of a New York City preschool. Benefits come in all shapes and sizes. Of course deals have been made up in advance, but the payoff usually isn't so direct where dots can easily be connected.

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Defined legalities are really hard things to prove. Most insider trading cases aren't layups like Raj Gupta calling from a Goldman Sachs board meeting to let his friend Raj Rajaratnam know that Warren Buffett is investing $5 billion in the company.

But now that the rules have been set — some on Wall Street will start to play ball again. The fear has been lifted. As I've said many times before: Trying to cheat is the exception not the rule on Wall Street. But for those who like to play aggressively, things just got a lot easier.

Commentary by Turney Duff, a former trader at the hedge fund Galleon Group. Duff chronicled the spectacular rise and fall of his career on Wall Street in the book, "The Buy Side," and is currently working on his second book, a Wall Street novel. He is also featured on the CNBC show, "The Filthy Rich Guide." Follow him on Twitter @turneyduff.