Loosely speaking, the job of a research analyst at an investment bank is to predict whether a stock will go up or down. That is a useful skill to have! If you have that skill, your bank can put it to use in two different ways. You can tell your bank’s traders which stocks will go up or down, and then they can trade and make money. Or you can tell your bank’s customers which stocks will go up or down, and then they will trade and pay your bank commissions and make money and feel grateful to your bank and want to give you more commissions.1
Those two uses create some tension. Most notably, if you are an influential analyst, and you release a report telling customers to Buy a stock, a bunch of them will, and the stock will go up. Your prediction is self-fulfilling!2 So one thing you can tell your bank’s traders is, “This stock will go up tomorrow because I am going to publish a Buy recommendation.” That is straightforwardly profitable for your traders, though also pretty straightforwardly illegal. Don’t do that. On the other hand, if you talk to your bank’s traders, and they ask you, “Hey do you think Company X’s margins are sustainable?” and you say, “Sure, I think those margins look fine,” then that’s just part of your job. Your job is to understand the company and have views on its future. But since your understanding of the company and your views on the future inevitably bleed into your published research, there’s some gray area between illegal front-running of published recommendations and perfectly normal conversations with traders. And so analysts, and banks, get themselves into trouble in that gray area.3
Here is an insider-trading case that may or may not be in the gray area. The Securities and Exchange Commission is accusing Gregory Bolan, a former research analyst at Wells Fargo Securities, of telling Joseph Ruggieri, a former trader at Wells Fargo, about his upcoming research reports. The idea is that Bolan was an influential analyst and so his reports would move stocks. Ruggieri would put on bets in his trading account ahead of the reports, and then close them after the reports were made public and moved the stocks.
On a basic mechanical level this was a good idea: Bolan’s research moved markets, and “Ruggieri generated over $117,000 in gross profits for Wells Fargo by trading ahead of six ratings changes authored by Bolan,” says the SEC. Otherwise it was dumb. For one thing, Ruggieri “was paid approximately six percent of the monthly net profit and loss in his Wells Fargo trading account,” meaning that he made like $7,000 personally for this alleged year-long insider-trading scheme, which will pay about one day’s worth of his legal bills. For another thing, this scheme is very easy to catch, in that Wells Fargo is aware of both (1) Bolan’s recommendations and (2) Ruggieri’s trades, and can eventually put two and two together. It seems to have done so: Ruggieri was fired, and Bolan resigned “after being questioned by Wells Fargo compliance personnel.” And now the SEC is coming after them.
What Your Peers Are Reading
My favorite part of the SEC complaint is the section describing the benefits Bolan got from tipping. This is a required incantation of insider-trading law: The SEC needs to prove that Bolan got a personal benefit to make it illegal insider trading. Here’s the benefit:4
Bolan benefited from his tipping of Ruggieri and Trader A by virtue of his friendships with Ruggieri and Trader A. After Bolan resigned from Wells Fargo, Ruggieri gave Bolan the keys to his apartment so that he could use it when interviewing for positions in New York.
So when Bolan was fired for tipping Ruggieri, Ruggieri let him sleep on the couch while he hunted for a new job? That’s … that’s not a benefit, really, is it? That’s just loss mitigation. If he’d never tipped Ruggieri, he’d never have been fired, and he’d never need to use the guy’s apartment. You can’t really say he was better off for the tipping.
But there’s another benefit in the next paragraph:
Additionally, Ruggieri, and his managers at Wells Fargo, provided positive feedback to Bolan’s managers at Wells Fargo. This feedback helped Bolan to be promoted from vice president to director at Wells Fargo. In fact, in Bolan’s director nomination form, Bolan’s manager stated “Greg is among the best analysts in the department in terms of his dialogue with trading. We consistently hear from trading that Greg provides great information flow to the desk and they are able to monetize his efforts. They often hold [him] out as the standard.”
In hindsight, I guess Wells Fargo regrets that review? Like, totally accurate: Bolan provided “great information flow to the desk,” insofar as he (allegedly!) gave the desk advance notice of his published research, and they were “able to monetize his efforts,” insofar as they (allegedly!) traded ahead of the recommendations and made easy money. The trick is: Part of Bolan’s job was to have a dialogue with trading, giving them “great information flow” so they could make money trading stocks using his insights. Another part of his job was to make sure that that dialogue never crossed over from “general insight about whether stocks will go up or down” into “specific preview of written research reports.”5 The information flow couldn’t be too great.