The Prosaic Mosaic Theory

The New York Times is trying to play catchup with The Wall Street Journal, which has dominated the hedge-fund investigation story. I don’t think the WSJ is hearing footsteps just yet.

The Times section-fronts a story reporting that more people have been wiretapped than previously understood: Seven rather than four. That’s a pretty incremental advance. Meantime, the Journal reports that the Microsoft of expert-network firms, Gerson Lehrman, is also being looked at by the feds.

Also on the Business Day front, Andrew Ross Sorkin presents the Wall Street defense, which is something like David Broder and Gerald Seib presenting the case for bipartisanship.

Sorkin focuses on mosaic theory, which is the practice of putting together a hundred different pieces of information to get a big picture of a business’s or industry’s health. Nothing wrong with that.

Weirdly, he uses Raj Rajaratnam as an example of somebody using the mosaic defense.

Indeed, the mosaic theory itself is one of the central defenses in the insider trading investigation of Raj Rajaratnam, founder of the Galleon Group.

Three paragraphs later (emphasis mine):

(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 into the traditional definition of insider trading.)

But my main beef is that Sorkin mentions the so-called expert networks that the feds are targeting and leaves the reader the impression that they’re just involved in putting together these mosaic pieces:

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 gray area.

According to most white collar lawyers, the ultimate test is whether the information is “material.” There is also a question of whether the manager is breaching his or her fiduciary duty to the company by providing such information.

Right, but what about if the Gap manager is getting paid by somebody other than his company to give up information about his company and its suppliers?

It’s worth revisiting Laurie Cohen’s Journal story from 2006 about Gerson-Lehrman, the biggest of the expert-network firms and one that now finds itself getting caught in the dragnet.

Marlin Kilgore’s day job is purchasing parts for Penske Truck Leasing Co. in Memphis, Tenn. His second job, which pays $100 an hour, is to answer questions from hedge funds and other big investors about the truck-parts makers he buys from…

Mr. Kilgore, for example, says he isn’t violating any policies at Penske Truck Leasing. A spokesman for the company, a joint venture of Penske Corp. and General Electric Co., says employees aren’t permitted to use data “obtained in the course of employment for personal advantage,” and that the company had no idea one of its employees was moonlighting for Mr. Gerson.

That changes the frame a bit when you find out the real money being passed along, no?

It seems to me that the issue is not just whether investors are piecing together lots of different datapoints. It’s whether investors and expert networks have been paying people to give up inside information about their companies and industries. That would breach fiduciary duty and provide the benefit to the tipper required to get an insider-trading conviction.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum. Tags: , , , ,