Insider trading target: 'Everyone has gone underground'

For 11 years, John Kinnucan was a stock analyst, digging information out of low-level contacts in the computer industry and selling it to clients. Then in October two FBI agents dropped by his three-story house and home office in Portland, Oregon, threatened to arrest him for “engaging in improper research” and asked him to secretly tape a conversation with a fund manager they were targeting, he said in an interview. Kinnucan, who wouldn’t name the manager, refused. Now Kinnucan is a defender of stock research and critic of U.S. authorities as they hunt for evidence of insider trading. Money managers that received subpoenas won’t say what information the government is seeking. U.S. Attorney General Eric Holder declined to elaborate on the investigation, which has included raids on three hedge funds. Kinnucan, meantime, has made two appearances on cable television and has written an opinion piece for the New York Times assailing the federal government for abusing its powers by cracking down on analysts who make a living providing legitimate research to investors. His outspokenness may come with a price. “He’s violating rule number one: don’t do anything that might upset the prosecutors,” said Andrew Stoltmann, a securities lawyer in Chicago. “When someone talks to the FBI, he usually goes as far underground as possible. He’s not helping himself.” Kinnucan, a 53-year-old married father of two, has done the opposite, airing the details of his encounter and questioning what he sees as a change in regulatory policy at the U.S. Securities and Exchange Commission. Larger Issue “It is a larger story at work here about the proper role of the SEC and its mandate as I understand it to provide guidance to the investment community,” Kinnucan said in an interview. “The Justice Department evidently would like to retroactively criminalize research activities which have been complicitly condoned by the SEC for years. If I don’t raise my voice, nobody will because everyone has gone underground.” If Kinnucan’s account is accurate, the Federal Bureau of Investigation may have made a mistake by threatening him, said Nathan Burney, an attorney who once worked for Manhattan District Attorney Robert Morgenthau. “It seems like a tactical blunder to go to someone like this if you don’t have him under your thumb,” he said. “He called their bluff.” Richard Kolko, an FBI spokesman in New York, declined to comment. Fund Experience Before he opened his one-man research operation, Broadband Research LLC, in 1999, Kinnucan was a money manager himself. He started a hedge fund at Strome Susskind Investment Management LP, which ran a fund incubator in Los Angeles in the 1990s. Strome helped Kinnucan set up a fund in 1996, Kinnucan said. It closed two years later. “He saw himself as someone who could get a good scoop on technology companies,” founder Mark Strome said in an interview. “He had a little bit of a chip on his shoulder, like, ‘I’m the brains of the operation and no one understands me.’ ” The fund was small, Strome said. “I don’t think it got critical mass.” Kinnucan said he left because the fund, with about $5 million in assets, wasn’t generating enough trading commissions for Strome to cover the cost of his office space. Geophysics Degree A native of Lake Forest, Illinois, an affluent suburb of Chicago, Kinnucan earned a degree in geophysics from the University of Alaska in Fairbanks, then did graduate work in computer science at the University of Texas in Austin, he said. From there, he set out to trade his own money in Portland, where he met his wife in 1992. “I was right 90 percent of the time,” Kinnucan said of his early trading record. An acquaintance heard about his success and told him he should contact Crabbe Huson Group Inc., a local mutual-fund firm. Kinnucan called and got Jim Crabbe, one of the founders, on the line. He went in and met with the investment team at the firm. Asked what stocks he liked, he said International Business Machines Corp., which was out of favor with investors because many believed that its mainframe computer business would be supplanted by smaller servers. Crabbe took his advice and bought IBM, Kinnucan said. Crabbe Huson Co-Manager After working for the firm as consultant for $5,000 a month, Kinnucan said he was hired as co-manager along with Crabbe of the Crabbe Huson Special Fund in June 1994, when it had $60 million. Kinnucan shorted many stocks in the last half of the year as the market declined, then covered those positions in December, just before the prices rallied, he said. In a short sale, a trader borrows shares and sells them, betting the market will decline, then buys them on the market, returns them and keeps the difference as a profit. The fund rose 12 percent in 1994, according to Institutional Investor magazine, which profiled Kinnucan in July 1995, and assets swelled to $800 million. Colleagues called him “Nuke,” Kinnucan said. Kinnucan said Crabbe didn’t like the attention he was getting, and prohibited him from talking to the press. Kinnucan erred, he said, when Netscape Communications Corp. sold shares to the public in August 1995. ‘Egregiously Overpriced’ He was quoted in several Bloomberg News stories that week, once saying that Netscape “probably sets a new point on the scale of egregiously overpriced merchandise.” Kinnucan also said at the time that his fund had gotten the right to buy 5,000 Netscape shares from Morgan Stanley, which arranged the sale along with Hambrecht & Quist LLC, and dumped them just after they started trading, reaping a $220,000 profit. “The attitude of the investment banks is that these are the payback to their best institutional or mutual-fund clients, like us or Fidelity Investments,” Kinnucan said at the time. “It’s a little game of mutual back-scratching.” Crabbe fired him after the stories appeared, Kinnucan said. Crabbe didn’t return messages left at a phone number listed in his name in Portland. Kinnucan moved to Los Angeles, he said, and in June 1996, started his hedge fund at Strome Susskind. When that closed, he went to work for Brad Peery Inc., a broker-dealer in Mill Valley, California, where he worked for less than a year. “John was hired and didn’t last very long,” said Brad Peery, the company’s founder. Peery closed his company in 2003 after 20 years in business. Kinnucan started Broadband Research in 1999. Channel Checkers Analysts like Kinnucan try to provide nitty-gritty details on the technology industry: which products are being shipped, and how much; whose semiconductors are being used in the latest mobile phones; whose software has glitches that are causing problems for its users. Kinnucan said he gets his information by talking to the “foot soldiers and worker bees” at companies. The calls are known as channel checks, and the results can be used by investors to piece together a broader view of a product, company or trend. “I know what’s important,” Kinnucan said. He gets paid a quarterly retainer by fund managers that get his reports. About 90 percent of the time, his contacts aren’t at the company that he’s researching, Kinnucan said. Rather, they are people who do business with it. Expanding on Galleon The U.S. crackdown on insider trading began last October with the arrest of Raj Rajaratnam, founder of Galleon Group LLC, a New York-based hedge fund. The probe, led by the U.S. Attorney’s office in Manhattan, initially focused on fund managers and corporate executives, with 14 people pleading guilty. Rajaratnam has denied wrongdoing and faces trial next month in Manhattan federal court. The investigation expanded to analysts and so-called expert-network firms with the Nov. 24 arrest of Don Ching Trang Chu, an executive at Primary Global Research LLC, a Mountain View, California-based company that connects investors with industry specialists who provide insight into a specific market. Chu facilitated the leaking of inside information from technology companies to a hedge-fund manager cooperating with prosecutors, according to an FBI complaint. Dan Charnas, a spokesman for PGR, and Chu’s attorney James DeVita have declined to comment. Clients Named Kinnucan, who purchased his house in an upscale part of Northeast Portland for $1.5 million in 2006, said his business is ruined. All his clients deserted him after he told them in an e-mail that the FBI had visited, something he was contractually obliged to do, he said. Three investment funds that have gotten subpoenas for information were clients of his, Kinnucan said: Wellington Management Co. in Boston, Janus Capital Group Inc. in Denver and SAC Capital Advisors LP in Stamford, Connecticut, which is run by billionaire art collector Stephen Cohen. Janus received an inquiry and plans to cooperate fully, the company said in a Nov. 23 statement. Officials at Wellington and SAC declined to comment. Kinnucan said other clients include mutual fund MFS Investment Management in Boston and hedge funds Citadel LLC in Chicago and Maverick Capital Ltd. in Dallas. One manager that Kinnucan named directly is Paul Wick at Columbia Management, a unit of Ameriprise Financial Inc. in Minneapolis. Wick said he had no comment. John Reilly, a spokesman for MFS, and John McCafferty, an attorney for Maverick, said the firms hadn’t received any requests for information from the government. Citadel, run by Ken Griffin, declined to comment. Funds Searched The raided funds were Diamondback Capital Management LLC in Stamford, Connecticut; Level Global Investors LP, in Greenwich, Connecticut; and Loch Capital Management in Boston. Diamondback received a subpoena and was told by the government it isn’t a target of the probe, according to a letter to investors obtained by Bloomberg News. The warrant appears to be focused on a portfolio manager, who was put on leave, and a former employee, the Nov. 29 letter said. Level Global said in a letter to investors that executives met with the U.S. Attorney’s office on Nov. 23, and that it wasn’t a target of their investigation. Loch Capital didn’t return calls seeking comment. Kinnucan said the FBI agents -- whom he described as “suits” in his interview on the CNBC cable network, haven’t been back since their Oct. 25 visit. “It does seem like the FBI is on a witch hunt,” said Strome, who currently manages only his own money. “Maybe John Kinnucan will be the hero against Big Brother.” --Bloomberg