"Hit it a little to the left, and buy Clorox." Photographer: Jamie Rhodes/Bloomberg News
"Hit it a little to the left, and buy Clorox." Photographer: Jamie Rhodes/Bloomberg News

When the news broke last week that the FBI was investigating Phil Mickelson for trading Clorox stock on indirect inside information from Carl Icahn, I thought that the most interesting question was, who leaked it to the press, and why? Now that it turns out not to be true -- there's some truth-adjacency, but Mickelson never traded Clorox on a tip or, apparently, otherwise -- that question gets even more interesting.

Were the "people briefed on the matter" who got it wrong at the FBI, as I first assumed? They would presumably have publicized the investigation to shake out information and/or to punish Mickelson (and Icahn, and gambler Billy Walters, the supposed intermediary between them) in the press because they couldn't get him in court. In that case ... I don't know, I was going to say "in that case it worked out badly," but that's not really true. The thing is, the standard of proof for trying someone in the court of public opinion really is lower than the standard in the court of court. Mickelson is still being investigated for something -- well-timed trading in Dean Foods stock just before it split off a subsidiary1 -- and Icahn and Walters are still perhaps in trouble over Clorox. Even if each individual trade that the prosecutors are looking into turns out to be innocent, they've done some damage just by publicizing the investigation and standing around raising their eyebrows.

Or was the leak from Mickelson's side? In which case, I cannot even begin to know what to tell you. Did he not know what he was being accused of? I suppose that is possible; the point of putting pressure on Mickelson, after all, seems to have been that he wasn't as financially and legally sophisticated as, say, Carl Icahn.2 Maybe he didn't know if he'd traded Clorox stock.

In any case, the FBI didn't. As Dealbook explained:

Initially, authorities pursued a theory that Mr. Icahn shared private details of his Clorox bid with Mr. Walters, who then traded on the information and passed on the tip to Mr. Mickelson.

Although Mr. Icahn and Mr. Walters remain under investigation over Clorox, the F.B.I. and the Securities and Exchange Commission have found no evidence that Mr. Mickelson traded Clorox shares.

Now, to the extent that insider trading is a hard crime to prove -- and it isn't, particularly -- the difficulty comes from the "insider" part. Often you have to piece together circumstantial evidence about who talked to whom about what; there's plausible deniability; Post-Its are eaten. The "trading" part is usually pretty easy. They keep records of that stuff you know!

If you ask regulators why they devote so much effort to pursuing insider-trading cases, the story you will hear is that they're important for public confidence in the stock market: Capital formation depends on small investors knowing that the market isn't rigged against them. I am extremely skeptical of that theory on a number of grounds,3 but it is the theory.

If that's your theory, though, you need to be especially careful about false positives. The SEC knows this, in the analogous market-structure context: It goes after naughty high-frequency traders and dark-pool operators, but it doesn't go around trumpeting that the market is pervasively rigged by a cabal of those traders and operators, because that in itself would undermine confidence. What you want is to catch the cheaters without unnecessarily conveying the impression that it's cheaters all the way down.

So this case is not just embarrassing -- and perhaps unfairly embarrassing -- for Mickelson and Walters and Icahn. It's also counterproductive for the purposes of insider-trading enforcement. For a while, everyone thought that a secretive cabal consisting of a powerful businessman, a Las Vegas gambler and an all-American sports hero, made millions of dollars trading on illegal inside information not available to the average investor.

And that was just not true! I mean, maybe some bits of it were true, we'll see, but that news media-ready cabal was just a paranoid fantasy. There are already plenty of those in the financial markets. It doesn't help for the FBI to make up one of its own.

1 Presumably by way of Walters:

Mr. Mickelson and Mr. Walters, as previously reported, still face an investigation over separate well-timed trades they made in Dean Foods in 2012 just before the company’s stock soared. Those trades generated more than $15 million in proceeds for Mr. Walters and nearly $1 million for Mr. Mickelson, one of the four people briefed on the matter said. Mr. Mickelson has denied any wrongdoing.

2 He is now!

Mr. Mickelson has hired Gregory B. Craig, a partner at the law firm Skadden, Arps, Slate, Meagher & Flom who was previously White House counsel under President Obama.

3 The principal ones being:

  1. The market really is rigged against small investors: Big investors have more access to information, better research, better computers, the whole thing, so they should always outperform retail. If you have no advantage, you're at a disadvantage, and should index.
  2. There is no reason to favor small investors -- who tend to be wealthy hobbyists -- over big investors, who tend to be institutions that manage regular people's pension funds and 401(k)s. The SEC shouldn't view its job as protecting the hobbyists at the expense of my retirement money, which is sensibly in index funds.

To contact the writer of this article: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this article: Zara Kessler at zkessler@bloomberg.net.