A Moonlite Bunny Ranch financial confidante.   Photographer: David Paul Morris/Bloomberg
A Moonlite Bunny Ranch financial confidante.  Photographer: David Paul Morris/Bloomberg

Pretty much the best line you'll read in a financial regulatory article today is this one, from a Wall Street Journal story about the Securities and Exchange Commission's whistleblower program:

“We have a sacred bond with our clients,” he said. “Money can’t take precedence.”

That is from the proprietor of a brothel, the Moonlite Bunny Ranch in Nevada. If you are in the business of simulating a close personal bond with your clients to induce them to give you money -- if you're a banker, say, or a bond salesman -- there's a lot to learn from this guy.

Meanwhile can you think of a profession where money does take precedence? Oh right obviously:

“My motivation at the beginning was compensation,” he said. “I was a witness to the banking fraud of the 2008 period. It needed to be corrected, and the bank’s behavior needed to be corrected. And I still believe that, absent the compensation opportunity.”

That's a hedge fund executive who was willing to expose a bank's misbehavior to regulators for money, but apparently not willing to expose it to the Wall Street Journal for free? The article says that he "was a counterparty in multiple transactions with a major U.S. investment bank," and that the bank altered the contracts in a way that "should have resulted in a significant loss in an off-balance-sheet vehicle and forced the bank to restate its earnings." The SEC thought about his tip, but ultimately passed. So the bank, and the contracts, and the alterations, remain a mystery, presumably until he can find a buyer for the information.

Anyway this article is great and you should read it.1

One thing worth considering is the connection between the whistleblower-compensation profit motive (the SEC "offers a bounty of up to 30% of penalties for any monetary sanctions the agency extracts that exceed $1 million") and the trading profit motive. One might think that that hedge fund executive who wanted to expose a bank's misstated earnings for profit could (1) short the bank's stock, (2) expose the fraud, and (3) sit back and profit.

The fact that he didn't do that means ... what? That he worries it would be illegal insider trading? (Would it be?2 Should it be?3 ) That he's not confident that he's right? Or more generally, that banks' stocks don't predictably go down when frauds and misstated earnings are revealed? If the answer is the latter (and I lean towards that, with perhaps a side of insider trading), then what does that tell you about the banking system and its incentives?

On the other hand there are the prostitutes and their sacred duty. They're not trading either:

Air Force Amy, a popular Bunny Ranch mainstay whose real name is Deanne Salinger, said clients constantly reveal material, nonpublic information. At first she said she would approach Mr. Hof to see if they should invest based on any of the tips, but they agreed that it wouldn’t be wise.

A puzzle in insider trading prosecutions is the following: Roughly speaking, it is illegal to trade based on material nonpublic information that has been misappropriated for personal gain in breach of a duty of confidentiality. But the SEC's and prosecutors' view on where that duty of confidentiality falls is sometimes mysterious.

So for instance we talked recently about a case where a corporate executive told his golf buddy about some material nonpublic information. You might think that the corporate executive had a duty to his company not to disclose material nonpublic information to his golf buddy. (I mean, the company would probably think that!) But the SEC thought otherwise, probably because it couldn't make out what personal benefit the executive got from chitchatting about his job on the golf course. So the executive didn't get in any trouble. Instead, the SEC argued that the golf buddy had a "duty of trust and confidence" to the executive. The analogy is to when a lawyer learns about a client's merger and trades on it: The client was well within his rights to tell the lawyer, but the lawyer breached his duty to the client by trading on it. Just swap in "golf buddy" for "lawyer."

You see where I'm going with this. There are lots of relationships that create not-immediately-obvious duties of confidentiality for insider trading purposes. Some, like the lawyer/client relationship, have explicit codes of ethics that require confidentiality; others, like the golf buddy relationship, have only the SEC to argue that there really ought to be a duty of confidentiality. The prostitute/client relationship seems to be ... in the first category?

The Moonlite Bunny Ranch is, obviously, a place that values its sacred bond with clients and takes seriously its obligation to train its employees in their duty of confidentiality. But eventually someone in the adult entertainment industry is going to trade on, or pass along, material nonpublic information obtained in the course of interaction with a corporate executive client.4 And when the SEC comes after that person,5 it will be able to point to this article as evidence that there's a well-understood duty of confidence in the industry. In that sense, the Moonlite Bunny Ranch has helped the SEC plenty already.

1 It's based on Freedom of Information Act responses about the actual whistleblower applications. The Journal reviewed the professions that the whistleblowers wrote down, and then wrote this deadpan sentence:

They include a diesel mechanic, an antiques dealer and a longshoreman; there’s an agronomist, two people who listed themselves as “ex-wife” and a veterinarian.

2 On the one hand, just being a customer doesn't feel like enough to be insider trading. But a question you might ask is, did he have any duty to keep the information -- about contract alteration, etc. -- confidential? Often transaction documents do have confidentiality clauses, so perhaps.

3 This story suggests that not every valid whistleblower tip actually results in an SEC case and a whistleblower award; the SEC supposedly passed on the hedge fund executive's tip "based on prosecutorial discretion." If he has a legitimate complaint that the SEC won't purchase for discretionary reasons, shouldn't he be able to, as it were, sell it to the market? Like, isn't he right that bank fraud should be exposed and corrected? And if the SEC won't do it, shouldn't the market?

4 Intriguingly, here's a hint that this might already have happened:

Then, in March 2007, the S.E.C. received an anonymous letter on plain white paper claiming that Galleon traded tips in exchange for prostitution and “other forms of illegal entertainment.” ... The S.E.C. could not identify the letter’s author, nor did prostitution figure in the eventual charges.

5 And, conversely, leaves the client alone. The client, on this theory, didn't do anything wrong by disclosing the information. It's like talking to your lawyer, or your priest. And of course if the SEC did go after the client for tipping, then ... he'd have a pretty good defense, no? Not legal advice! Though I'd certainly enjoy seeing that defense.

[Important Update: Several people have pointed me to this 1999 prosecution of the former chairman of Keefe, Bruyette & Woods "in a bizarre case in which he is accused of leaking information about potential billion-dollar bank deals to an X-rated movie actress he was dating." How do you reconcile that with the adult entertainer duty of confidentiality? Perhaps different parts of the industry have different ethical codes.]

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

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.