Maverick Tube Corp. announced after the market closed on Monday, June 12, that it agreed to be acquired by Tenaris S.A. at $65 per share, a 30%+ premium over its stock price. A St. Louis Post-Dispatch article (here) notes that trading in Maverick Tube July 60 call options spiked in the days before the deal announcement. While the average trading volume for those options was about 100 per day, in the last three trading days before the announcement the volume was over 1,000 per day. The call options give the purchaser the right to buy Maverick Tube shares at $60 until the contract expires in mid-July, a very bullish bet on a stock then trading in the $45-$49 range, especially because the option expire in about 5 weeks and the market has been in the doldrums. Did someone just get lucky and win the lottery? That’s unlikely, as shown in other insider trading cases, most notably in the acquisition of Reebok by Adidas in 2005, in which the SEC and federal prosecutors are pursuing cases against a number of purchasers. The Maverick Tube options trading is likely to pique the SEC’s interest because the gain is so enormous and the bet so risky. Of course, if the purchasers had inside information, then transactions were risk-free. There is no word yet about an SEC investigation, but I think the likelihood of such an inquiry is quite high, especially if the call option purchases were conducted through entities or brokerage accounts designed to shield the identity of the true owners. And don’t be surprised to see prosecutors from the Southern District of New York lurking about. (ph)
Category: Insider Trading
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If you don’t share the basketball with your teammates, you are likely to lose the game. When you share insider information with them, however, you may well come to the attention of the SEC and be sued for insider trading. Such is the fate of Matthew Roszak, Douglas Jozwiak, Darrin Edgecombe, and two others when Roszak learned from a director of Blue Rhino that the company was in the process of being acquired by Ferrellgas Partners. Roszak worked with the director closely, including serving as the CFO of a company controlled by the director. The director first told Roszak in December 2003 that he would be doing significant work on a deal involving Blue Rhino, and on January 9, 2004, after spending two days together, Roszak made his first purchase of Blue Rhino shares and tried to figure out how to buy call options on the stock — a much more cost-effective way of trading on inside information.
If the trading had stopped there, Roszak might have stayed underneath the radar because he had once before bought Blue Rhino shares. Inside information is like a wad of cash in one’s pocket, however, and pretty soon it burns a hole and has to be let out. On January 29, the director told Roszak that he would be in daily Blue Rhino board meetings, a clear signal that the deal was close to completion. That evening, Roszak called basketball teammates Jozwiak, his brother-in-law, and Edgecombe, his friend for 15 years, apparently to tell them about the deal. The SEC complaint (here) details a number of telephone calls between the three men, the type of circumstantial evidence on which these types of cases are often built. Roszak also called two relatives, who are not identified in the complaint, that evening. The next morning, the Blue Rhino spigot was turned on as the tippees began buying up shares at a rapid clip. Jozwiak bought $56,000 worth of stock the next morning, his largest trade since opening the account, and Edgecombe bought almost $300,000 the moment the market opened the next morning — nothing like trying to be subtle about using your inside information.
Edgecombe tipped two other friends, Trifon Beladakis and Mark Michel, who also started buying Blue Rhino. The complaint details the calls on January 29 down to the minute as the information burned up the telephone wires in Illinois, where all the defendants reside. To compound matters by making it more likely that the securities exchanges and the SEC would notice the trading, Michel, a registered rep at Wachovia Securities, also bought $1.2 million worth of Blue Rhino for relatives and clients in addition to his own purchases. When the companies announced the deal on February 9, Blue Rhino jumped almost 20%, and the defendants reaped the following profits: Roszak $23,230; Edgecombe $65,017; Jozwiak $14,136; Beladakis $29,783. Michel made almost $32,000 for himself, $92,381 for relatives, and almost $202,000 for clients. Not bad for less than two weeks worth of investing. I vaguely recall an adage about hogs getting slaughtered.
According to the SEC Litigation Release (here), four of the five defendants settled on the following terms: "Roszak, Edgecombe and Beladakis have agreed to pay disgorgement, plus prejudgment interest thereon, and civil penalties totaling $240,740, $114,805 and $62,353, respectively. To settle charges against him, Jozwiak agreed to pay a civil penalty in the amount of $14,136." Michel did not settle the case, and likely faces some pretty unhappy Wachovia Securities clients (and if he hasn’t been fired yet, he probably will be very soon) who do not want to have to return their ill-gotten Blue Rhino bonanza. (ph)
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Along with the criminal indictment on false statement, perjury, obstruction, and conspiracy charges filed on June 4, 2003, Martha Stewart and Peter Bacanovic were sued the same day by the SEC for insider trading (complaint here) arising from her sales of ImClone Systems, Inc. stock on December 27, 2001. The Commission alleged that Stewart sold her shares (and avoided approximately $45,000 in losses) based on information about stock sales by ImClone’s CEO, Dr. Sam Waksal, that was passed on to her by Bacanovic, her broker at Merrill Lynch. The complaint does not allege that Waksal — who is serving a 7-year prison term after pleading guilty to insider trading and tax charges — tipped either Stewart or Bacanovic about problems ImClone was having in obtaining FDA approval for its main drug, Erbitux. Instead, the SEC alleges that Bacanovic violated his fiduciary duty to Merrill Lynch by tipping Stewart about customer information: "As of December 27, 2001, the Waksals’ efforts and instructions to sell their ImClone stock were not public and Merrill Lynch policies specifically required employees to keep information about those transactions confidential. Indeed, Merrill Lynch had in place at least four policies that prohibited employees, such as Bacanovic and [his assistant Douglas] Faneuil, from disclosing client transactions to others or effecting trades on information about client securities transactions." The alleged insider trading is a step removed from the confidential information, and concerns market information rather than corporate information, raising questions of materiality and causation. Federal prosecutors did not charge Stewart and Bacanovic with securities fraud, most likely because it would have been too difficult to establish guilt beyond a reasonable doubt. The SEC suit operates under the more relaxed civil standard of preponderance of the evidence, although the case is certainly not an easy one.
The parties agreed to stay the civil case until the criminal case was over, and now that Stewart will not pursue any further appeals from the affirmance of her conviction by the Second Circuit in January 2006, the SEC suit can move forward. An AP story (here) states that Stewart and Bacanovic must now file an answer to the complaint. The civil case involves a fairly trivial amount of money for someone of Stewart’s wealth, and could probably be settled for not much more than $200,000 with interest and a triple penalty, at the most. The problem in settling the case most likely is a possible director and officer bar that could be imposed on Stewart if there is a finding that she engaged in a violation of the antifraud provisions of the federal securities laws. The complaint seeks the following relief: "Order[] that Stewart be barred from acting as a director of, and limiting her activities as an officer of, any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act, 15 U.S.C. § 781, or that is required to file reports pursuant to Section 15(d) of the Exchange Act, 15 U.S.C. § 78o(d) . . . ." A D&O bar would prevent Stewart from exercising control of Martha Stewart Omnimedia Inc. as a senior executive, barring a move to take it private so that it would not be subject to the registration and reporting provisions of the Securities Exchange Act of 1934. If the Commission is insisting on a bar, that may be too high a price to pay, especially in a case that Stewart stands a reasonable chance of winning, although at the cost of another round of negative publicity. Then again, having appeared on a version of The Apprentice, there may be no such thing as too much bad publicity. (ph)
UPDATE: An AP story (here) states that Martha Stewart filed an answer to the SEC complaint asserting that she acted in "good faith," which is a defense to a fraud charge under Section10(b) and Rule 10b-5, the legal basis for the insider trading prohibition. At this point, discovery will move forward, which means deposition notices are likely to go out to Stewart and Peter Bacanovic, her co-defendant and former broker. Unlike the criminal case, in which neither testified, as civil defendants the opposing party has the right to compel them to testify. While either can assert the Fifth Amendment privilege at the deposition, that can be used as evidence to infer that the person had the requisite intent to violate the antifraud provisions. Settlement is certainly not precluded at this point, and as discovery proceeds the sides may move closer to resolving the issues. (ph)
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My mother always said that it wasn’t what I did that got me in trouble, it was the fact that I lied about it. That was not entirely true, of course, but the lie can certainly turn a bad situation worse. That is especially applicable when the lie involves an SEC insider trading investigation and the initial story is that the information was overheard from two guys talking in a bar, a tale sure to pique the Enforcement Division’s interest. Stephen Messina will plead guilty to violating Sec. 1001(criminal information here) for making a false statement during an SEC investigation of his purchase of call options in Electronic Boutiques right before the announcement of an acquisition of the company by Game Stop that triggered a 34% increase in the stock price, giving him a profit of over $300,000. It turns out that the information came from Messina’s friend Robert Downs, an attorney at the time at Philadelphia law firm Klehr Harrison, which worked on the deal, although Downs was not involved in the representation.
Messina and Downs settled an SEC civil insider trading action, with Messina disgorging his profits, plus paying a 50% penalty, while Downs paid a penalty equal to Messina’s profits (Litigation Release here). Down, who is no longer with the law firm, was not involved in the criminal prosecution, and it will be interesting to see if the Pennsylvania state bar pursues any disciplinary action against him if the SEC allegations are correct. As a general matter, disclosing client-related information to a third party to trade on it would violate the confidentiality rules and the fiduciary obligation of lawyers that prohibits use of client information for personal benefit, even if the client does not suffer any direct harm. A Philadelphia Inquirer story (here) discusses the case. (ph)
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The story of the insider trading ring organized by David Pajcin and Eugene Plotkin, who met while working at Goldman Sachs, took another turn with the arrest of Pajcin’s high school friend, Jason Smith, on insider trading and criminal contempt charges. Pajcin and Plotkin showed a voracious appetite for inside information, as discussed in an earlier post (here), that involved obtaining deal information from an analyst at Merrill Lynch and hiring two men to work at a printing plant in Wisconsin to get a sneak peak at advance copies of Business Week. Pajcin first came to the government’s attention in August 2005 when large-scale call option purchases in Reebok right before the announcement of its acquisition by Adidas, including trades through an account in the name of his aunt in Croatia, first surfaced and caused the SEC to look at a variety of trading accounts for suspicious transactions.
The latest twist involves a letter carrier who was a member of a federal grand jury in New Jersey. Smith is accused of leaking information to Pajcin and Plotkin about the pending investigation of Bristol-Myers Squibb and its executives for accounting fraud related to channel stuffing that was before the grand jury. That investigation ultimately resulted in a deferred prosecution agreement for the company and indictments of two of its former financial officers on June 14, 2005. According to a press release issued by the U.S. Attorney’s Office for the District of New Jersey:
Smith allegedly kept Pajcin abreast of progress and developments in the grand jury and what he believed was the anticipated indictment of one particular BMS officer who appeared multiple times before the grand jury. The two allegedly discussed trading in BMS stock and also met in Manhattan with another of Pajcin’s co-conspirators, Eugene Plotkin, then an associate at Goldman Sachs’ fixed-income research unit . . . According to Pajcin, as related in the criminal Complaint from the District of New Jersey, Pajcin told Smith of the insider trading scheme with which he, Plotkin and others were engaged. Pajcin said he opened a brokerage account in the fall of 2004 with about $6,000 or $7,000 provided by Smith, as well as with money from a $20,000 bank loan taken by Plotkin. Pajcin said Smith told him to use Smith’s money in the insider trading scheme. Subsequently Smith began passing along information on the progress and status of the BMS grand jury investigation. Smith and Pajcin allegedly agreed to share in any profits made as a result of Smith’s information.
Pajcin has been cooperating with the government’s investigation since late 2005, and it appears that he assisted in an undercover contact with Smith in April 2006. According to the press release, "During a recorded telephone conversation on April 12, 2006, according to the Complaint, Pajcin told Smith he was considering cooperating with authorities. If he did, Pajcin told Smith, he might have to tell the government about ‘the jury thing.’ In response, Smith expressed, among other things, serious concerns for himself and discussed possibly fleeing, according to the Complaint."
It is not clear whether Pajcin and Plotkin made any money on their short sales of BMS, although the U.S. Attorney’s Office for the Southern District of New York and the SEC are pursuing insider trading charges against them (and Smith) for that trading (see SEC Litigation Release here). While trading based on material nonpublic information usually results in a gain or loss avoided, a Rule 10b-5 violation does not require the defendant to realize a profit from the transaction, and it is not a defense that the trade turned out to be a loser if it was made while the person had inside information that caused the transaction. Of even greater concern for Smith is the contempt charge for violating Federal Rule of Criminal Procedure 6(e), which strictly prohibits disclosure of grand jury information. Courts are particularly concerned about leaks of grand jury information, so if the allegations prove to be true, then Smith will probably face a much more severe sentence than would be the case for the insider trading, particularly because the contempt statute does not contain a statutory maximum (18 U.S.C. Sec. 401 here). (ph)
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Former Qwest CEO Joseph Nacchio’s attorney have sought dismissal of the 42 insider trading charges on the ground that venue is not proper in Colorado and prosecutorial misconduct. An earlier motion to dismiss because the indictment failed to charge a criminal offense failed, and these motions do not deal with the substance of the charges but the process of the indictment and its location. According to an AP story (here), Nacchio alleges that prosecutors tainted the grand jury by having other Qwest executives testify regarding internal corporate policies on selling shares, and only six witnesses testified before the grand jury in a rush to secure an indictment before the five-year statute of limitations expired. The problem with this argument is that under U.S. v. Costello, 350 U.S. 359 (1956), a facially valid indictment cannot be dismissed because of the quality or sufficiency of the evidence before the grand jury. It will be difficult for Nacchio to show that the grand jury process was so tainted by prosecutors that the grand jury’s function was usurped, so an evidentiary claim is unlikely to succeed even when coupled with a claim of prosecutorial misconduct.
The second motion to dismiss is based on the ground that none of the stock sales took place in Colorado, so venue is not proper in that jurisdiction. The securities fraud statute is not quite so restrictive, however, and covers any scheme or artifice to defraud "in connection with the purchase or sale of a security." The fact that Nacchio was a Qwest executive in Colorado at the time of the alleged insider trading is likely sufficient to establish venue, and to the extent he wishes to raise a factual issue on this element then it is a jury question and not one the judge is likely to decide before trial. As an alternative, Nacchio also requests a change of venue because he is "among the most reviled figures in recent Denver history." While I thought Jake Plummer would rank as #1 on that list these days, the issue for the court is whether Nacchio can receive a fair trial and not the general perception of him. Once again, this is a difficult argument to win, and the trial is likely to be held in Denver, the site of Qwest’s headquarters. An AP story (here) discusses the venue issues. (ph)
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An earlier post (here) discussed an insider trading case in New York in which the live-in boyfriend looked at the deal documents his girlfriend brought home from her office and bought shares in the client-company involved in an extraordinary transaction. A slightly different situation arose in an SEC civil insider trading case filed in San Francisco involving Marnie Sharpe, who got the news from a "close friend" and almost immediately tipped her father about it. As described in the SEC complaint (here), Sharpe received the information from an executive at biotech company Renovis, Inc., and "Sharpe and the executive, both divorced, met socially and exchanged email, phone calls and text messages." The executive and Sharpe had dinner at which he said the company expected to receive the results of a clinical trial on its most advanced drug on May 2. Shortly after the executive received information on May 2 that the results were positive, Sharpe called the executive and asked about the test results. After initially resisting her requests for information, he told her that the results were positive and warned her not to disclose the information. The executive then called her back to reiterate the confidentiality of the information and, when she asked if she or her family could trade, the executive said "of course not."
At this point, Sharpe’s relationship with the executive probably hit the skids because she immediately called her father, who liquidated mutual funds in his brokerage account to raise cash, and Sharpe wire transferred $10,000 to her father’s account. The father even asked the broker whether a company could trace who was buying its stock. On May 3, 2005, the father purchased over 7,000 Renovis shares, apparently not knowing that the best way to trade on such inside information is to purchase out-of-the-money call options on the company’s shares. On May 4, Renovis announced the positive clinical test results, and the stock nearly doubled, generating a $42,000 profit. Sharpe and her father settled the SEC case by disgorging the profits and each paying a one-time penalty of $42,000.
The SEC’s theory that Sharpe breached her fiduciary duty in tipping her father was the pattern of sharing confidential information in the relationship with the executive. As described in the complaint, "During their friendship, Sharpe and the Renovis executive had a history, pattern or practice of sharing confidential work and personal information. They each expected the other to keep such exchanges confidential and, until May 2005, did so. Because of their close personal relationship and history of sharing confidences, the Renovis executive trusted Sharpe and expected her to keep information about his work confidential." This is not the type of classic fiduciary relationship that is the basis for an insider trading case under Chiarella or O’Hagan, but it is consistent with the SEC’s definition of the "Duty of Trust or Confidence in Misappropriation Insider Trading Cases" in Rule 10b-5-2(b)(2). Whether that definition, which goes further than most judicial decisions have in describing the contours of the type of duty that can trigger insider trading liability, would hold up to a judicial challenge is an open question. While this case might have presented a good vehicle to address the scope of the fiduciary duty arising from a personal relationship, the San Jose Mercury News quotes the attorney for Sharpe and her father (here) as stating "[i]t is unfortunate that it is so expensive for people to defend themselves against government charges like these." The cost of settling was probably less than litigating the case, especially if it went up on appeal. But then, if you can’t trust your girlfriend, who can you trust these days. (ph)
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The SEC filed civil insider trading charges against hedge fund manager Nelson Obus, Peter Black, an analyst at the hedge fund firm, and Thomas Strickland, who formerly worked at GE Capital. The inside information concerned the acquisition in 2001 of SunSource, Inc. by Allied Capital Corp. in a deal financed by GE Capital. According to the SEC complaint (here), Black and Strickland are close friends, and on May 24, 2001, Strickland allegedly told Black about the upcoming transaction, who in turn told Obus, who then called SunSource’s CEO to discuss the transaction. According to the complaint, "Obus told the CEO that a ‘little birdie’ at Capital had told him that SunSource management was planning to sell the company to a financial buyer." The complaint goes on to note that "Black was present when Obus spoke with Sunsource’s CEO. When Black heard what Obus told the CEO, he jumped out of his chair and began waving his arms because he was concerned that his friend Strickland would get into trouble. When Obus finished his conversation with Sunsource’s CEO, Black told Obus of his concern, and Obus responded that, if GE Capital fired Strickland, Obus would offer Strickland a job or find him a job elsewhere on Wall Street."
To this point, the SEC case describes a fairly mundane insider trading case. The issue in the case will be whether the defendants traded on the inside information, because they did not purchase any shares until June 8, when Obus bought 287,000 shares and apportioned them to three hedge funds his firm manages. When the deal was announced on June 19, SunSource’s stock increased by over 90%, and the funds had a profit of over $1.3 million. The tricky part of the case is the following allegation in the complaint: "Following Strickland’s May 24,2001, conversation with Black, Strickland continued to work on, and thus receive nonpublic information about, the progress of the proposed transaction between SunSource and Allied. On June 4,2001, Black called Strickland, and they had a four-minute conversation. That conversation provided Black with the opportunity to receive an update on the progress of the transaction and to update Obus." The italicized language does not say that Strickland actually provided additional information to Black and Obus, only that it could have happened. While the complaint has many details about the interactions of the defendants, like the arm waving, it is curiously vague on whether Strickland provided additional information to Black and Obus that can show the transaction was based on material nonpublic information.
Obus and his firm, Wynnefield Capital, have vigorously denied the SEC’s allegation. A press release (here) issued in response to the Commission complaint states:
We will detail our factual and legal case in our court filings, but you should know that the allegations are baseless and unsupported by the documentary or testimonial evidence. Our attorneys have advised us that the lawsuit lacks merit. We intend to contest this vigorously in the courts. Specifically, the facts are these:
- We acted ethically and legally;
- We followed and researched the stock for more than 10 years – and repeatedly invested in it for more than five years;
- We did not engage in insider trading;
- Our actions were consistent with our long-standing strategy to build positions in small-cap value investments;
- Our actions were consistent with the protection and enhancement of value for the company’s shareholders; and
- Our actions were intended to provide continued excellent results for our funds’ investors.
The press release notes that the trading took place nearly five years ago, and they cooperated in the investigation. Obus claims that he and his firm thought the matter had been been dropped, an assumption that should never be made with a government agency.
It is a fair question why the case took so long to come to fruition. None of the three defendants settled the matter, so it does not appear that the Enforcement Division would have received information from a cooperating witness at a late date to propelled the case forward. It may be that, due to staff turnover or other extraneous factors, the investigation became inactive for a period of time and only recently got restarted. Regardless of the reason for the delay, the defendants show no inclination to settle at this point, and given the pace of civil litigation, the trial may not begin until seven or eight years have elapsed since the trading. (ph)
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Federal prosecutors and the SEC filed new criminal and civil insider trading charges in a case that grew out of suspicious trading in shares of Reebok in August 2005 right before the announcement of a friendly takeover by Adidas. A short time later, charges were filed against David Pajcin, who worked at Goldman Sachs and is the nephew of a woman in Croatia who was the name on the account that traded Reebok stock and call options. Pajcin was also charged with insider trading based on reviewing advance copies of Business Week, an old insider trading ploy that seems to crop up every few years. Pajcin has cooperated with the authorities, and a wide-scale insider trading operation has come to light that generated profits of over $6 million. The two lead players are Pajcin and Eugene Plotkin, who worked with Pajcin at Goldman and was most recently in the firm’s Fixed Income Research division — and I suspect he was terminated from that position as soon as the news hit the wire. The scheme had two prongs, with information coming from a junior analyst at Merrill Lynch about deals in that firm’s shotpand another pipeline into the printing plant for Business Week. The SEC’s litigation release (here) summarizes the two aspects of the insider trading operation:
The Merill Lynch Scheme:
The Complaint alleges that Plotkin and Pajcin infiltrated the investment banking unit of Merrill Lynch, repeatedly learning of mergers and acquisitions transactions before they became public. In exchange for a share of the illegal profits, Stanislav Shpigelman (“Shpigelman”), an analyst at Merrill Lynch, leaked confidential information to defendants Plotkin and Pajcin concerning at least six mergers or acquisitions that Merrill Lynch was working on, prior to the time the deals became public, including deals between (i) The Proctor & Gamble Company and The Gillette Company; (ii) Novartis AG and Eon Labs, Inc.; (iii) Duke Energy and Cinergy Corp.; (iv) Quest Diagnostics, Inc. and LabOne, Inc.; (v) Celgene Corp. and a company considering acquiring Celgene; and (vi) Reebok and Adidas. Plotkin and Pajcin traded on the insider information and passed the insider information on to individuals in the United States and Europe (“Traders”) who traded on it. Plotkin and Pajcin had an agreement with the Traders, pursuant to which they were to receive a percentage of the illicit profits made by the Traders. The Merrill Lynch Scheme yielded over $6.4 million in illicit trading profits.
The Business Week Scheme:
The Complaint further alleges that Plotkin and Pajcin also infiltrated one of the printing plants utilized by Business Week, repeatedly obtaining advance copies of the market-moving IWS [Inside Wall Street] column in Business Week. Plotkin and Pajcin recruited two individuals — first, Nickolaus Shuster (“Shuster”), and later Juan C. Renteria, Jr. (“Renteria”) — to obtain employment at Quad/Graphics, Inc., one of four printing plants that print Business Week magazine, for the sole purpose of stealing copies of upcoming editions of the magazine, and calling Plotkin or Pajcin to read them key portions of IWS — a widely-read column in the magazine that generally moves the price of the securities of companies mentioned in it – prior to the time the column became available to the public. The Complaint alleges that Shuster and Renteria provided Plotkin or Pajcin with insider information concerning at least twenty companies that were featured in the IWS column. Plotkin and Pajcin then either traded on the IWS insider information or passed the information to some or all of the Traders, who traded on the insider information. The Business Week Scheme yielded over $345,000 in illicit trading profits. here) discusses the charges. (ph)
All of the main players are in their 20s, with Pajcin the oldest at 29, although this is much more than a youthful indiscretion. Plotkin and Shpigelman were arrested in New York on the criminal charges. If the charges are proven, their careers on Wall Street were over before lunch was served. A Reuters story (here) discusses the charges, and the criminal complaint is available (here) on Findlaw. (ph)
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An article in the Wall Street Journal (here) discusses proposed legislation that would make it illegal for members of Congress and their staff to trade on nonpublic information related to legislative action that affects the price of a stock. The legislation is not yet available, and the article notes that it covers more than just insider trading: "In addition to banning trading on inside information, the proposal would require that lawmakers and their top aides disclose within 30 days any stock trades. Congressional rules now require lawmakers to disclose their trades once a year. The bill also would require that companies register with Congress if they sell information about congressional activity to Wall Street investors."
As Peter Lattman on the WSJ‘s Law Blog (here) notes so well, "If you’re asking yourself, ‘Wait a minute, members of Congress are allowed to commit insider trading?’ you’re not alone. We asked the same question." Can Capitol Hill’s investors really do better than Wall Street’s? Bruce Carton on the Securities Litigation Watch blog (here — welcome back from that nasty flu bug) points out that a study of securities investing by Senators in the 1990s showed that their picks beat the market by 12%, a strikingly high return. The legislation introduced by Reps. Louise Slaughter and Brian Baird is motivated in part by the trading of a former aide to Rep. Tom DeLay in 1999 and 2000, although it is not clear whether his trading was based on nonpublic information.
While the usual basis for insider trading cases (civil and criminal) is Sec. 10(b) and Rule 10b-5, the Supreme Court’s interpretation of those provisions requires that there be a duty to maintain the confidentiality of the information. That duty appears to be lacking for our elected officials and their staff, unlike corporate executives, employees, lawyers, accountants, journalists (particularly from the Wall Street Journal), printers, consultants, and many, many others.
It may be possible to solve the insider trading problem without having to enact legislation which — here’s a shocker — could get bogged down in partisan bickering. Instead, the House and Senate could adopt rules imposing on each member and their staff a duty to maintain the confidentiality of information arising from the legislative process that could affect a company’s business or share price. Companies, professional firms, and other organizations routinely require employees to sign forms acknowledging such a duty, and a similar requirement could be adopted by Congress for those working on Capitol Hill. Once such a duty is in place, an insider trading case can be pursued for violating the antifraud provisions of the federal securities laws.
While Congressional hearings and legislation can affect a whole industry, it would seem better to restrict trading in the shares of individual companies to avoid questions about whether legislation that negatively affects one industry and helps another means there can be no trading in either. It would hardly make sense to put the entire energy or pharmaceutical industry off-limits for investing (either buying or selling). A prohibition on trading based on nonpublic information about single-company proposals, which are common in the tax area, would be more workable.
After the Supreme Court endorsed the misappropriation theory in U.S. v. O’Hagan, the source of the information was rendered largely irrelevant so long as the defendant owed a duty of trust and confidence to the source of the information and breached that duty by trading. By changing its rules, Congress can effectively adopt a prohibition on insider trading for its members and staff by imposing a duty to maintain confidentiality and abstain from trading before information is disclosed.
Whether information arising from the legislative process is "material" is another issue. Moreover, there are few real secrets on Capitol Hill, so it might be that an insider trading action could not succeed except in particularly blatant situations. That is where the disclosure requirements of the proposed legislation might be useful by shining a light on trading that, while not up to the standard of insider trading under Rule 10b-5, is still questionable and possibly unethical. (ph)
MattBray.net 