In March 2004, the SEC filed a civil injunctive action against unknown purchasers of InVision Technologies, Inc. call options shortly before the company announced that it had agreed to be acquired by General Electric. The option purchases were through accounts at a Swiss private bank, and the purchases were executed through UBS, a global securities firm. Not surprisingly, the identity of the actual purchasers was not disclosed, and the SEC moved quickly to freeze the proceeds of the transaction before the money left the country. The unknown purchasers bought over 4500 out-of-the-money short term call options in the week before the announcement, and had total profits of approximately $2.7 million (although not all the call options were sold, and likely expired unexercised). Such a transaction is sure to get the SEC’s attention, and the Enforcement Division filed a TRO action to freeze the accounts the day after the announcement of the deal. According to the SEC’s most recent Litigation Release (here), the U.S. District Court for the Southern District of New York issued an injunction forfeiting the proceeds of the transactions and enjoining the unknown purchasers from future violations of the securities laws. This is not an injunction likely to be enforced in the future given the fact that no one decided to show up in the United States to put in a claim for the money, which would trigger an immediate arrest by the FBI or Postal Inspectors on insider trading charges. Funny how those unknown purchasers never quite seem to show their faces, but at least they thought they could get away with a big killing in the market. (ph)
Category: Insider Trading
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The investigation of Senate Majority Leader Bill Frist is moving forward quickly, although as with many such investigations, it is likely to move into an extended quiet period once the documents are delivered and testimony is taken. On Sept. 29, HCA disclosed (here) that the SEC had issued a formal order of investigation, which means the Enforcement Division staff has subpoena power to compel the production of documents and testimony from witnesses. The staff is likely to seek testimony from a number of individuals at HCA because of the large volume of stock sales during the period before the negative earnings announcement. With the number of attorneys involved, it will probably take months rather than weeks to get through the depositions.
A Washington Post article (here) discusses e-mails involving the decision-making process for the sale of Senator Frist’s HCA stock from the so-called "blind trusts" that held the shares. It appears that Senator Frist first raised the possibility of selling the shares in late April with his counsel and accountant, and the process took until late June to complete. That makes it more difficult to establish a link between the sales and any possible tipping about the earnings problems at HCA, although the company’s disclosure was not the result of a single event, such as a buy-out offer or other specific decision. Earnings shortfalls don’t occur over night, and it is not impossible that information started to leak out from HCA about potential problems much earlier in the quarter. An interesting question would be whether a person who makes a tentative decision to sell stock, and then learns inside information that would impel such a sale, violates Rule 10b-5 by trading while in possession of the information. This raises issues about the materiality of the information and to what extent the information has be a cause of the decision to trade.
Senator Frist has brought in the first-team to represent him in the SEC and U.S. Attorney investigations of his HCA stock transactions: former Enforcement Division director Bill McLucas of Wilmer Cutler. Unfortunately for the Majority Leader, the investigation is unlikely to be resolved quickly. (ph)
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An analyst for Citizens Bank and her husband are among the defendants in parallel criminal and civil insider trading cases filed by the U.S. Attorney for the District of Massachusetts and the Securities & Exchange Commission. Shengnan Wang worked in a division responsible for conducting the due diligence on possible acquisitions, and she became aware of Citizens’ pending acquisition of Charter One in 2004. Wang tipped the manager of a hedge fund in which she and her husband, Hai Liu, had invested, about the pending deal. Michael Tom then purchased Charter One shares on behalf of a hedge fund he managed for Global Time Capital Management, LLC. According to the SEC’s Litigation Release (here):
[B]etween April 29, 2004 and May 4, 2004, Michael Tom purchased numerous Charter One call options, which increase in value with a rise in the stock price, for his personal account and for his hedge fund, GTC Growth Fund. Michael Tom also traded Charter One securities prior to Citizens’ announcement in a joint account he held with his wife and in accounts he managed for his wife and in-laws. According to the complaint, Michael Tom’s illegal insider trading in Charter One securities resulted in total imputed profits of approximately $743,505.
The Complaint also alleges that Michael Tom and Wang’s husband, Hai Liu, tipped their brothers, David Tom and Zheng Liu, respectively, about Citizens’ acquisition plan. As a result, both David Tom and Zheng Liu traded in Charter One securities prior to Citizens’ announcement. David Tom’s trading resulted in imputed profits of approximately $39,089, while Hai Liu’s brother, Zheng Liu, made imputed profits of approximately $2,736.
The SEC complaint names Wang, Liu, Tom, Global Time Capital, and the two brothers as defendants, while the criminal case involves a one-count criminal complaint against Wang and Liu charging securities fraud (U.S. Attorney’s press release here). The filing of a criminal complaint usually indicates that the defendants will enter a guilty plea, and look for criminal charges against Tom and the hedge fund in the near future, perhaps by way of an indictment if he chooses to fight the charges. Once again, even if it looks like free money by trading in a stock before news hits the market, it just doesn’t seem to work out that way once the SEC and U.S. Attorney’s Office connect the dots — and this does not sound like a particularly tough puzzle to put together. (ph)
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In addition to seeking information from HCA, Inc., federal prosecutors in the U.S. Attorney’s Office for the Southern District of New York and attorneys from the Enforcement Division of the SEC have contacted Senate Majority Leader Bill Frist’s office for information related to the sales of HCA stock in so-called "blind trusts" that held assets in his name, and for his wife and children. With the parallel investigations, Senator Frist may be asked to testify under oath before the Commission staff and federal prosecutors, and could even be subpoenaed to testify before a grand jury in Manhattan. An AP story (here) notes that at one time, Senator Frist stated about the trusts that "I have no control. It is illegal right now for me to know what the composition of those trusts are. So I have no idea." I’m not sure where he got the idea that it is illegal, although the Senator may simply have meant it would be a violation of the trust agreement for him to be involved in investment decisions. It’s hard to think of a crime involved just from his directing the sale of assets (leaving aside possible insider trading), unless he were to have taken trust assets improperly, which certainly does not appear to be the case. Whether his conduct is proper under the trust instrument is largely irrelevant to the DOJ and SEC investigations, which will focus on any leaks of information from the company. Given the volume of stock sales by other HCA executives around the same time as Senator Frist’s sales, it may be difficult to track down any improper disclosure of information, but investigators from those offices have not shied away from tough cases in the past. (ph)
UPDATE: A New York Times article (here) discusses how blind the trusts are under Senate disclosure rules. (ph)
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HCA Inc., the large private hospital and medical clinic company, disclosed that it received a subpoena from the the U.S. Attorney’s Office for the Southern District of New York for information related to sales of the company’s stock by Senate Majority Leader Bill Frist. A company news release (here) states: "HCA (NYSE: HCA) today announced that the company received a subpoena from the office of the United States Attorney for the Southern District of New York for the production of documents. The company believes the subpoena relates to the sale of HCA stock by Senator William H. Frist. The company intends to cooperate fully with the office of the U.S. Attorney in this matter." Senator Frist directed the sale of all of his shares in HCA, including those owned by trusts for his wife and children, that were held in a blind trust. Approximately two weeks after Frist’s shares were sold, HCA announced an earnings shortfall, and the company’s shares dropped approximately $5 per share, from $55 to $50.
According to an AP article (here), Frist’s HCA shares were worth between $7 and $15 million at the beginning of the year. A large number of HCA executives also sold shares, and the company was founded by Frist’s father. The Wall Street Journal reports (here) that the SEC is also looking into the sale. One interesting aspect is that the trust arrangement for holding assets is usually designed to insulate the person from any direct control over the trust holdings, so that any transactions cannot be tied to any particular knowledge the owner might have. Senator Frist’s financial disclosure form for 2003 (here) lists a number of blind trusts for which the assets are "unknown," and my quick review of the form does not show any specific listing for HCA shares (he does own Krisy Kreme shares in 2003). I always thought a blind trust meant the person could not be involved in the decisions, but I confess to no knowledge in the area beyond that general impression. (ph)
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Each time a story like this comes out — and they seem to appear with alarming regularity — it causes me to wonder whether corporate executives and board members pay any attention to the discussions about how insider trading in the company’s stock is illegal. The SEC filed an insider trading suit against Swift Transportation Co. CEO (and former board chairman) Jerry Moyes for buying 187,000 shares of company stock in the two trading days before an announcement that that Swift projected better-than-expected revenues and a stock repurchase program that sent shares up 20%. Moyes had a paper profit of $622,000, not bad for a two-day investment. Once the information about the transactions was disclosed on the Form 4 filed with the SEC, Moyes put the profits from the trades into a trust. The board was apparently asleep at the switch, though, because the SEC’s Litigation Release (here) notes that "[u]pon learning of Moyes’ trades, Swift’s independent directors took corrective action, including implementing a stricter insider trading policy and instituting a pre-clearing process for all trades by company insiders." I can only imagine what Swift’s insider trading policy was before this took place. Moyes settled the case by disgorging the profits and paying a one-time penalty; he will step down as CEO in December 2005.
Swift issued a press release (here) touting the fact that the SEC did not take any action against the company related to Moyes’ trading, under the following headline: Swift Transportation Co. Inc. Announces Great News from the Securities and Exchange Commission. Welcome news, perhaps, but "great"? (ph)
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An earlier post (here) discussed the settlement by Oracle CEO Larry Ellison of a law suit in California alleging that he sold $900 million of Oracle stock while he was privy to information about declining earnings at the company that were announced only a month later, i.e. insider trading. Ellison has agreed to make $100 million in charitable contributions spread over five years. On our sister blog Business Law Prof, Dale Oesterle has an extensive discussion of the settlement, and the parallel Delaware Chancery Court case in which Vice-Chancellor Leo Strine dismissed the case on a summary judgment motion, and the post (here) wonders whether he was hoodwinked by Ellison. Paul Caron, emperor of the LawProf Blog empire, has a post on sister blog TaxProf (here) that considers that all-important question whether the donations to charity are deductible, and for reasons that he explains far better than I can understand the answer appears to be "No" (thank goodness). (ph)
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This is one we’ve heard before, yet somehow it just keeps happening. The SEC sued four employees of Cryolife, Inc., and two of their spouses, for selling shares in the company immediately before a product recall. Cryolife sells implantable human tissue, and the FDA ordered a nationwide recall of the company’s product. Before the news became public, the defendants sold their shares, avoiding a loss of approximately $136,000 when the stock dropped from $9.46 to $2.03. The SEC Litigation Release (here) discusses the case, which the defendant’s settled by paying disgorgement and a one-time penalty.
Bruce Carton on the Securities Litigation Watch blog has an interesting post (here) imploring employees of company’s whose shares are publicly traded to avoid the insider trading temptation — one that the Cryolife employees could not resist — if they think they will get away with it. Bruce writes:
I saw it when I was at the SEC and I’ve seen it regularly ever since: SEC enforcement actions against employees of publicly-traded companies who get advance notice of earnings news or other big news concerning their companies and buy/sell the company’s stock prior to the announcement of that news. Of course, that practice is called "insider trading" and it is against the law. As I hope to persuade you below, it is also called "incredibly stupid." Seriously, people, we’re talking about Darwin Award-level stupidity here.
I would add one more item to Bruce’s list of reasons why it’s difficult to get away with insider trading, at least on any significant scale. One of the best ways to make a "big score" on inside information is to trade in options, particularly the out-of-the-money kind that are especially cheap. Once the news hits, either positive or negative, the upside can be enormous. The recent SEC case involving highly suspicious trading in Reebok stock options the day before the announcement of the Adidas takeover is a good example of how the leverage from options trading can produce large profits. If you trade options, however, you will be noticed by the options market-makers. Unlike stock trading, in which firms usually sell shares out of their inventory, stock options are written by firms that make a market in the securities by writing calls and puts. Like a Las Vegas sports book (and no criticism is meant by the comparison), the market makers seek equilibrium, a match between those buying and selling the options, and they will hedge their position to limit the potential exposure. When a sudden burst of buying (or selling) catches them in an exposed position, that money comes straight out of the firm’s capital, and they will raise the roof if the transactions look suspicious. Both the exchanges and the SEC pay attention to the complaints of options market makers because they have a very expensive ring-side seat for insider trading. The big money may be in options, but that money comes from someone whose livelihood may be seriously affected by the transactions. And, they know who you are. (ph)
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A civil action alleging insider trading may be resolved by a payment of $100 million dollars to a charity. The New York Times reports here that the CEO of Oracle has agreed to pay this sum "to resolve a lawsuit charging that he engaged in insider trading in 2001." The agreement is subject to approval by the board. This type of resolution is certainly different and one has to wonder if this could have happened if DOJ were doing the negotiating, as opposed to this being a derivative shareholder suit. So, which charity will receive the funds – -it seems the CEO may get to choose.
(esp)
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The SEC announced the settlement of securities fraud action involving sales before disclosure of negative news about a company that presents an interesting issue on the scope of insider trading liability. In SEC v. Johnson, David Johnson learned of a negative analyst report about PMA Capital Corp., and spoke with the chairman of the company’s board of directors. The chairman stated that the company was having financial difficulties and would likely have to eliminate its dividend. The SEC’s complaint (here) states that "[a]t no time during the conversation did the Chairman tell Johnson that he expected him to keep the information conveyed in their conversation confidential or that he should not trade based on this information."
Johnson then sold his substantial holdings in the company, and had his son sell his shares. When PMA’s stock dropped 62% after announcing the dividend elimination, Johnson avoided over $325,000 in losses, and his son avoided over $55,000. The interesting point about the Commission’s complaint is that it merely asserts that Johnson knew the information he received from the company’s chairman was confidential, and that he then assumed the fiduciary obligation to maintain the confidentiality of the information and abstain from trading. The complaint (here) states:
The information Johnson obtained from the Chairman concerning the loss reserve charge and the discontinuation of the common stock dividend was material and nonpublic. Johnson knew, or was reckless in not knowing, that the Chairman had provided confidential information to him. By disclosing this information to Johnson, the Chairman breached his fiduciary duty to PMA’s shareholders. Therefore, Johnson assumed this duty of trust and confidence to PMA and its shareholders not to trade, or to direct others to trade, in PMA securities. By trading and by tipping his family members, including his son and daughter, Johnson breached that duty.
I’m not sure how you get to the part after "therefore" without some evidence that the chairman intended to tip Johnson, or that Johnson accepted a responsibility to maintain the confidentiality of the information and then violated the "abstain or disclose" rule. The complaint sure sounds like the "possession" theory of insider trading, ostensibly rejected by the Supreme Court in Chiarella and revived, as least somewhat, by the SEC in Rule 10b-5-1, an amendment that has never been tested in court. As a settled matter, the assertions in the complaint will not be tested in court, but the SEC’s position that an outsider can assume a duty to the company without any assertion that the person agreed to undertake that duty, or was a tippee under the more common Dirks analysis, is beyond anything I have seen the courts sanction regarding liability for insider trading. (ph)
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