Insider Trading and Privileged Information in a · PDF fileInsider Trading and Privileged...

Insider Trading and Privileged Information in a Regulatory Context

Mitchell E. Herr

January 24, 2008

INSIDER TRADING IS RAMPANT

• Oct. 27, 2007, SEC’s Director of Enforcement d l d i id di b ll Sdeclared insider trading by Wall Street professionals “rampant”

Following Wall Street insider trading scandals of • Following Wall Street insider trading scandals of 1980s (Boesky, Levine & Milken), SEC did not bring any such cases in early 1990s and only 10 in l 1990late 1990s

• 2007 will be record year -- 10 new SEC insider trading cases in the last month alonetrading cases in the last month alone

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WALL STREET PROFESSIONALS

SEC v. Guttenberg, et al. (SEC Lit. Rel. 20022, 200 )Mar. 1, 2007)

– 2 overlapping schemes involving hundreds of thousands of trades and more than $15MM in profits over 6 yearsof trades and more than $15MM in profits over 6 years

– UBS Scheme: senior professional tipped outside traders about analyst recommendations -- $14MM in profits

– Morgan Stanley Scheme: global compliance attorney tipped others about corporate acquisition announcements

– Defendants being prosecuted criminally– Defendants being prosecuted criminally

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SEC v. Barclays Bank PLC, et al. (SEC Lit. Rel. 20 32 30 200 )20132, May 30, 2007)

–Barclays trader sat on creditors committees; traded bonds on inside informationtraded bonds on inside information

–Barclays paid over $10.9MM in settlement

• full disgorgement of $3,971,736

• prejudgment interest of $971,825

• civil penalty of $6MM

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Trading by Other Securities Professionals– SEC v. Aragon Capital Management LLC, et al. (SEC Lit.

Rel. 19995A, Feb. 13, 2007)

• pharmaceutical company exec tipped three sons, all pharmaceutical company exec tipped three sons, all Wall Street accountants or lawyers

• family members prosecuted criminally

– SEC v. Heron (SEC Lit. Rel. 20079, Apr. 18, 2007)

• general counsel/chief insider trading compliance officer traded ahead of announcementstraded ahead of announcements

• SEC seeking disgorgement, penalties and bar order

• criminal prosecution

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criminal prosecution

DEFINITION OF INSIDER TRADING

• Section 10(b) of Exchange Act and Rule 10b-5 generally prohibit securities fraud

• Insider trading is use (or possession) of material non-public information in the purchase or sale of securitiespurchase or sale of securities

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Definition of Materiality

–“substantial likelihood” that a reasonable investor would have considered information “important” in making investment decision or as making investment decision or as

–“significantly altering” the total mix of available informationinformation

Basic v. Levinson, 485 U.S. 224, 231 (1988); TSC Indus. V. Northway, 426 U.S. 438, 449 (1976)Indus. V. Northway, 426 U.S. 438, 449 (1976)

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Examples of Material Information– Mergers, acquisitions and significant asset sales

– Earnings reports, especially if over/under street expectations

Capitalization events (secondary offerings PIPEs stock splits)– Capitalization events (secondary offerings, PIPEs, stock splits)

– Significant customer events (gain/loss of major contract)

– Significant business events (new products, price changes)

– Insolvency or defaults

– Changes in senior management

Significant labo disp tes– Significant labor disputes

– Significant regulatory developments (e.g., FDA approvals)

– Significant actual/threatened litigation

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Definition of Non-Public

–Insufficient time for the market to absorb the information (a day or two for a widely-traded company)company)

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Two Theories of Insider Trading Liability

–Classical: breach of duty of confidence owed to the corporation. Dirks v. SEC, 436 U.S. 646 (1983)(1983)

–Misappropriation: misappropriates confidential information to in breach of duty owed to the information to in breach of duty owed to the source. U.S. v. O’Hagan, 521 U.S. 642 (1997)

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SANCTIONS FOR INSIDER TRADING

Civil Sanctions

–Injunction

–Disgorgement of gain or loss avoidedDisgorgement of gain or loss avoided

• tipper can be held liable with tippee

Ci il lt t 3 di t–Civil money penalty up to 3x disgorgement

• tipper can be penalized for tippee’s trades

–Industry bar

–Director and officer bar

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Civil Money Penalties

–SEC usually willing to settle for 1x penalty

–SEC will impose higher penalty if:SEC will impose higher penalty if:

• conduct is particularly egregious

d f d t i l d i ti t• defendant misleads investigators

• defendant conceals or disguises trading

• defendant is a recidivist

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SEC v. Smith, et al. (SEC Lit. Rel. 20306, Sept. 27 2007)27, 2007)

–Investment banker at BAS told father (broker); father traded, but son did notfather traded, but son did not

–Father and son ordered to pay $818,000

• father ordered to disgorge profit of $204 476 • father ordered to disgorge profit of $204,476

• son ordered to pay civil penalty of $204,476

f th d d t i il lt f • father ordered to pay civil penalty of $408,952 for creating false documents to mislead SEC

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Criminal

–SEC works closely with DOJ to jointly prosecute insider trading cases

• 13 criminal indictments in Morgan Stanley trading ring

• June 27, 2007, three former Countrywide Financial execs pled guilty to criminal insider trading chargesexecs pled guilty to criminal insider trading charges

–Post-SOX, if charged as wire or mail fraud, maximum sentence of 20 years per count maximum sentence of 20 years per count (Sarbanes-Oxley Act section 903)

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INSIDER TRADING IS A “NO FLY ZONE”• SEC has zero tolerance for insider trading

– SEC v Blackwell (SEC Lit Rel 17944 Jan 21 2003)SEC v. Blackwell (SEC Lit. Rel. 17944, Jan. 21, 2003)

• trader made only $4,317.01

– SEC v. McKay (SEC Lit. Rel. 20314, Sept. 28, 2007)SEC v. McKay (SEC Lit. Rel. 20314, Sept. 28, 2007)

• McKay traded and tipped two siblings

• total combined profits of only $11,416p y $ ,

• Low threshold for criminal prosecution– Countryside Financial executives indicted for profits of Countryside Financial executives indicted for profits of

only $48,000, $36,000 and $20,000

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INTERNATIONAL REACHSEC will prosecute insider trading affecting US markets, no matter where trades are placed

– SEC v. Sonja Anticevic: Croatian resident traded through Croatian accts (SEC Lit. Rel. 19327, Aug. 5, 2005)

– SEC v. Purchasers of Petco Options: trades placed in UK brokerage houses (SEC Lit Rel 19778 July 27 2006)brokerage houses (SEC Lit. Rel. 19778, July 27, 2006)

– SEC v. Purchasers of TXU Corp. Options: trades purchased through Swiss, German and UK accounts (SEC Lit. Rel. 20028, March 2, 2007)a c , 00 )

– SEC v. Kan King Wong, et al.: Hong Kong residents traded through Hong Kong branch account (SEC Lit. Rel. 20106, May 8, 2007)

– SEC v. Jennifer Xujia Wang, et al.: trades in online brokerage acct of Beijing resident (SEC Lit. Rel. 20112, May 10, 2007)

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SEC INVESTIGATIONS & TOOLS

Market Surveillance– SROs (e.g., FINRA, AMEX) constantly surveil trading

markets

– SEC’s Office of Market Surveillance monitors marketsSEC s Office of Market Surveillance monitors markets

– E.g., Petco Animal Supplies (SEC Lit. Rel. 19778, July 27, 2006)

• July 14, 2006 Petco announced acquisition. During preceding three weeks, trader in London purchased options and derivatives from Swiss financial institution and UK brokerage houses brokerage houses.

• SEC sued July 18th (four days after announcement) against “one or more unknown purchasers of call options for the common stock of Petco Animal Supplies”

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co o stoc o etco a Supp es


Bounty Program

–SEC operates a bounty program through which it can award up to 10% of any penalty

–http://www.sec.gov/divisions/enforce/insider.htm

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Vigorous and Creative Investigation

–SEC Enforcement Director testimony to the US Senate (Sept. 26, 2006):“our staff has become particularly adept at sifting through all available forms of evidence, including phone records, emails, instant messages, and the electronic footprints of internet protocol data. Our staff culls through trading records, interviews and takes the testimony of witnesses, and reviews bank and brokerage statements With these tools and and brokerage statements. With these tools and resources, our staff has built solid, creditable enforcement actions against hundreds of wrongdoers.”

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• Intrusive Investigations– SEC may demand all emails within timeframe

• Captious Investigations– SEC wants to catch trader in a lie

– SEC and SROs will cold call traders while several staff members take notes

– Politely decline to respond to cold call and explain that your attorney will return the callyour attorney will return the call

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SRO INQUIRIES

• SRO will request chronology, list of people who h d d k l d d ill i hhad advance knowledge, and will require those people to identify traders they know

Responses to SRO inquiries should be thorough • Responses to SRO inquiries should be thorough and careful

• Incomplete or incorrect responses will put • Incomplete or incorrect responses will put company in bad light

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AREAS RECEIVING SPECIAL SCRUTINY• Hedge Funds

– SEC created hedge fund working group to coordinate and SEC created hedge fund working group to coordinate and enhance efforts to combat hedge fund insider trading

– SEC working with other federal law enforcement agencies and SROsand SROs

• 10b5-1 PlansP id f d t d t ifi d i – Provide for pre-arranged trades at specified prices or dates

– Executives using 10b5-1 plans outperform peers by 6%

– SEC suspects misuse of 10b5-1 plans to facilitate trading on inside information

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PUBLIC COMPANIES SHOULD PROTECT MATERIAL NON-PUBLIC INFORMATION

• Comply with listing requirements (eg, NYSE Listed Company Manual Sec. 202.01)

• Create and implement insider trading policies and procedures to protect the company’s own and its clients’ material non-public informationclients material non-public information

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PUBLIC COMPANIES SHOULD PROTECT MATERIAL NON-PUBLIC INFORMATIONMATERIAL NON-PUBLIC INFORMATION

Key aspects of insider trading policies

– Clear written policies prohibiting insider trading

– Blackout periods for corporate insiders

– For major transactions:

• restrict access to information

document who has access• document who has access

• require recipients to acknowledge insider trading prohibition

– Compliance Officer implements and monitors policiesp p p

– Periodic training on risks of insider trading

– Foster “need to know” culture for sensitive information

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PUBLIC COMPANIES SHOULD PROTECT MATERIAL NON-PUBLIC INFORMATIONMATERIAL NON PUBLIC INFORMATION

Key aspects of insider trading policies– Establish IT firewalls to limit access to sensitive

information

– Require Compliance Officer pre-clearance of Require Compliance Officer pre clearance of officer/director trading in company stock

– Encourage use of 10b5-1 plans, with restrictions on making changesmaking changes

– Monitor trading in company stock

• investigate unusual trading activity

• consider immediate public announcement if unusual activity detected

– Adopt a zero tolerance policy for insider trading

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– Adopt a zero tolerance policy for insider trading

BROKERS AND INVESTMENT ADVISERS

• BDs and RIAs must have and enforce effective li ipolicies

• BDs and RIAs required to“establish, maintain, and enforce written policies and

procedures reasonably designed, taking into consideration the nature of their business, to prevent the misuse of material, nonpublic information by them or any person associated with them.” Exchange Act section 15(f); Investment Advisers Act section 204A.

• Policies and procedures must be closely tailored to specific risks and must monitor and enforce compliance

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and enforce compliance

BROKERS AND INVESTMENT ADVISERS• In the Matter of Gabelli & Co. - $50,000 penalty each for broker and adviser

• In the Matter of Wyser-Pratte, et al.: $400,000 penalty (Admin. Proc. File 3-10479, May 9, 2001)

• In the Matter of DePrince, Race & Zollo, Inc.: no monetary In the Matter of DePrince, Race & Zollo, Inc.: no monetary penalty (Admin. Proc. File 3-10798, June 12, 2002)

• In the Matter of Gintel Asset Management, Inc., et al.: $275 000 total penalties for all defendants (Admin Proc File $275,000 total penalties for all defendants (Admin. Proc. File IA-2079, Nov. 8, 2002)

• In the Matter of Goldman, Sachs & Co.: $2.5MM di t $5MM lt (Ad i P Fil 3 11240 disgorgement; $5MM penalty (Admin. Proc. File 3-11240, Sept. 4, 2003)

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• In the Matter of Greenfield, et al.: $150,000 penalty (Admin. Proc File 3 12098 Nov 7 2005) Proc. File 3-12098, Nov. 7, 2005)

• In the Matter of Morgan Stanley & Co., et al.: $10MM penalty (Admin. Proc. File 3-12342, June 27, 2006)

• SEC v. Friedman, Billings, Ramsey & Co., Inc.: $3.75 disgorgement and penalty (SEC Lit. Rel. 19950, Dec. 20, 2006))

• In the Matter of Banc of America Securities LLC: $10MM disgorgement; $6MM penalty (Admin. Proc. File No. 3-12591, March 14 2007)March 14, 2007)

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BDs and RIAs must:

–Identify specific risks that they or employees will abuse non-public information

–Design written policies and procedures to address those specific risks

–Design and implement systems to monitor compliance with policies and procedures

–Enforce compliance

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BEST PRACTICES

• Institutions must develop, monitor and enforce ff i i id di li ieffective insider trading policies

• Employees should follow a very simple rule – what happens at the office stays at the officehappens at the office stays at the office

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MITCHELL E. HERR

• Practice concentrates in securities litigation, primarily the defense of SEC enforcement matters, securities class actions and internal corporate investigations. matters, securities class actions and internal corporate investigations.

• Joined Holland & Knight in December 2000, after serving for over five years as the chief trial counsel for the SEC’s Southeast Regional Office where he was responsible for the SEC’s litigation in eight states and two territories.

• Since joining Holland & Knight, Mr. Herr has handled numerous SEC enforcement matters and internal corporate investigations Mr Herr has represented public matters and internal corporate investigations. Mr. Herr has represented public companies, broker-dealers, registered investment advisers and associated persons, municipal issuers and bond counsel, accountants, and others concerning a variety of subjects.

• Honors and Awards• Elected by peers to The Best Lawyers in America (2006, 2007 and 2008 eds.).

Additionally, in 2005, 2006 and 2007 he was recognized as a Top Lawyer in the field of Securities Litigation in the South Florida Legal Guide; in 2006 and 2007 he was recognized as a Florida Super Lawyer; he also was named by Florida Trend magazine in 2005, 2006 and 2007 as a member of Florida's Legal Elite; in 2006 he was selected as a finalist in the South Florida Business Journal's Key Partners competition.y p

• Education• Earned B.A. degree summa cum laude from Dickinson College, Carlisle, Pennsylvania,

in 1978, where he was elected to Phi Beta Kappa in his junior year and was awarded a three-year Army ROTC full-scholarship. Received J.D. cum laude from the University of Chicago Law School in 1981 where he served as an Associate Editor of the Law

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of Chicago Law School in 1981, where he served as an Associate Editor of the Law Review and was elected to the Order of the Coif.

CONTACT INFORMATION

• Holland & Knight LLP0 i k ll S i 3000701 Brickell Avenue, Suite 3000

Miami, Florida 33131Tel. 305-374-8500Fax 305-789-7799

• Mitchell E. HerrDi di l 305 789 7736Direct dial [email protected]

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