Securities Alert
November 2009
Authors: Steven D. Feldman
The F.B.I. and Securities and Exchange Commission are focusing on insider trading among financial industry professionals—hedge fund traders, analysts, stock brokers and company insiders. The cases focus on industry professionals who use a network of industry contacts to gather information on a company. Potentially, a trader may come across a piece of problematic information when building a big picture mosaic about the company. In these situations, ignorance of the basic rules can expose you or your company to monetary and criminal liability. You build your overall assessment of an investment with many pieces of information. What if one out of a hundred constitutes insider information? Below, we look at certain "grey areas" of the law to help you avoid crossing the line.
When a rumor is already public, you may still be at risk.
Picture the following scenario: a major publication releases news that a potential takeover of Company A may be in the works and could even be imminent. Obviously, you can trade on this information since it is available to the general public. The night of the publication's release, you get a phone call from a friend who works at Company A telling you that the takeover is likely to occur. You might think to yourself that this isn't inside information since the rumor is already public knowledge and the phone call simply confirms this.
But you would have been better off if your friend had never called you, because now you may be breaking the law if you make that trade. While the law provides an "escape clause" for traders where the information has already been "publicly disclosed by the press or otherwise," public disclosure won't relieve a trader from liability if he or she in fact trades on material, non-public information (i.e., the confirmation phone call). In United States v. Mylett, a Wall Street Journal report speculated about a possible takeover of NCR Corp. by AT&T. After the article was published, an insider told an investor that the news story was accurate but the deal was still "contingent and speculative." This investor traded on the information. The court found the investor guilty of insider trading, concluding that the information provided by the source was non-public since it was "substantially more specific than in the newspaper" and would make a reasonable investor less likely to believe that "nothing" would happen. So the courts consider any such non-public information which is likely to make someone more confident in the truth of a rumor to be inside information—and trading on this information can be a crime.
Materiality: Can a drop of insider information change the color of the entire picture?
You've crossed the line between rumor and insider trading only if the information you received is "material." What does this mean? Courts use what's called the "total mix" test—there must be a substantial likelihood that a reasonable investor would view the "inside tip" as having altered the "total mix" of information available. In other words, without that "inside tip" the investor's opinion of the stock would be different and he would most likely not trade it. For example, in the course of her research an analyst may stumble upon a small bit of non-public information that she takes into account in making her recommendation. While she may believe this information is harmless given the amount of information she has collected, the courts may disagree. The courts believe that if a "reasonable investor" would find this bit of information important enough to alter the total picture in some way, then the information is material. And if you trade on it, you've broken the law.
The source of information is also important in determining whether a bit of information is "material." For example, one court noted that "[t]he fact that the information comes from an executive, who worked twenty-three years at Burlington and who was privy to the company's confidential information, heightens the credence a reasonable shareholder would attach to such information." In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3d Cir. 1997).
Finally, the specificity of the statement is crucial. While there is no definitive test, the following lists provide examples of pieces of information and how courts view them:
|
Material & Non-Public Inside Information |
Immaterial |
|
·Information regarding a meeting between a potential target company and bidder.
|
·Information from an insider about a company's mere intention to pursue a merger at some time in the future, prior to any contact with potential suitors and absent any evidence of an interested suitor.
|
|
·A company vice president's "speculative" prediction of an acquisition by his company.
|
·An assistant comptroller's estimate of year end earnings that was 2% lower than the company's announcement ten days earlier.
|
|
·The dissemination of bookings data for a company.
|
·A corporate spokesperson's disclosure to an outsider that preliminary earnings statements for the company will be coming out in a week.
|
|
·When asked if earnings for the 2nd quarter will be down, a corporate spokesperson tells the questioner that there is a good possibility and to keep the information confidential.
|
·A forecast that future sales and revenue would not be as good as in the past.
|
What this means to you:
For financial institutions: Hedge funds, investment advisors or any other financial services firms must ensure that their insider trading compliance programs are robust and active so that they are insulated from employees' illegal actions. Does your company provide an annual insider trading training class to your employees? Does your company enforce its insider trading policy? If you become aware of a suspicious trade by an employee, do you investigate it thoroughly and self-report to the authorities? Do you record employees' business phone calls to compel compliance with your company's anti-insider trading policy?
For financial industry professionals: You must understand the "grey line" between permissible industry rumor and illegal inside information. When confronted with questionable information, always err on the side of caution and involve your compliance department and outside counsel if necessary. If the information seems suspect, it most likely is.
For more information please contact: Steven D. Feldman at (212) 592-1420 or sfeldman@herrick.com.
Copyright © 2009 Herrick, Feinstein LLP. Securities Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
 |
 |
 |
 |