Most public company executives and other employees are fully aware that the insider trading laws strictly prohibit trading in their company’s securities when they possess material non-public information concerning the company.
What public company employees may not be aware of, however, is that they may be the subject of an SEC investigation and civil or criminal enforcement action if--rather than trading themselves--they share that inside information with another person who then trades on that information. Take for example, Bill, a management-level finance employee who learns that his company is likely to miss its earnings guidance or the analysts’ consensus earnings estimate and, at a school play or cocktail party, Bill happens to confide this to his good friend Joe in response to a question of “how’s business”. Unbeknownst to Bill, his good friend Joe goes out and sells shares of that company as well as shorts some shares of Joe’s company. When the earnings miss subsequently becomes public, the company’s stock sinks and Joe makes a quick $10,000.
As everyone knows, Joe violated the federal securities laws and can be subject to both civil and criminal action for insider trading. His friend Bill is a company fiduciary and Joe took this confidential information and used it for his own economic benefit.
What many employees do not know is that Bill, the employee who passed this information on to his good friend Joe, also violated the federal securities laws and may likewise be the subject of an SEC enforcement action, even when he does not financially benefit from his friend’s trade (or perhaps even know about the trade). That is what happened in a recent federal district court case (SEC v. Gad (S.D.N.Y. 12/17/07)) involving Nathan Rosenblatt, a director and audit committee member of MBTY Inc.
According to the allegations, Rosenblatt as a director became aware that MBTY Inc. would have a significant shortfall in its quarterly earnings and he passed this information on to his friend, Morris Gad.
Rosenblatt neither bought nor sold any of his company’s shares. However, his friend Gad sold his entire position, as well as entered into derivative and short positions in the company’s stock, prior to the public release of the quarterly results, and Gad made about $400,000 between avoided losses and trading profits. The SEC brought an enforcement action against Gad for insider trading and Gad ultimately entered into a settlement with the SEC. The SEC also brought an enforcement action against Rosenblatt, the director of MBTY who did not trade or gain any direct economic benefit from his friend Gad’s trading. He may not even have been aware of Gad’s trading.
Nevertheless, because Rosenblatt “tipped” this important information to his friend Gad, who did profit from the news and such activity might be viewed as a “gift” of a non-pecuniary nature, Rosenblatt likewise was the subject of an insider trading action brought by the SEC in federal district court.
Citing the Second Circuit Court of Appeals 1998 decision in SEC v. Wade, the court concluded that the SEC need not prove that “tipper” expected or received a specific or tangible benefit in exchange for the tip, only that the tipper made a “gift” of confidential information to a relative or friend who in fact traded in the securities. “Tipping” material non-public information to family or friends is against the law and subjects an individual to potential SEC civil and/or criminal enforcement action. It also paints the company in a terribly poor light (and, under the Insider Trading Act of 1988, might potentially subject the company itself to liability).
The SEC staff continues to be extremely vigilant concerning insider trading, even when amounts far less than claimed in this case are involved. Education of employees concerning the problems associated with passing on important company information is crucial. It is important that all executives and employees know that they too could be the subject of a career-ending SEC enforcement action for tipping company information to others, even where the executive or employee receives no direct benefit.