With the holidays underway, and as celebrations with family and friends are filling the calendar, we take this opportunity to wish you a happy holiday season and to encourage you to talk about something other than nonpublic work news during your festivities. This is not a new topic: we first cautioned about the perils of sharing nonpublic work information with friends and family in August 2011, and then again during the holiday season in late 2011. In just one more year, several enforcement cases provide additional reminders that we should all be vigilant in protecting our clients’ information, as well as in protecting our family and friends from temptation.
Headlines about insider trading may seem to focus on rings of friends or family members who intentionally tip each other and conspire to avoid detection.1 But as the cases discussed below demonstrate, corporate officers, directors, advisors and others can end up in the midst of a government insider trading investigation if they simply share (or if the government believes they shared) confidential information with friends or family members who then trade in securities. Whether sharing exciting new career developments, venting about the stresses of an important project, or just sharing seemingly innocuous information to make conversation, accidental tippers continue to appear in SEC enforcement cases.
Even Old Friends Can Be Tempted. Even some of the most seasoned business professionals and the most trusted of friends can sometimes misappropriate nonpublic information if details are revealed obviously and repeatedly. This year a chief executive officer of a public company was confronted publicly with that possibility when the SEC filed an enforcement action against his friend of over 30 years — a friend so close the CEO had named him executor of his estate.2 The SEC’s complaint alleges that, over the years, the two had worked together at several companies and in recent years had maintained a weekly tradition of dinner and drinks on Friday evenings. They shared confidential information with each other, “including information concerning their health, individual investments, investment strategies, and retirement planning, which information was expected to be and was maintained as confidential.”3
In late 2009 and early 2010, the CEO’s company proceeded through merger negotiations with Manpower, Inc. According to the SEC, during that period, the CEO openly conducted the confidential business in his friend’s presence and “reasonably expected” that the friend “would refrain from disclosing or otherwise misusing the confidential information.”4 This included conducting deal-related calls during their weekly dinners and during a sailing vacation the two took together, taking merger-related documents on the sailing trip without concealing them from the friend, and potentially telling the friend outright the details of the transaction as the contract documents were being finalized in late January 2010.
During this period, the SEC alleges, the friend used the information he obtained about the upcoming deal to trade multiple times in the CEO’s company’s securities. According to the SEC, in late January, the friend even converted his own 401(k) account into a self-directed account in order to buy more shares, ultimately compiling 71,822 shares with a value of $950,000. On February 1, 2010, Manpower publicly announced the merger agreement and a planned tender offer. After the deal was announced, the friend allegedly made profits of $511,580 from his trading.
The SEC did not charge the CEO, noting “the nature of their relationship,” the friend’s awareness of the CEO’s restrictions and prohibitions against insider trading, and the friend’s “general understanding of the restrictions and prohibitions against insider trading.”5 But while the CEO apparently fully expected his friend not to trade — and may even have directly told him not to trade at some point — the friend is litigating this case, so the two men will continue to endure the time, cost, scrutiny, and embarrassment of an SEC enforcement action for some time. This serves as a good reminder to conduct calls and perform deal-related work in privacy.
What’s New With You? Being too forthcoming about exciting new developments in your own, or even your spouse’s, career can also lead to unexpected problems. One Massachusetts man became enmeshed in an SEC investigation, for example, by allegedly divulging nonpublic information about his spouse’s work to a longtime friend. The man’s spouse worked as an executive at Art Technology Group, Inc., with “access to high level, confidential and sensitive information relating to the business of Art Technology,” which the friend allegedly knew.6 While the Massachusetts man and his friend were together for a social occasion on the evening of Saturday, October 30, 2010, “in the context of a discussion of personal matters,” the SEC alleges that the Massachusetts man communicated to his friend “the material non-public information about an imminent acquisition of Art Technology.”7
According to the SEC’s complaint in this settled action, in which the friend neither admitted nor denied the SEC’s allegations, the next Monday morning, the first business day after their conversation, the friend purchased 24,400 shares of Art Technology at the market price of $4.14 per share. Prior to the market open the following day, Art Technology announced that Oracle Corporation had agreed to buy the company for $6.00 per share. The friend then held the shares until Oracle completed the acquisition, and he received cash for his shares, earning $44,268 in profits. Pursuant to the settlement, the friend consented to an injunction and an order requiring him to pay disgorgement of $44,268, prejudgment interest of $365, and a civil penalty of $44,268.8
While the Massachusetts man and his spouse — the sources of the information — were not charged, their lives undoubtedly were interrupted by the stress and apprehension of participating in the SEC’s investigation of the case. It can be very difficult to connect with friends and family members while not being able to share information they might expect would be easy to share. Even so, no matter how excited or concerned you are about an as-yet-unannounced development in your own or your spouse’s career, this case serves as a good reminder to keep that news under wraps until it has been announced publicly.
Keep Your Guard Up. A case that reached the Second Circuit this year and remains in litigation began in 2001 when an assistant vice president and underwriter at General Electric Capital Corporation spoke with a college friend about a company.9 According to the SEC, the assistant vice president was assigned to conduct due diligence on SunSource, Inc. after GE Capital was approached to finance a potential purchase of SunSource. Each page of that transaction’s deal book was marked “Extremely Confidential,” and the assistant vice president had reviewed and annually signed a GE Capital employee code of conduct requiring information about upcoming deals to be kept confidential. Nevertheless, the SEC alleges, when the assistant vice president realized that a college friend worked for a hedge fund manager with a large position in SunSource stock, he called to ask the friend’s opinion on SunSource’s management. The friend claims that he deduced from the assistant vice president’s questions and from SunSource’s recent public actions that a transaction was being considered. The friend allegedly passed the information on to his supervisor at the hedge fund manager, and the supervisor then contacted SunSource’s CEO and communicated his hope that SunSource would not enter a deal that would dilute shareholders. When the supervisor hung up with the SunSource CEO, the SEC claims the friend became “ashen” and “upset,” saying, “[W]hat are you doing? … You realize, you know, my friend is going to be fired.”10
According to the SEC, about two weeks later, the hedge fund where the friend worked and for which the supervisor was principal purchased 287,200 shares of SunSource for $4.75 per share, representing about five percent of SunSource’s outstanding shares at the time. Eleven days later, a deal was announced under which SunSource would be purchased for $10.38 per share. A multi-year SEC investigation followed, and GE Capital conducted its own internal investigation. In 2006, the SEC sued the assistant vice president, the friend, and the friend’s supervisor.
The trial court dismissed the case against the assistant vice president, the friend, and the supervisor in 2010.11 But the Second Circuit heard the SEC’s appeal this year and reversed the trial court’s decision, sending the cases against all three defendants back for trial, partly over issues of whether the assistant vice president misappropriated nonpublic information about the merger by passing that information to his friend. GE Capital’s internal investigation had concluded that Strickland made a mistake, but not one that merited firing him. Based on the investigation’s conclusions and related testimony from a GE Capital representative, the trial court had decided Strickland breached no duty to GE Capital. As the alleged victim of the breach, GE Capital did not even consider itself a victim, the trial court reasoned.12 The Second Circuit, however, held that GE Capital’s investigation was not dispositive, noting that the investigation had relied on limited evidence and was aligned with GE Capital’s corporate interests, which “may or may not coincide with the public interest in unearthing wrongdoing and affording a remedy.”13 The Second Circuit also reiterated that liability for tipping can arise where the tipper merely meant to confer a gift of information to a friend (and where the tipper never received any kickback or other tangible benefit). Here, the undisputed fact that the two were college friends was enough to create a question for a jury trial, the appeals court stated.
In cases like this, the SEC often builds its case based on circumstantial evidence, such as the timing and length of phone calls. If a case is not decided at the summary judgment phase, then litigation expenses will continue increasing, as a jury decides whether sufficient evidence exists to support the SEC’s allegations. The SEC and the two friends in this case still dispute whether the assistant vice president affirmatively tipped his friend about a pending merger or whether he simply told the friend that GE Capital was potentially doing business with SunSource. A jury may now decide the answer to that question. It seems likely that the friends would now prefer that the conversation, whatever it entailed, had never occurred.
Anonymous, Maybe, But Not Confidential. Unfortunately, even circumstances in which one would expect disclosing confidential details would be accepted and respected may give rise to insider trading liability. According to the SEC, the confessions of one senior executive of Philadelphia Consolidated Holding Corp. about the pressures he was confronting at work led a fellow Alcoholics Anonymous attendee to trade on that information.14 The fellow AA member then allegedly tipped a colleague, who passed the information to a series of people in what led the SEC this year to charge five individuals for insider trading violations and four others as relief defendants.
The SEC’s complaint alleges that the senior executive first met the fellow AA member in 1999, when the two attended the same AA meeting. As part of participating in AA, members are asked to abide by a policy of anonymity called the “Twelfth Tradition” that aims to encourage participants to speak with each other before, during, and after AA meetings. Confidentiality is also underscored at each meeting, as participants are reminded “what is discussed here stays here.”15 The senior executive gravitated to his fellow AA member because of their similar career, family, and athletic backgrounds, and because the fellow member had a “long, successful history of sobriety.”16 The two remained close during the ensuing decade. The fellow AA member stated multiple times that the senior executive “could confide anything to him.”17 As the sale of the senior executive’s company was nearing completion in early July 2008, he confided in the fellow AA member that his company was being sold and that stress of the negotiations had affected his ability to remain sober. The fellow member probed about details of the transaction and learned the identity of the acquirer, the general price of the deal, and plans for operations after the transaction.
The fellow AA member, who worked as a registered representative, allegedly bought stock in the senior executive’s company both on margin and by selling other securities, realizing profits of $292,128 from his trades. The SEC alleges that he also tipped a colleague, who traded in his own account, as well as those of his wife, sister, mother, and grandmother, and that the colleague tipped his father and a friend, who then tipped other friends. The SEC’s complaint alleged that the colleague, his family, and his tippee friends made more than a combined $1.5 million from their trades. Although part of this case has settled, much of it remains contested.
Again, here the senior executive was not charged for his role as the unwitting original tipper. But avoiding personal liability was likely cold comfort for the senior executive, who must still in 2012 endure the ramifications of trades that occurred in 2008, apparently without his knowledge but allegedly as a result of his confessions in what he believed was a safe place. This case shows just how far material nonpublic information can spread if it is shared with someone willing to take advantage of it. It also shows that nonpublic information does not have to be pitched as exciting news to entice others to use it for trading purposes.
Conclusion. Generally speaking, to allege tipping, the SEC must be ready to prove: that the tipper was in possession of material, nonpublic information; that the tipper had a duty to keep that information confidential; that the tipper communicated that information to a tippee, intending to benefit personally by giving the tip; and that the tippee traded and/or tipped others to trade.18 The law holds tippers jointly and severally liable with their tippees (both direct and indirect) for the amount of the tippees’ profits or avoided losses resulting from the tip.19 The tipper may also be charged interest on that amount and fined up to three times the disgorgement amount.20 Often, defendants settle with the SEC for a penalty equal to the disgorgement amount.21
Even “accidental tippers” can suffer years of negative consequences if their friends and family trade in securities. In our previous articles, we warned that the SEC builds its cases on circumstantial evidence, meaning that investigations often delve into the private and personal lives of the people involved. These disruptions may last for multiple years. In most of the cases above, the SEC did not file charges against individuals until 2012, even though the trades at issue were conducted in 2008, 2009, or 2010. Even worse, the SEC’s extended litigation against the college friends and the hedge fund supervisor centers on trades conducted in 2001, while the SEC did not bring its enforcement action until 2006.
A quick reminder of some basic things to remember during the holidays:
- Take precautions to keep confidential documents away from prying eyes, including limiting access to laptops, tablets, and smart phones that may contain sensitive documents.
- Emails and calendar entries can sometimes convey enough to entice someone to trade illegally, so they should be password protected and kept away from others’ access.
- Working remotely provides great advantages, but be careful to conduct nonpublic business in private places.
These cases show that even repeated cautions not to trade are sometimes insufficient to persuade people from using the low-hanging fruit represented by nonpublic information disclosed to them. At the end of the day, it is true that the SEC may decide not to bring charges against the original source of leaked nonpublic information. But watching your friends and loved ones dealing with a government investigation, enduring it yourself, and perhaps even being charged, is hardly a satisfying result. Nonpublic information is not the kind of holiday gift you want to give your friends and family this holiday season.