Shortly before his recent departure, former Deputy Attorney General Rod J. Rosenstein stated that the Department of Justice was "fighting corporate fraud and white collar crime with energy and resolve." In 2018, the DOJ increased white collar prosecutions over the prior year, charging more than 6,500 defendants. Health care fraud, criminal use of cryptocurrecy, foreign bribery, and corporate accountability for the opioid epidemic remain mainstay priorities for the DOJ, but so does policing the integrity of capital markets as shown by a pair of recent convictions from Chicago and New York that involved tipper and tippee theories of insider trading.
On April 17, 2019, a federal jury in Chicago convicted a defendant for one count of conspiracy to engage in insider trading related to a Minnesota-based company, Life Time Fitness, Inc., which owned a chain of fitness centers in the United States and Canada. Life Time's common stock was traded on the New York Stock Exchange and options in its stock were traded on the Chicago Board Options Exchange. According to the indictment, Life Time's vice-president of corporate sales learned that the company was in advanced acquisition negotiations with several private equity firms and shared this information with a longtime friend and business partner who, in turn, shared the information with others. The coterie agreed to execute financial trades and to share the profits along with the Life Time Fitness insider who provided the material, non-public information.
From February 25, 2015 to March 3, 2015, the defendants purchased hundreds of call options in Life Time Fitness stock. On March 5, 2015, Life Time's share price was $57.67. After markets closed trading for the day, the Wall Street Journal published an article regarding the acquisition discussions. On March 6, 2015, the share price increased to a high of $69.13. On March 16, 2015, Life Time Fitness issued a press release announcing that two private equity firms were purchasing all of Life Time Fitness's shares for $72.10 per share.
Nine defendants were charged with conspiracy to engage in insider trading and insider trading. Five defendants pleaded guilty to conspiracy, while three others entered into deferred prosecution agreements after admitting to their roles in the conspiracy and cooperating with the government. The remaining defendant-tippee was convicted for his participation in the insider trading conspiracy.
In New York on April 26, 2019, a Standard and Poor's (S&P) credit ratings analyst was convicted of insider trading after a seven-day trial. During an assignment for S&P, the defendant learned that a company had a planned, but unannounced, acquisition of another corporation. Despite reviewing and certifying a duty of loyalty and confidentiality to S&P and its clients, the defendant misappropriated information about the acquisition and passed it to his friend and his hairdresser so that they could use it to make profitable trades in stock of the company being acquired and options. On March 21, 2016, the first trading day after the public announcement of the acquisition, the price of acquired company's stock increased approximately 23 percent over the prior day’s close.
Armed with this material nonpublic information, the defendant's friend opened a brokerage account on March 13, 2016, and shortly thereafter purchased 480 shares of the acquired company's common stock. On March 18, 2016, the last trading day before the acquisition was publicly announced, he purchased 75 call options and made approximately $106,806 in profits.
Similarly, from March 10, 2016, through March 18, 2016, the defendant's hairdresser bought 8,630 shares of stock in the acquired company and made approximately $192,080 in profits when he later sold them. The hairdresser later paid the defendant a kickback for the lucrative tip.
Both the defendant's friend and hairdresser pleaded guilty before trial. In June 2016, the Financial Industry Regulatory Authority ("FINRA") sent S&P a list of individuals and entities that had traded in the company's stock in advance of the public announcement of the acquisition. S&P forwarded the list to its employees who had worked on the acquiring company's rating, including the defendant. The defendant denied having a relationship with anyone on FINRA's list despite the fact that both his friend and hairdresser were named on it.
Tipper & Tippee Insider Trading
The Securities Exchange Act of 1934’s section 10(b), bans the “use . . . in connection with the purchase or sale of any security . . . [of] any manipulative or deceptive device.” Insider trading is willfully buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material nonpublic information.
The Chicago and New York convictions reaffirmed the standard for tipper and tippee insider trading liability. In Dirks v. SEC, the Supreme Court established that "[n]ot only are insiders forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage, but they may not give such information to an outsider for the same improper purpose of exploiting the information for their personal gain." There, the Court held that, in order to determine whether a tipper breached his fiduciary duty, the relevant inquiry is "whether the insider personally will benefit, directly or indirectly, from his disclosure." The Court stated that while a personal benefit could include pecuniary gains or reputational benefits that later result in future earnings, a breach may also occur when the tipper provides information to a trading relative or friend. A breach can occur when an insider "makes a gift of confidential information to a trading relative or friend," as the "tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient." Furthermore, the Court stated that a tippee is equally culpable if he knows or should have known about the tipper's breach.
Thirty-three years later, in Salman v. United States, the Supreme Court unanimously reaffirmed Dirks in a case involving an investment banker who made a gift of material, non-public information to his brother. Both traded on the information and passed it along to others, including investment banker's brother-in-law. The Court stated that "when a tipper gives inside information to a trading relative or friend, the jury can infer that the tipper meant to provide the equivalent of a cash gift." The Court further observed that while Dirks held that the mere "disclosure of confidential information without personal benefit is not enough," Dirks also squarely held that a "personal benefit can often be inferred from objective facts and circumstances . . . such as a relationship between the insider and the recipient that suggests a quid pro quo from the latter . . . [or] when an insider makes a gift of confidential information to a trading relative or friend."
Here are five takeaways from the most recent insider trading convictions based on tipper and tippee insider trading liability in Chicago and New York:
- The DOJ, SEC, CFTC, and other federal market regulators will continue to prioritize securities, commodities, and investment fraud to ensure fair prices and build confidence in the securities marketplace. Legislators are also prioritizing enforcement. On May 7, 2019, Representative James Himes of Connecticut, a member of the House Financial Services Committee, introduced H.R. 2534, the "Insider Trading Prohibition Act," which seeks to amend current laws on insider trading to "end decades of ambiguity for a crime that has never been clearly defined by law."
- "Tippees," or those to whom insiders or misappropriators have provided material, nonpublic information, will continue to be the subject of federal enforcement actions. Agencies like FINRA will be monitoring transactions related in time and size to notable mergers and acquisitions.
- Understanding and navigating the concept of a "fiduciary duty" remains essential, particularly in the context of tippers and tippees where an insider can "gift" confidential information to a trading relative or friend.
- DOJ policies create incentives for corporate and individual cooperation, remediation, and compliance as shown by the three deferred prosecution agreements allowed by the U.S. Attorney's Office in Chicago.
- Publicly traded companies must prioritize the exercise of greater vigilance and monitoring of their most sensitive deals to strengthen confidentiality and lay the foundation for a faithful and trustworthy conclusion.