As we reported in 2013, the U.S. Court of Appeals for the Seventh Circuit left open the possibility that insider trading prohibitions may apply to trading in mutual fund shares, and remanded the case to the district court to determine whether the insider’s alleged conduct properly fit under the misappropriation theory of insider trading. Now the district court has weighed in and declined to extend the misappropriation theory to the insider trading claim in the case because the theory was never raised with the court. (Securities and Exchange Commission v. Bauer, U.S. District Court, E.D. Wisconsin, Aug. 29, 2014) This result should allow mutual fund chief compliance officers to breathe a little sigh of relief.
The court noted in dismissing the allegations and counts that there is no authority to extend the misappropriation theory to a corporate insider trading mutual fund shares, and that it was not aware of any authority extending the misappropriation theory to a situation where the insider was a corporate insider at all times. Expressing further doubt about the application of insider trading theories to mutual funds, the court stated that no court has addressed whether insider trading theories apply to mutual fund redemptions, and that the SEC has never brought a claim under Section 10(b) in the mutual fund context.
Key Take Away: The SEC remains focused on insider trading.
While the SEC may not be inclined to bring another insider trading case related to trading in mutual fund shares in the near future, the SEC will not hesitate to bring an insider trading case related to trades by insiders related to portfolio securities. So, be extra vigilant in developing and adhering to insider trading policies.
Items like a fund freezing redemptions and selling off portfolio securities at discounted prices to generate cash are most likely material to investors, and care should be taken to disclose such material information to shareholders on a timely basis.