The Absurdity of the Law on Insider Trading

Teaching about insider trading is always a pleasure.  The law in this area is ridiculous.  What seems to be insider trading may not be; what seems like it is often isn't.   Sometimes the facts of actual cases provide exam style questions that would otherwise seem almost too contrived to be real. 

This came up in connection with the SEC's action against a "group of friends, most of them golfing buddies" that alleged insider trading.  See SEC Charges Group of Amateur Golfers in Insider Trading Ring, Press Release 2014-134.  The complaint is here.  

In some ways, this is the usual fact pattern.  An insider allegedly tips information to others who then trade.  In this case, the information allegedly went from an insider to a "close friend" who then allegedly passed the information along to others.  

Nothing unusual about that except that the insider was not charged with insider trading.  As the press release stated: 

  • In a complaint filed in federal court in Boston, the SEC alleges that Eric McPhail repeatedly provided non-public information about American Superconductor to six others, most fellow competitive amateur golfers.  McPhail’s source was an American Superconductor executive who belonged to the same country club as McPhail and was a close friend.  According to the complaint, from July 2009 through April 2011, the executive told McPhail about American Superconducter’s expected earnings, contracts, and other major pending corporate developments, trusting that McPhail would keep the information confidential.      


There are a number of possibilities here.  The insider may have been viewed as culpable but the SEC did not charge him/her as a discretionary exercise.  If that is the case, the insider is the tipper and the "close friend" is the tippee.  Under Dirks, the insider must have benefited from the information.  If not, the tippee avoids liability. 

The other possibility is the application of the misappropriation theory. Misappropriation provides that insider trading can occur where the tipper gives out material non-public information in violation of a duty of trust and confidence.  When information is given to lawyer or investment bank or accounting firm, it is done with the expectation that the information will remain confidential.  As a result, the insider has done nothing wrong even if those individuals subsequently trade on the information.  The same is usually true where the insider gives the information to a spouse.  In general, one can reasonably expect that a spouse will not trade on material non-public information received from a husband/wife.  

This case, though, in an exam worthy fashion, involved an insider and a "close friend."  For misappropriation to apply, there would need to be a relationship of trust and confidence between the two individuals.  Even with a "close friend," however, there can be no automatic expectation that information will remain confidential.  Friendship connotes no single bundle of qualities, including the obligation to keep material non-public information confidential.  

In this case, therefore, insider trading will essentially come down to the strength of the friendship.  To the extent relying on the misappropriation theory, the SEC will presumably need to show, as a matter of fact, that both the insider and the "close friend" had an expectation of trust and confidentiality.  If this plays out the usual way, the insider will represent that it was and the recipient will represent that it was not.  

It is where the law has taken us.  An insider allegedly gives material non-public information to someone who trades on it and allegedly passes the information along to others.  Whether this is legal or illegal depends not on the unfair trading advantage obtained by those using the information but upon the degree of friendship possessed by the insider and recipient.  To the extent this is the applicable theory of insider trading, the busy enforcement attorneys at the SEC are not spending their time calculating trades and running down tips but are trying to figure out the strength of the friendship.  It is where the law (mostly driven by Supreme Court opinions) has taken us.    


Insider Trading and Another Argument Against Playing Golf

What is it about insider trading and golf?   

There was the KPMG partner alleged to have passed along tips at a "golf outing."  See SEC Charges Former KPMG Partner and Friend with Insider Trading, 2013-58 (individuals "communicated almost exclusively using their cell phones, although on at least one occasion London disclosed nonpublic information in the presence of others during a golf outing.").  Then there was the case in North Carolina where tips were allegedly made to a "golfing partner."  See SEC Charges Three in North Carolina With Insider Trading, Press Release 2012-193 (tip allegedly made to "friend and business associate" who allegedly "later tipped his golfing partner").   The complaint in that case is here.  There have been other examples.  See SEC v. Watson, Litigation Release No. 16648 (Aug. 9, 2000) (allegations that nonpublic information "tipped [to] two his friends and golfing partners").  

Which brings us to the most recent example.  Last week, the Commission announced that it had charged a "group of friends, most of them golfing buddies" with insider trading.  See SEC Charges Group of Amateur Golfers in Insider Trading Ring, Press Release 2014-134.  The complaint is here. The press release had this to say about trading on golf courses: 

  • “Whether the tips are passed on the golf course, in a bar, or elsewhere, the SEC will continue to track down those who seek an unfair advantage trading stocks,” said Paul G. Levenson, director of the SEC’s Boston Regional Office.  “Working with our partners in law enforcement, we are sending a message to all investors that insider trading does not pay.”  

So the SEC has made it clear that trading activities on the golf course will fall within its vigilent oversight.  Perhaps for some insiders, its better to changes sports to something more solitary.  Jogging anyone?  


Gender Equality and Insider Trading

Insider trading can occur where someone violates a duty of trust and confidence. In the corporate world, these duties are often set out in an express confidentiality agreement. The duties can, however, be explicit.

The duty can also arise in other circumstances. Anyone with a duty of trust and confidence may be guilty of insider trading if they trade on material non-public information in violation of that duty. A psychiatrist who learns something from a patient or a lawyer who receives details from a client both qualify. 

Even more interestingly the duty can also arise in the context of family relationships. Sometimes information is conveyed to a family member with an expectation that it will be kept confidential and not used as a basis for trading activity. Needless to say, family members typically do not sign confidentiality agreements with each other so the obligation is implicit rather than explicit. 

A duty of trust and confidence often is said to exist between a husband and wife. Moreover, with more women reaching important positions in the corporate world, it is increasingly likely that they will be the source of the material nonpublic information. This was in fact the case in two recent actions brought by the SEC

In both, one spouse allegedly "overheard" the business conversations of the other and used the acquired information to profit in the stock market. In each instance, it was the wife who held the relevant corporate position and the husband who traded on the information. In one case, the wife was a finance manager; in the other she was the senior tax director.

The release noted that this case, as well as others, involving a husband allegedly trading on material nonpublic information obtained from his spouse:

  • The SEC has brought other insider trading cases involving individuals who traded on material, nonpublic information misappropriated from spouses. For example, last year the SEC charged a Houston man with insider trading ahead of a corporate acquisition based on confidential details that he gleaned from his wife, a partner at a large law firm that was consulted on the deal. In 2011, the SEC charged an Illinois man who bought the stock of an acquisition target of a company where his wife was an executive despite her requests that he keep the merger information confidential. In a different 2011 case, the SEC charged the spouse of a CEO with insider trading on confidential information that he misappropriated from her in advance of company news announcements.

As gender roles evolve husbands have increased their role in the housework and the child rearing function. They have also, apparently, increased their risk of insider trading.   


Wagner v. Royal Bank of Scotland Grp. PLC: Defendants’ Motion to Dismiss Denied in Insider Trading Lawsuit

In Wagner v. Royal Bank of Scotland Grp. PLC, No. 12 Civ. 8726 (PAC), 2013 BL 239950 (S.D.N.Y. Sept. 5, 2013), the United States District Court for the Southern District of New York denied Defendants’ motion to dismiss a securities claim seeking the recovery of short swing profits under Section 16(b) of the Securities Exchange Act of 1934 (“Section 16(b)”). 

The transactions at issue involved swap agreements between the Royal Bank of Scotland Group PLC and its affiliates (collectively, the “RBS Defendants”) as well as various counterparties.  According to the allegations, RBS Defendants swapped LyondellBasell Industries, N.V. (“LBI”) Class B shares for payments based on the shares’ increase in value or dividends paid on them. Because of the structure of the Class B shares, they were automatically converted to Class A shares upon the occurrence of a specific event shortly after the swap agreements were made. In addition, the “RBS Defendants beneficially owned more than 10% of outstanding Class A shares.”

A shareholder of LBI requested that LBI seek disgorgement of the RBS Defendants’ short-swing profits.  When this did not occur, Jeff Wagner (“Plaintiff”) brought this lawsuit against the RBS Defendants to recover the amount.

To succeed on a Section 16(b) claim, the plaintiff must prove that there was “(1) a purchase and (2) a sale of securities (3) by an officer or director of the issuer or by a shareholder who owns more than 10% of any one class of the issuer’s securities (4) within a six-month period.” Although they owned more than 10% of the outstanding Class A shares, the RBS Defendants moved to dismiss.

The RBS Defendants argued that the transactions did not involve a change in their “pecuniary interest” and were, therefore, exempt under Section 16.  See Rule 16a-13, 17 CFR 230.16a-13 (“A transaction, other than the exercise or conversion of a derivative security, or deposit into or withdrawal from a voting trust, that effects only a change in the form of beneficial ownership without changing a person's pecuniary interest in the subject equity security shall be exempt from Section 16 of the Act.”). 

The RBS Defendants argued, among other things, that the court should not apply Section 16(b) to the transactions at issue because they are “far afield from trading on inside information and do not implicate the concerns that animate Section 16(b).” The court noted that scrutiny of borderline transactions only occurred when an insider made an involuntary transaction with no access to inside information. This case, however, did not warrant heightened scrutiny because the RBS Defendants had “not yet demonstrate[d] that no such possibility” existed. 

Additionally, the RBS Defendants sought to rely on SEC No-Action Letters finding  Section 16(b) inapplicable to transactions where the parties had no pecuniary interest in the securities involved. The court, however, rejected reliance on these letters, finding that the transactions by the RBS Defendants were “quite different” from those discussed in the letter.  Therefore, because the RBS Defendants did not successfully argue that Section 16(b) was inapplicable, the court denied their motion to dismiss.

Primary materials are available on the DU Corporate Governance website


Tremont Sec. Law v. Tremont Grp. Holdings: Plaintiffs Get a Chance to Amend

In Tremont Sec. Law v. Tremont Grp. Holdings, Inc., multiple Plaintiffs with similar actions against Tremont Group Holdings (“Defendants”) filed complaints to recover assets lost in the Madoff Ponzi scheme, and the complaints were consolidated before a single judge.  Master File No. 08 Civ. 11117, 2013 BL 235336 (S.D.N.Y. Sept. 3, 2013).  Defendants moved to dismiss the complaints and the Plaintiffs moved for leave to amend, requesting requested that the court stay its decision on the motion to dismiss until the Supreme Court of the United States decides the Troice cases currently before it.  The court granted the motion to dismiss with leave to amend the compliant and denied the motion to stay.

According to the complaints, various Plaintiffs invested in three of Tremont’s funds: Rye Select Broad Market Fund, the Rye Select Broad Market XL Fund, and the Rye Select Broad Market Prime Fund.  Plaintiffs alleged that Defendants falsely represented the quality of the investment strategy used by the funds and the quality of the due diligence undertaken in connection with the investments.  Plaintiffs further alleged that their investments were blindly turned over to Bernie Madoff’s Ponzi scheme, evidencing a lack of due diligence, and that Defendants’ assertions of consistent gains were false.

The Plaintiffs brought a number of state law claims including fraud, negligence, breach of fiduciary duty, breach of contract, and professional malpractice.  The Defendants moved to dismiss the case pursuant to the Securities Litigation Uniform Act (“SLUSA”).  The SLUSA “[1] bars covered collective actions, [2] brought under state law [3] that allege a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.”

The court found the first and second element present.  All of the claims were brought under state law.  As for the requirement of a collective action, SLUSA defined the term as a single class action, a single action with more than 50 plaintiffs, or a group of lawsuits filed in the same court that have “common questions of law or fact, in which (I) damages are sought on behalf of more than 50 persons; and (II) the lawsuits are joined, consolidated, or otherwise proceeds as a single action for any purpose.”  The original actions were filed separately and none had 50 or more plaintiffs.  After the actions were consolidated, however, the action sought damages on behalf of more than 50 plaintiffs, therefore satisfying the first element.

The third element required that the action allege a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.  The court found that the state law claims “revolve[d] around allegations of misrepresentation.”  Id.  (“This court and others in this circuit routinely dismiss state-law claims like plaintiffs' claims for negligence, breach of fiduciary duty, etc. when those claims are included in a broader complaint that substantially revolves around allegations of misrepresentation.”).  Consequently, the court granted the motion to dismiss, finding the action precluded by SLUSA.

Plaintiffs moved for leave to amend the complaint to include additional factual allegations and replace state law claims with federal securities claims.  Defendants argued that Plaintiffs deliberately filed the individual actions in state court in an attempt to avoid the SLUSA’s effect and, as a result of the undue delay, should not be granted leave to resign.  Leave to amend is generally liberally granted at the early stages of litigation; however, it may “only be given when factors such as undue delay or undue prejudice to the opposing party are absent.”  The court found that there was no evidence that the original pre-consolidation filings were made in bad faith and, as a result, denial of leave to amend would be too harsh a result. 

The court denied the Plaintiffs’ motion to stay because the Supreme Court decision was not likely to be forthcoming. 

The primary materials for this case may be found on the DU Corporate Governance website.