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.