Rule 10b5-1, enacted in August 2000, codified the SEC’s position that trading while in possession of material non-public information is sufficient to establish liability for insider trading. The rule also provided an affirmative defense for individuals who could prove that the purchase or sale of stock was made pursuant to a pre-existing written plan executed before the individual became aware of the material non-public information. These so-called 10b5-1 plans have long been considered to be an efficient way to trade company stock without raising suspicion of insider trading or another improper motive.
However, recent news stories have reignited concerns that corporate insiders may be abusing 10b5-1 trading plans to trade on material non-public information. An April Wall Street Journal article reported that not only has the use of 10b5-1 plans by non-executive directors nearly doubled between 2006 and 2011, but a significant percentage of the plans were being used to unload all or a large percentage of the directors’ holdings in a short period of time. An earlier November 2012 Wall Street Journal article analyzing thousands of trades made by corporate executives found evidence that company insiders did statistically much better than expected in realizing trading profits. Together, these articles suggest that the lack of transparency and regulation of 10b5-1 trading plans has allowed them to be misused as vehicles to effectuate opportunistic trades.
In the latest development in an SEC lawsuit filed Friday, February 15, U.S. District Judge Rakoff extended a freeze on a Swiss Goldman Sachs account linked to possible insider trading in H.J. Heinz Company call options. The complaint alleges that these options were bought for $90,000 the day before the ketchup maker agreed to be bought by Warren Buffett’s Berkshire Hathaway, Inc. and Brazilian investment firm 3G Capital, giving the mystery investors $1.7 million in profits. The SEC said that the timing and size of the trades were suspicious because the account had had no history of trading Heinz stock over the last six months.
On Friday, February 15, Rakoff approved an emergency court order to freeze the assets in a Swiss trading account, which would prevent the investors from taking the profits out of the account until they showed up in court to “unfreeze” them. At a hearing the following week, none of the investors showed up. Rakoff relished: “They can hide, but their assets can’t run.” Read More
It has been over three years since the SEC filed its insider trading charges against Galleon Management and Raj Rajaratnam. When that complaint was filed, the Director of the SEC’s Division of Enforcement, Robert Khuzami promised to “roll back the curtain” and “look at patterns across all markets” for illegal insider trading. Last month, Mr. Khuzami echoed those remarks when he announced that the SEC had filed its largest-ever insider trading case and warned “would-be insider traders” that the SEC is “here to stay.”
In that case, SEC v. CR Intrinsic Investors, LLC, the SEC alleges that a group of hedge funds and their managers made $276 million in illicit profits by improperly trading on insider information about pharmaceutical clinical trial results. One of the defendants, a medical consultant for an “expert network” firm who allegedly provided the inside information on which the trades were based, entered into a settlement with the SEC and a non-prosecution agreement with the Department of Justice. The case against the portfolio manager who allegedly made the trades, and the investment adviser with whom he was affiliated, is ongoing.
Last week, the SEC filed yet another insider trading complaint, this time against ten individuals who made stock trades in advance of four merger and acquisition transactions. In SEC v. Femenia, the SEC claims to have identified a “massive, serial insider trading scheme obtaining at least $11 million in illicit trading profits” centered around a former investment banker who misappropriated the information and “tipped” his personal friends about the upcoming deals. According to the SEC, those personal friends (who are also defendants in the case) traded on the information and paid a portion of their profits to the investment banker. In some instances, the information was even “tipped” a second time to friends and family members of the original “tippee.”
According to the SEC’s statistics, it has brought 58 enforcement actions for insider trading in 2012, the second-highest total in the last ten years and the most in any year since 2008. Those numbers confirm that the SEC really is “here to stay” on insider trading.
In a case involving all of the hallmarks of the housing and economic crisis, on September 25, 2012 the SEC announced that it had charged three Nebraska bank executives and the CEO’s son with violations of securities fraud and insider trading laws stemming from subprime lending, undercapitalization, and the ultimate demise of TierOne Bank.
TierOne Bank was a century-old thrift that had traditionally focused on loans to the agricultural and residential sectors in Midwestern states, but like many banks caught up in the housing boom, in 2004 TierOne expanded into riskier loans in then-exploding markets such as Nevada, Florida, and Arizona. All of these markets would collapse just a few years later, leaving banks like TierOne with significant losses on their books. As a result, in June 2008, the Office of Thrift Supervision gave TierOne a choice: maintain elevated core and risk-based capital ratios or face enforcement action—the top leaders at TierOne allegedly chose neither.
Rather than increase capital ratios or accept an OTS enforcement action, CEO Gilbert Lundstrom, COO James Laphen, and Chief Credit Officer Don Langford allegedly materially understated TierOne’s loan and OREO losses. Not to be confused with the cookie, “OREO” in the banking context refers to “other real estate owned”—in this case real estate that TierOne had repossessed. Though TierOne was left holding real estate from failed markets around the country, its executives allegedly ignored the fact that the value of these assets was based on stale and inadequately discounted appraisals, and consequently made misstatements in its 2008 10-K and a number of other filings. Read More
On July 11, 2012, the Securities and Exchange Commission (SEC) approved a new rule, which will require the national securities exchanges and self-regulatory organizations like the Financial Industry Regulatory Authority (FINRA) to establish a market-wide consolidated audit trail. The new consolidated audit trail will improve regulators’ ability to monitor and analyze trading activity. With the approval of Rule 613, the exchanges and FINRA must jointly submit to the SEC a comprehensive plan of how they plan to develop, implement, and maintain the consolidated audit trail. Rule 613 also requires that the consolidated audit trail collect and identify every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options in all U.S. markets. Read More
The United States Supreme Court held on March 26th that the two-year statute limitation for Section 16 insider trading begins to run as the fraudulent trade is or should have been discovered by a shareholder plaintiff. See Credit Suisse Securities LLC et al v. Simmonds. This decision was yet another rebuke to the Ninth Circuit, which had previously held that the limitations period for a Section 16(b) claim could be tolled until the insider actually discloses his or her improper trade to the SEC and shareholders.
Defendant underwriters challenged the Ninth Circuit’s holding, calling it contrary to language of Section 16(b) that indicates the limitation period should begin to run as soon as an insider makes a profit from an illegal short-swing trade. In an unanimous decision penned by Justice Scalia, the Court agreed, noting that if the filing of a Section 16(a) disclosure statement were necessary for Section 16(b) liability to attach, company insiders and underwriters who failed to file a 16(a) disclosure would forever face the possibility of claims under 16(b). The Court held that “the potential for such endless tolling in cases in which a reasonably diligent plaintiff would know of the facts underlying the action is out of step with the purpose of limitations periods in general.” The Court did not reach the larger question of whether Section 16(a) are subject to any equitable tolling and thus remanded the case to the Ninth Circuit for further consideration.
The Credit Suisse case is notable because it was one of 55 nearly identical actions filed over ten days in October 2007 by Vanessa Simmonds, then a 22-year old college student. The cases all alleged Section 16(b) claims against the underwriters and other financial institutions who had participated in IPO’s during the late 1990’s and 2000.