SEC v. Knight, Civ. 2:11-cv-00973 (D. Ariz. Filed May 18, 2011) is a a settled insider trading case against a corporate official and her tippee friend. At first glance the case is a routine insider trading case. A closer reading of the facts suggests otherwise.

Defendant Mary Beth Knight is a senior vice president of Choice Hotels. Her long time friend Rebecca Norton is also a defendant. On June 22, 2006 Ms. Knight attended a meeting for senior executives of the company in Phoenix. Prior to the meeting each attendee received a packet of information about the performance of the company in the second quarter. During the meeting there was a detailed discussion of those materials and the financial performance of the company during the quarter.

The projections discussed at the meeting estimated that the company would miss analyst expectations by one cent. The last time that happened was October 2004 the managers were told. The market had a negative reaction. While the period was not closed the assistant controller making the presentation said there was little chance that the actual results would differ from the projection. Results for the period were due to be released on July 25, 2006.

At the conclusion of the meeting Ms. Knight had lunch with others attendees. During the discussion she mentioned her plan to sell company stock to purchase property in Alaska.

The next weekend Ms. Knight told her friend Rebecca that the company would miss earnings for the quarter. At the time the executive knew her friend owned shares in Choice Hotels. Between June 26 and July 7 Ms. Norton sold 3,229 shares of Choice Hotels stock in two transactions. She also sold short an unspecified number of shares. Ms. Knight sold 12,000 shares of company stock on June 27, 2006.

When the earnings announcement was released the share price dropped the next day nearly 25%. As a result Ms. Norton avoided losses of $65,747 and made a profit on her short position of $7,690. Ms. Knight avoided losses of $140,400.

Both defendants settled, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, Ms. Knight agreed to disgorge the loss avoided of $140,400. That obligation was deemed satisfied by the fact that Ms. Knight had previously given this amount to the company. No explanation is provided for that action. Ms. Knight also agreed to disgorge the losses avoided and profits made by her friend and pay a penalty of $185,111. Ms. Norton agreed to pay a civil penalty in an amount determined by the court.

To this point the case looks like many other insider trading cases. A detailed chronology of the events pulled from the complaint raises other issues:

• The day after the June 22 management meeting Ms. Knight e-mailed the associate general counsel of Choice Hotels, informing him that she was considering selling some of her shares “this summer” and asking if there are black out dates over the next 60 days.

• Three days later the Associate General Counsel responded noting that the black out period would begin on June 30 and continue until after the earnings release on July 26. He attached a copy of the insider trading policy for the company.

• On June 27 Ms. Knight sent a follow up e-mail to the associate general counsel stating that she was “exercising 12,000 shares today. I also mentioned to [my boss] last week I would be doing so.”

• The complaint does not indicate that there was any response.

• The shares were sold on June 28, two days before the black out period.

The essence of insider trading is a breach of duty. A breach of duty is required since it supplies the element of deception required by Section 10(b). Under the facts here it could be argued that the company acquiesced in the trades since it was repeatedly told about them in advance. The general counsel’s office was told as well as Ms. Knight’s supervisor who presumably knew she attended the critical meeting. If the company knew and agreed to permit the trades there was no insider trading. In the end the question is whether this seemingly routine enforcement action is in fact an enforcement action at all.

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