ANOTHER INSIDER TRADING CASE – OR IS IT?

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.

THE SEC’S FIRST DEFERRED COOPERATION AGREEMENT: A NEW APPROACH?

The SEC and Tenaris S.A resolved and FCPA case with a deferred prosecution agreement. It is the first deferred prosecution agreement under the initiative the Commission announced last year. The company also settled FCPA charges with the Department of Justice, entering into a non-prosecution agreement. The resolution of these actions reflects what DOJ terms the “extraordinary cooperation” of the company.

Tenaris is a Luxembourg based international seller of steel pipe products and related services to the oil and gas industry. In 2006 and 2007 Tenaris bid on contracts with OJSC O’ztashqineftgaz (“OAO”) to supply pipeline for the development and production of oil and natural gas in Uzbekistan. OAO was a subsidiary of Uzbekneftegaz, a state owned holding company of Uzbekistan’s oil and gas industry.

To facilitate the bidding process the company retained a local agent. Through the agent Tenaris was able to obtain confidential information regarding the bids of competitors. As a result, the company was successful in obtaining contracts during the time period which generated almost $5 million in profits. The agent was paid a commission, portions of which went to state officials as bribes.

Tenaris first learned of the bribes in March 2009 through a third party. The audit committee immediately retained counsel who launched an internal investigation. In a filing with the SEC on June 30, 2009 Tenaris disclosed the customer allegations that lead to the inquiry and the investigation, noting that it had self-reported to DOJ and the SEC. The next month counsel for the company briefed DOJ and SEC officials, promising to conduct a more detailed investigation and report again.

Subsequently, the company conducted a world-wide inquiry of its business operations and controls. It also provided DOJ and the SEC what the latter called “extensive, through, real-time cooperation . . .“ making full voluntary disclosure of the underlying conduct. The company also enhanced its compliance measures. The steps taken included the adoption of a strengthened Code of Conduct, Business Conduct Policy and Agent retention Procedure that addresses anticorruption and compliance with the FCPA.

Tenaris resolved the charges with DOJ by entering into a non-prosecution agreement. The company also agreed to pay a criminal fine of $3.5 million.

The deferred prosecution agreement executed with the SEC is modeled on those used by the Justice Department. Under its terms the company agreed to pay $5.4 million in disgorgement and prejudgment interest. Tenaris also accepted responsibility for its actions and agreed “not to contest or contradict the factual statements” regarding the underlying conduct detailed in the agreement. A footnote provides that the agreement is the result of settlement negotiations and thus the statements in it are not binding on the company in any other proceeding.

As part of the agreement Tenaris will continue to cooperate with the SEC. The company also agreed to: 1) provide the Commission with a written certification of compliance prior to the end of the agreement in 2013; 2) annually review and update its Code of Conduct; 3) require that each director, officer and management level employee certify compliance with the Code of Conduct on an annual basis; and 4) conduct FCPA training and supervision for all officers and managers, finance employees, other working in areas implicated by its anticorruption and compliance policies and future employees.

The fact that the SEC chose an FCPA case to enter into its first deferred prosecution agreement may indicate a shift in approach. DOJ has long used this type of agreement to resolve FCPA charges. In those agreements the Justice Department typically acknowledges the cooperation of the company. In many cases a description of the cooperation is provided and DOJ indicates the impact of it on the resolution of the matter.

In contrast the SEC frequently makes little reference to the cooperation of the company in its parallel FCPA settlements, an approach which seems at odds with the purpose of the initiative under which the agreement was crafted. This approach also makes it difficult at best to evaluate the impact of cooperation on the ultimate resolution of the case and offers little guidance to issuers. This is particularly true since SEC settlements in these cases all tend to be similar. In contrast, the agreement here details the cooperation steps of the company as well as its compliance undertakings. Perhaps the Tenaris agreement signals the beginning of a new effort to foster cooperation and focus on compliance and prevention.