INSIDER TRADING: THE MISSING COO AND UNIDENTIFIED CALLER

The SEC and DOJ are being aggressive in bringing insider trading cases. DOJ and, in particular the Manhattan U.S. Attorney’s Office, have focused on the use of so-called blue collar tactics. The SEC has relied on more traditional methods keyed to analyzing the trading and the surrounding facts and circumstances. Whatever the method it is critical that the source of the inside information be found. No source and no inside information equals no case.

Last week the Commission brought another “friends and family” insider trading cases. SEC v. Carroll, Case No. 3:11-cv-00165 (W.D. Ky. Filed March 17, 2011). The complaint alleges insider trading based on the possession of material non-public information regarding the take over of Steel Technologies, Inc. by Mitsui & Co. Named as defendants are four employees of Steel Technologies, Patrick Carroll, William Carroll, David Stitt and David Calcutt. Each traded. Also named as defendants are four alleged tippees: James Carroll (son of Patrick), John Monroe (friend of Christopher Calcutt) , Stephen Somers (friend of John Monroe) and Christopher Calcutt (brother of David Calcutt). Each traded. In “family and friends” case such as this one the source of the inside information is typically one of the family members or friends named as a defendant.

Not here. None of the employee defendants were “over the wall,” that is part of the deal team. There is no allegation that any of the employee defendants misappropriated the inside information. If they do not have inside information then clearly the tippees do not.

Where then does the inside information come from? The complaint alleges two key sources. For three of the four employee defendants the source is, according to the SEC, Steel Technologies then President and COO Michael Carroll who is now the President and CEO. He is the brother of Patrick and Tad and uncle of James. Michael was involved in the transaction according to the complaint. Each employee defendant reported to Michael. The complaint specifically identifies him as the source for:

David Calcuitt: After detailing earlier trades unrelated to the case where the Commission suggests he had inside information, the complaint states that “[a]s a result of one or more of his communications with Michael . . .Calcutt learned material nonpublic information . . . “ about the deal;

Patrick Carroll: After noting that Mitsui representatives toured several company facilities including one where Patrick worked the complaint claims that “[a]s a result of those tours and one or more communications with his brother Michael . .. Patrick learned material nonpublic information . . . “ about the deal; and

William “Tad” Carroll: After alleging that on prior occasions not related to the case Michael had given him confidential information, the complaint states that as a result of “communications with his brother Michael . . . Tad learned material nonpublic information about the forthcoming … “ deal.

The source for David Stitt is also identified but is nameless. In this regard the complaint claims that Mr. Stitt made numerous telephone calls to and from individuals at the corporate headquarters after learning that he might have to make what was characterized as an unusual trip there on short notice. Then in the space of a few minutes he received five consecutive calls from the same number at corporate headquarters. This was also “unusual” according to the complaint. Trading commenced. There is no information about the telephone number, identification of the person to whom it belongs or the individual on the other end of the five calls.

The SEC’s case here hinges on a person identified but not named as a defendant or cooperating witness and an unnamed caller. To be sure the complaint contains a significant amount of detail regarding the securities transactions of each defendant, all of which are unusual according to the SEC. There are also instances where a defendant acted in a manner which suggests a cover-up, according to the complaint. In the end however, the complaint has two glaring omissions: one is COO Michael, identified in the complaint under the heading “Relevant Entities and Individuals.” The other is the unidentified caller who is simply missing.

THE IBM CASE: FCPA COMPLAINCE PROGRAMS AND INTERNAL CONTROLS

There was Congressional testimony last fall to consider possible modifications to the Foreign Corrupt Practices Act. In part the testimony focused on the issue of FCPA compliance procedures as a defense for a business organization. Under current practice those procedures are not a defense but mitigation. In contrast, under the new UK Bribery Act compliance procedures can be a defense. Precisely what will be required is yet to be decided however.

The SEC’s recent action against International Business Machine or IBM highlights the relation between FCPA compliance procedures and internal controls. In its complaint the SEC notes that the company has anti-bribery and FCPA procedures. IBM’s internal controls however were inadequate, according to the SEC. This resulted in violations. Improper payments were made to South Korean officials, Improper travel and entertainment was paid for Chinese officials. All the payments were by subsidiaries for which IBM was held responsible. SEC v. IBM, Case No. 1;11-cv-00563 (D.D.C. Filed March 18, 2011).

The complaint centers on the activities of IBM-Korea, LG-IBM and IBM-China and payments made to employees at South Korean government entities and Chinese government officials to obtain or retain business. IBM-Korea is a wholly owned indirect subsidiary of IBM International Group B.V. which is owned by IBM. LG-IBM is a joint venture between IBM-Korea and LG Electronics, Inc. which is 51% owned by the IBM subsidiary. IBM-China is owned by IBM/Hong Kong which is ultimately owned by IBM. The actions detailed in the complaint involve only these subsidiaries, not IBM.

In Korea the violations are based on the alleged improper payments by either IBM-Korea or LG-IBM. The complaint states that from 1998 through 2002 these two subsidiaries made improper payments to South Korean government officials who worked for sixteen government entities. IBM-Korea is alleged to have made payments over the four year period totaling $135,558 while LG-IBM’s payments totaled $71,599.

Typical of these allegations are the ones made regarding SKGE -1 or South Korean Government Enterprise No. 1. According to the complaint, in mid-December 1998 officials from IBM-Korea met with representatives of SKGE-1. At the meeting IBM-Korea “gave him [SKGE-1] a shopping bag containing a large IBM-Korea envelope filled with KRW 20 million ($19,093).” This happened repeatedly during the time period.

The summary section of the complaint states that IBM had “corporate policies prohibiting bribery and procedures relating to compliance with the FCPA; however, deficient internal controls allowed employees of IBM’s subsidiaries and joint venture to use local business partners and travel agencies as conduits for bribes or other improper payments to South Korean and Chinese government officials over long periods of time.” The complaint does not provide any detail or specify how the internal controls were deficient with respect to the claimed improper payments in Korea.

The conduct alleged in China differs. There the SEC complaint states that from 2004 through 2009 IBM-China employees created slush funds at local travel agencies in China. Those funds were used to pay for overseas and other travel expenses incurred by government officials. The complaint goes on to specify that in at least 114 instances the internal controls of the company failed to detect improper payments. This occurred because: “(1) IBM-China employees and its local travel agency worked together to create fake invoices . . . (2) trips were not connected to any DTRs [Delegation Trip Requests]; (3) trips involved unapproved sightseeing itineraries . . . (4) trips had little or no business content; (5) trips involved one or more deviations from the approved . . [itinerary]; and (6) trips where per diem payments and gifts were provided to Chinese government officials.”

To resolve the case IBM consented to the entry of a permanent injunction prohibiting future violations of the books and records and internal control provisions of the FCPA, Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). The company also agreed to pay disgorgement of $5.3 million along with prejudgment interest and a $2 million civil penalty. There is no indication in the papers as to how the disgorgement or penalty were calculated. There is no reference to cooperation by the company.