On September 26, 2006 the Commission’s Division of Enforcement announced a cease-and-desist proceeding against Scott G Monson, former general counsel of J.B. Oxford Holdings, Inc. (JBOH), and its wholly owned broker-dealer firms, J.B. Oxford & Co. and National Clearing Corporation (NCC), for his role in a late trading scheme facilitated by NCC. http://www.sec.gov/litigation/admin/2006/ic-27497.pdf. The Commission alleged that as General Counsel, Monson drafted late trading agreements that provided NCC’s institutional customers with the ability to confirm, cancel, or revise mutual fund trades after 4:00 p.m. Eastern time, utilizing information that was not available to other fund shareholders required to make trading decisions before 4:00 p.m. http://www.sec.gov/litigation/admin/2006/ic-27497-o.pdf. The Enforcement Division also alleged that Monson failed to properly analyze the agreement to determine whether it complied with SEC rules and regulations or whether it was appropriate for NCC to accept mutual fund trades after 4:00 p.m. On January 18, 2006, in a related proceeding and without admitting or denying the allegations against them, JBOH, NCC, and three former NCC officers agreed to a settlement for their participation in the late trading scheme. http://www.sec.gov/litigation/litreleases/2006/lr19641.htm. NCC disgorged over $1 million in the settlement, paid a civil penalty of $1 million, and paid prejudgment interest in the amount of $69,000. JBOH agreed to cease and desist from future violations of the federal securities laws and to refrain from having a controlling interest in or operating a firm engaged in the broker-dealer clearing business for a period of five years. The three officers each paid civil penalties and, among other sanctions, were barred from associating with any broker dealer for a period ranging from three to five years.
On September 26, 2006 SEC Enforcement Director Linda Thomsen told the Senate Committee on the Judiciary that insider trading remains a priority for the Division. Ms Thomsen pointed out in her testimony that since 2001 the agency has brought 300 actions against over 600 individuals and entities for insider trading violations. Over that period insider trading cases have made up 7 –12% of the Commission’s case load.After recounting some of the more Division’s more significant insider trading cases, the Enforcement Chief noted the Division’s Office of Market Surveillance is in daily contact with the various SROs who perform primary surveillance over the markets. The SROs monitor the markets for unusual peaks and valleys in trading, sudden changes in the price of a stock or other unusual market activity.
Insider trading cases are very difficult to prove according to the Enforcement Chief. Since there typically is no “smoking gun” the cases are based largely on circumstantial evidence. In this regard Ms. Thomsen told the Committee that “[building an insider trading case based on circumstantial evidence can be frustrating, risky and time-consuming. Because of these challenges, we also have to accept that a number of the insider trading investigations we open may not result in a filed enforcement action –not for any lack of diligence on the part of the staff, but for lack of evidence.”
The requirements for proving an insider trading case using circumstantial evidence are discussed in a forthcoming article in the fall issue of Securities Regulation Law Journal titled Is Evidence of Contacts Followed by Trading Sufficient to Infer and Prove Tipping in an Insider Trading Case? The “Plus Factor” Rule.
Typically the SEC seeks a “one-time” penalty in an insider trading case which is equal to the amount of the illegal profits realized or the losses avoided according to the testimony, particularly where the case settles before litigation according to Ms. Thomsen. In some egregious cases the agency has sought an enhanced penalty such as where there were “extraordinary measures” to conceal the trading or where there is a history of fraud. In some instances the agency has settled for less than a one-time penalty.
The testimony comes about one month after a front page New York Times article about insider trading. That article, discussed in an August 29, 2006 post in this blog, was based on a study commissioned by the newspaper. That study suggested that there was a significant about of increased trading activity in advance of many mergers. The article notes that this may be from insider trading. Interestingly, the article did not discuss the economic theory of leakage. Under that theory the increased business activity surrounding a potential merger partner prior to the transaction may explain increases in trading which are not based on insider trading. In discussing the difficulty of proving insider trading cases Ms. Thomsen acknowledged that frequently the staff is confronted with alternate explanations for trading although she did not specifically mention the New York Times article or leakage.