The Week In Review (December 7-13, 2007): Cooperation, Insider Trading and Option Backdating – Perhaps The Start of New, Significant Trends
Last week, securities enforcement by the SEC and DOJ struck familiar themes – insider trading and option backdating. The impact of last week may, however, have significant, lasting implications.
One key issue from last week is the question of cooperation standards, a key question raised by the insider trading case of Hans Wagner, a former director of msystems, Ltd. Much has been written about cooperation under the SEC’s Seaboard Release and DOJ’s Thompson and McNulty memos. Usually, the question is whether government prosecutors and lawyers should ask for privilege waivers from corporations seeking to minimize their potential liability. This question is highlighted by the proposed legislation which recently passed the House of Representatives and was sent to the Senate for consideration – The Attorney Client Protection Act of 2007, which is discussed here.
The case of Mr. Wagner is different, however. In his capacity as a director of msystems, Mr. Wagner learned of a proposed offer to buy his company. Before his company announced the merger, Mr. Wagner bought 200,000 shares at $27.77 per share. After the announcement, the value of the shares increased by 13.2%. Nothing unusual here – a routine insider trading case.
What happened next is not routine, however. Mr. Wagner, according to the SEC’s release, reported himself to the staff and offered to disgorge his trading profits. Mr. Wagner took this action in recognition of his ethical obligations as a board member.
The SEC and Mr. Wagner settled the matter. An insider trading case alleging violations of antifraud Section 10(b) was filed, and Mr. Wagner consented to the entry of a statutory injunction. Mr. Wagner also consented to the entry of an order requiring that he disgorge $566,756 in trading profits and prejudgment interest of $11,335. No penalty was assessed. SEC v. Wagner, Civil Action No. 07-2213 (D.D.C. Filed December 7, 2007).
This is not the standard SEC settlement. Typically, a penalty is assessed which equals at least the amount of the disgorgement if not more. While the SEC’s release does not mention cooperation, it seems clear that the settlement reflects Mr. Wagner’s cooperation. In this regard, the SEC and the staff should be commended. Cooperation standards should be about more than the issue of waiving the attorney client privilege. Cooperation standards should be about what their title says: Cooperation. Those standards should encourage everyone to aid legitimate law enforcement efforts and help foster a climate of lawful and ethical conduct. This is the ultimate “tone at the top” issue – the government not just enforcing the law but helping create a climate that encourages everyone to do this.
In this context I offer a thought for consideration. Actions such as those taken by Mr. Wagner in self reporting are rare. Clearly he made a huge mistake by trading. Self-reporting does not take that away. At the same time, Mr. Wagner’s conduct in self-reporting is precisely what the SEC wants and should expect. In the future, rather than requiring the person who takes such actions to consent to an injunction, an alternative resolution should be considered: a Section 21(a) report of investigation, along with the payment of disgorgement and whatever other restitution might be necessary should be considered. The report and lack of sanction would serve to encourage others who make mistakes to self report and correct them. Encouraging cooperation, self reporting and an atmosphere of compliance is clearly preferable to having a court enter a standard injunction which is not needed.
Another significant insider trading case was also in court this week. The trial of U.S. v. Naseem started and ended – at least for now. As discussed earlier, Mr. Naseem is the former Credit Suisse investment banker alleged to have been involved in the TXU deal as discussed here. This is the first of the major insider trading cases brought this year to go to trial and may have given some indication of where other similar cases might go. Earlier this week, the case ended when District Judge Richard Berman in Manhattan declared a mistrial when two jurors failed to follow instructions.
Finally, as discussed earlier here, former UnitedHealth Group CEO William W. McGuire settled his option backdating case with the payment of a record sum. While the roughly $800 million total payment number drew a lot of ink, it clearly did not end the matter. Dr. McGuire still faces an on-going criminal probe.
Another little noticed ramification of Dr. McGuire’s case may be its impact on derivative suits. Typically, derivative suits settle for revised corporate government procedures and the payment of attorney fees to the attorneys who brought the case on behalf of the corporation. The case involving Dr. McGuire and UnitedHealth, however, settled for more that $400 million – about half of the reported approximately $800 million paid in settlement went to resolve the derivative suit. Such a huge payment is this case may well impact settlements in other derivative suits based on option backdating. Ultimately, this settlement, and perhaps others which follow, may alter the course of future derivative suit settlements.
Overall, the past week may change the course of securities suits. Mr. Wagner’s case could alter cooperation standards in the future. Dr. McGuire’s settlement may alter future derivative suit settlements.