Part IV: SEC Enforcement Trends, 2009: Insider Trading
Insider trading has long been a high priority of SEC enforcement. Last year, the number of insider trading cases brought by the agency increased by about 25%, according to SEC statistics. Beyond the statistics, the emphasis on insider trading is evidenced by the new market surveillance approach created last year, as well the often aggressive manner in which cases were brought and the wide variety of defendants named in those actions.
The new market surveillance program was announced in August 2008. NYSE Regulation and the Financial Industry Regulatory Authority (“FINRA”), under the supervision of the SEC, entered into an agreement under which the two self regulatory organizations will supervise eleven current insider trading programs on various exchanges. The new approach calls for NYSE Regulations to be responsible for the detection of insider trading for New York Stock Exchange and NYSE Acra listed securities. FINRA will be responsible for American Stock Exchange and NASDQ listed securities. Participating in this arrangement include the American, Boston, CBOE, Chicago, International, NASDAQ, National, New York, NYSE Acra, and the Philadelphia. Appropriate cases will be referred to the SEC for further inquiry.
The new arrangement replaces the prior system under which each exchange conducted its own investigation. It is designed to enhance detection of possible insider trading.
Year end statistics from NYSE Regulation suggest that the new program may be having the desired effect. At year end 2008, NYSE Regulation reported a small increase in suspicious trading and the number of cases referred to the SEC
More significantly however, the composition of the cases seems to have changed. In 2007, about 72% of the referrals for further investigation involved hedge funds. In 2008, only about half of the cases related to hedge funds while the other 50% involved insiders, a significant increase over 2007. These statistics may reflect in part the dynamics of the marketplace, with hedge fund trading declining because of the market crisis. At the same time, the rise may suggest an increase in insider trading by corporate insiders.
The aggressive posture of the SEC in this area is reflected in the cases it selected to litigate. In SEC v. Talbot, Case No. 06-55561 (9th Cir. June 30, 2008), the Commission won a significant victory in a court ruling discussing the nature of the breach of duty which is required to sustain an insider trading charge. There, the SEC brought and insider trading action against Mr. Talbot, a director of Fidelity National Financial for insider trading.
LendingTree was in negotiations to be acquired. The CEO of that company told a vice president of Fidelity about the proposed transaction and requested that the information be kept confidential. The Fidelity vice president later told his CEO who, in turn told the board at a regular meeting attended by Mr. Talbot at a time when Fidelity owned 10% of LendingTree. There was no request that the information be kept confidential. One director at the meeting stated however, that this was inside information. Mr. Talbot later purchased shares of LendingTree before the public announcement.
The district court dismissed the SEC’s complaint, concluding that it failed to establish a breach of duty. The court found there was no continuous chain of fiduciary relationships from Mr. Talbot to the source of the information. The Ninth Circuit reversed, holding that a continuous chain is not necessary, just a breach of duty. Here, Mr. Talbot breached a duty to his company the circuit court concluded by trading on the information. That breach is sufficient.
The breach of duty issue is also central to the SEC’s claims in SEC v. Dorozhko, Civil Action No. 07-9606 (S.D.N.Y. Oct. 29, 2008). In this case the Commission’s complaint was brought against Mr. Dorozhko, a Ukrainian resident. The complaint claimed he hacked into a company’s computer files and stole inside information which was later used to trade.
The district judge dismissed the SEC’s complaint, concluding that there was no deception. Absent deception, which typically flows from a breach of duty in an insider trading case, there is no violation of Section 10(b). The SEC’s appeal of this action is pending before the Second Circuit. That court did extend an asset freeze order the Commission obtained prior to the dismissal of its action.
The SEC also took an aggressive posture in SEC v. Patton, Civil Action No. 02 cv2564 (E.D.N.Y. Filed April 30, 2002), one of the few insider trading cases tried to a jury. There, the SEC prevailed in a case against a downstream recipient of a tip, Constantine Stamoulis, after criminal charges against him had been dismissed.
The SEC’s complaint centers on alleged insider trading in the securities of WLR Foods, Inc. prior to the September 2000 announcement that the company was being acquired by Pilgrim’s Pride Corporations. The fourteen defendants include Eric Patton, the former Director of Manufacturing for the Turkey division of the company, his brother Steve Patton, his registered representative Michael Nicolaou, and several others. Mr. Stamoulis was allegedly tipped by his business partner, John Tsiforis, who the complaint claimed was tipped by his friend Michael Nicolaou, who had been tipped by Steven Patton.
Criminal insider trading charges were brought against Eric and Steve Patton, Mr. Stamoulis and others. Three defendants pled guilty. The criminal charges against Mr. Stamoulis were dismissed. Following the verdict in the SEC’s case however, the court enjoined defendant Constantine Stamoulis from future violations of the antifraud provisions and directed him to disgorge his trading profits and pay prejudgment interest as well as a fine equal to three times his gain.
The SEC’s aggressive posture in this area has not always served it well. In SEC v. Mangun, Civil Action No. 06-CV-531 (W.D.N.C. Filed Dec. 28, 2006), the Commission had its Section 5 charges and insider trading claims dismissed.
Here, the SEC’s complaint claimed that defendant John Mangun, a registered representative and hedge fund operator, engaged in the sale of unregistered securities and insider trading in connection with a PIPE offering. According to the complaint, Mr. Mangun agreed to participate in a PIPE offering and just prior to its announcement sold the underlying shares short. Later, he used the shares from the resale registration to cover. The court rejected the SEC’s claim that this constituted a violation of Section 5 because at the time of the short sale the shares used to cover were not registered. The court also rejected the charge that this constituted insider trading.
In SEC v. Boutraille Corp., Case No. 05 CV 9300 (S.D.N.Y. Filed Nov. 4, 2005) the Commission was aggressive in filing insider trading charges and obtaining an emergency freeze order over $3 million in assets only to dismiss its case after years of litigation.
The initial complaint, apparently predicated on a suspicious trading pattern, was brought against unknown purchasers of call options in the common stock of Placer Dome, Inc. In October 31, 2005 Barrick Gold Corp, a Canadian based gold mining company announced an offer to purchase Placer Dome, also a Canadian based gold mining company.
Prior to the announcement of the deal, the SEC claimed that unknown purchasers, while in possession of inside information and through overseas brokers, bought over 10,000 call options for Placer stock. At the time, over 5,000 of the options were out of the money and set to expire in November, within weeks of the purchases. The account had what the SEC claims was $1.9 million in illegal profits.
Subsequently, the complaint was amended to name Boutraille Corporation, Trinity Partners Ltd. and John C. Fraleigh as defendants. After years of litigation however, the SEC was forced to dismiss the case.
Next: Significant settlements in insider trading cases