Part V: SEC Enforcement Trends, 2009 — Insider Trading (continued)

Typically, the SEC settles most of its insider trading cases. Last year was no exception. Two high profile cases illustrate the point: the News Corp/Dow Jones case and the Guttenberg case, viewed by many as the most significant insider trading case brought in years.

SEC v. Kan King Wong, Civil Action No. 07 Civ. 3628 (S.D.N.Y. Filed May 8, 2007) centers on trading in advance of the May 1, public announcement of News Corp’s bid for Dow Jones. The initial complaint was filed seven days after the merger announcement. It named as defendants Kan King Wong and his wife Charlotte Ka On Wong Leung, both residents of Hong Kong. The complaint claimed the couple purchased 415,000 shares through a Merrill Lynch Hong Kong account before the announcement. When the husband ordered the sale, there were $8.1 million in profits from the increase in the share price following the announcement of the deal.

Subsequently, the SEC amended the complaint and settled the action. The amendment stated that News Corp. board member David Li told his close friend Michael Leung about the deal. Mr. Leung in turn told his daughter and son-in-law — the original defendants. Messrs. Li and Leung were added as defendants to an amended complaint which claims that Mr. Leung traded through the account of his daughter and son-in-law with their assistance.

To settle, each defendant consented to the entry of an order enjoining them from future violations of Section 10(b) and Rule 10b-5. In addition, Mr. Li was ordered to pay an $8.1 million civil penalty; Mr. Leung was ordered to pay $8.1 million in disgorgement plus pre-judgment interest and an $8.1 million penalty; and K. K. Wong was ordered to pay $40,000 in disgorgement plus prejudgment interest and a $40,000 civil penalty.

U.S. v. Guttenberg, 1:07-cr-00141 (S.D.N.Y. Filed Feb. 26, 2007) and SEC v. Guttenberg, Civil Action No. 07 CV 1774 (S.D.N.Y. March 1, 2007) are two more high profile insider trading cases that partially settled. The criminal case charged thirteen individuals while the SEC named as defendants fourteen individuals. The defendants were primarily Wall Street insiders.

The claims in each case involved two overlapping schemes. The primary scheme alleged that Mr. Guttenberg furnished others with information from his employer about up coming UBS recommendations on stocks prior to the announcement date. A second scheme centered on information obtained by a Morgan Stanley attorney who furnished others with inside information regarding up coming deals. The criminal case resolved with each defendant pleading guilty. The SEC case is still pending.

Many of the insider trading cases brought last year involved trading in advance of a corporate event such as a merger or an earnings release or had international aspects. SEC v. Tedder, Civil Action No. 3-08-CV-1013 (N.D. Tex. June 17, 2008) is an example of an insider trading case centered on a merger where the SEC took an aggressive position. The SEC, which obtained a portion of the facts alleged from a corporate internal investigation, claims that defendants Tedder and Carr, both employees of Aviall, Inc. traded in advance of the acquisition of their company by The Boeing Company.

The SEC’s insider trading claims are based on a series of events which it claims support an inference that the defendants traded on inside information. The mosaic of facts used to create the inference include extending a trading blackout, an executive tour at the company by Boeing executives, repeated closed door meeting by the in-house counsel and an e-mail inadvertently sent by the company CEO to 122 employees about a conference call involving due diligence and rumors. The case is in litigation.

SEC v. One or More Unknown Purchasers of the Call Options for the Common Stock of DRS Technologies, Inc., Civil Action No. 08-cv-6609 (S.D.N.Y. Filed July 25, 2008) is an example of an insider trading case with international aspects. The complaint here is based on trading in call options on two take over stocks through an account at UBS AG in Zurich, Switzerland. The first instance involved a proposed transaction between Schneider Electric SA and American Power Conversion Corporation. According to the SEC’s complaint, Schneider sent a letter to American Power in September 2006 expressing interest in acquiring the company. Shortly after the letter, an unknown purchaser bought 2,830 American Power out of the money call options. After the deal was announced the share price of American Power rose 26%. Subsequently the options were liquidated for a profit of about $1.7 million.

The second involved a proposed transaction in which Finmeccanica SpA would acquire DRS Technologies, Inc. Prior to an announcement by Finmeccanica on May 12, 2008 that it would acquire DRS for $5.2 billion, the unknown purchaser bought 1,820 DRS call options that were out of the money and due to expire shortly. As a result of the announcement the share price of DRS increased significantly after which the options were liquidated for a profit of about $1.6 million. The case is in litigation.

Last year the SEC brought insider trading cases against a wide variety of defendants including directors, audit committee members, in-house counsel, auditors and others. For example:

Director and outside counsel: SEC v. Boshell, Civil Action No. 08-CV-3292 (N.D. Ill. April 28, 2008) is a settled insider trading case which named as defendants a board member who learned about a potential acquisition at a board meeting and an attorney with an outside law firm doing due diligence on the deal.

Audit committee member: SEC v. Gad, Case No. 07-CV-8385 (S.D.N.Y. Sept. 27, 2007) is an insider trading case brought against an audit committee member who is alleged to have tipped his close friend after learning there would be an earnings short fall. The case settled last year. See also SEC v. Erickson, Civil Action No. 03-07-CV-0254 (N.D. Tex. Filed Feb. 7, 2007) (action against an audit committee member who allegedly participated in negotiations regarding the acquisition of his company and then traded. The case settled last year).

General counsel: SEC v. Heron, Civil Action No. 07-cv-01542 (E.D. Pa. Filed April 18, 2007). After litigating, this action settled last year. The defendant is the former general counsel of the company who is alleged to have repeatedly traded on inside information about his company.

Outside auditors: SEC v. Raben, Case No. CV-08-0250 (N.D.CA. Filed Jan. 15, 2008) is a settled insider trading case brought against two former PwC auditors for trading in advance of pending deals of audit clients.

Securities professionals: SEC v. Stephanou, Case No. 09 CV 325 (S.D.N.Y. Filed Feb. 5, 2009) is an insider trading case brought against two securities professionals and a hedge fund manager. The complaint alleges that the defendants traded in advance of pending deals. The case is in litigation. See also SEC v. Devlin, Case No. 08-CV-1101 (S.D.N.Y. Filed Dec. 18, 2008) (insider trading case against securities and legal professionals and their friends and clients which alleges illegal trading on a series of deals. This case is in litigation.)

Public figures: SEC v. Cuban, Civil Action No. 3-08-CV-2050 (N.D. Tex. Filed Nov. 17, 2008). This insider trading action was brought against Mark Cuban, the owner of the Dallas Mavericks, HDNet and Landmark Theaters. The case is based on a PIPE offering made by, Inc. According to the SEC, in 2004 when the company was planning the offering, Mr. Cuban, its largest known shareholder, was contacted several times about the proposed offering. Before information about the transaction was provided to him Mr. Cuban agreed to maintain its confidentiality. Mr. Cuban was reportedly upset by the offering because it would dilute his interest. He declined to participate. Shortly before the public announcement Mr. Cuban sold his entire stake in the company, avoiding what the SEC claims was potentially a $750,000 loss. The case is in litigation.

In view of the aggressive posture of insider trading enforcement, all companies should consider implementing and/or updating their compliance procedures. Brokerage firms are required under the securities laws to have insider trading compliance procedures. Non-regulated entities are not. The SEC recently stressed the importance of having insider trading compliance procedures, however. In Retirement System of Alabama, Release No. 574461 (March 6, 2008) the SEC resolved an insider trading investigation against an Alabama state pension fund by issuing an Exchange Act Section 21(a) report of investigation rather than brining an enforcement action. The resolution centered on the system agreeing to adopt insider trading procedures.

Next: Financial fraud