Part V: SEC Enforcement Trends and Priorities 2008 – Insider trading

Key areas in which the SEC brought cases last year include, insider trading, the Foreign Corrupt Practices Act, financial fraud, hedge funds, options backdating and attorneys. In addition, the Enforcement Division created a subprime taskforce which is coordinating with other regulators to investigate that area.

Last year saw a renewed emphasis on insider trading enforcement. The emphasis stems from congressional directives to step up enforcement in this area, as well as reports of rampant insider trading in U.S. markets and those around the globe.

To step up enforcement a new elite “watch dog” has been created. A group composed of investigators from FINRA, ORSA, NYSE Regulation and the SEC has been put together to focus on serial insider trading rings. This group not only shares information, but has also developed new computer models to monitor the markets and identify suspicious trading. The SEC is also working closely with other regulators around the globe.

The SEC is also trying new approaches to detecting insider trading. The Office of Compliance and Examinations has been testing a new template for inspections which has an insider trading component. Enforcement also circulated a questionnaire to hedge funds and other large traders in an effort to collect information about those with access to inside information in an effort to create a profile. This effort proved so controversial and raised so many privacy issues that it was later withdrawn.

SEC enforcement is also pushing into new areas in its insider trading investigations. Enforcement officials have repeatedly noted that they are scrutinizing executive trading under so-called Rule 10b5-1 plans. Those plans were suppose to be safe harbors for executives to sell company shares without insider trading concerns. Since a new business school study suggested that executives were receiving abnormal returns – the same type of study which started the option backdating scandal – Enforcement has been examining this so-called safe trading with an eye toward insider trading liability.

In other instances, Enforcement is defining what constitutes insider trading with litigation and consent decrees. In SEC v. Barclays Bank, Civil Action No. 07-CV-4427 (S.D.N.Y. May 30, 2007), the Commission filed a settled insider trading enforcement action against the bank and its chief bond trader. The complaint alleged that the defendants violated the antifraud provisions by trading on information obtained from sitting on creditors committees in bankruptcy proceedings and then trading in the securities of those companies. Some of the trades involved the use of so-called “big boy” letters in which the bank told the trader on the other side that it may have additional material and undisclosed information. Following the settlement, SEC officials noted that, in their view, the use of “big boy” letters did not shield the trader from insider trading liability. This theory is controversial in academic circles.

Another critical enforcement case in which insider trading liability is being defined is SEC v. Dorozhko, Civil Action No. 07-cv-9606 (S.D.N.Y. Oct. 29, 2007). There, a hacker broke into the computer system of Thomson, obtained information about IMS Health, Inc. and traded. The district court dismissed the case, noting that while the defendant may have violated some law, it was not the insider trading laws, because there was no violation of duty. The SEC has appealed this case to the Second Circuit.

Next: Significant insider trading cases