The insider trading probes being conducted by the Manhattan U.S. Attorney’s Office are changing insider trading enforcement. Traditionally, insider trading is about trading in the securities markets for ill-gotten gains. In the classic model of insider trading, a high ranking corporate executive who has material non-public information about the company breaches his or her duty to the company by using the information to trade. Using the information for personal gain rather than for a corporate purpose breaches the duty of the executive to the company and its shareholders. Price discovery in the markets suffers and other traders are injured. The executive profits by misusing information that does not belong to him or her for a personal use.

The misappropriation theory of insider trading is similar. Here, the trader breaches a duty and essentially steals inside information which should only be used for a corporate purpose. The stolen information is used to trade in the securities markets. Those to whom the trader owed a duty are injured, as well as the markets. The trader however, profits, again obtaining ill-gotten gains.

The wrong and harm under either theory centers on the trading. This only occurs if the stolen information is material to the decision to trade in the securities markets. Stated differently, the information must be important in the total mix of information to a decision about trading in securities.

In the typical SEC insider trading case, the inside information is used to secure ill-gotten gains. After the trading, the SEC investigates. How the trader obtained the inside information is often the focus of the investigation and in many instances is inferred from the trading. The trading and ill-gotten gains are the center of the case.

U.S. v. Shimoon (here), the most recent insider trading cases brought by the New York USAO, fundamentally alters the traditional focus of insider trading cases. The criminal complaint in this case charges conspiracy to commit securities fraud and wire fraud. It is replete with snippets of recorded conversations discussing details about an array of companies. The conversations appear important, perhaps material in the sense of a securities transaction. Payments of sums for money are scattered throughout the complaint.

What is not mentioned in the complaint is securities trading or ill-gotten trading profits. There are no trades in the complaint. Apparently nobody used the information being transmitted from the expert net network and its band of insiders. The only money made was fees paid to the expert network. There are no trading profits.

The absence of trading may stem from the fact that the information went to cooperating witnesses – that is, government informants. The critical question then becomes: Would they trade? The first count alleges conspiracy to commit securities fraud. Presumably, the illegal purpose of the conspiracy was to insider trade and make illegal trading profits. Presumably, the services of the expert network were retained to “find an edge” as on tape recorded conversation notes. There is nothing wrong however, with obtaining an “edge.” To the contrary, it is in the best interests of the markets that traders work hard, dig for information and piece together small bits of available detail in an effort to obtain an “edge” and make better investment decisions.

Critical to these non-trading insider trading cases then may be the quality of the information. Whether that information turns out to be securities investment decision type data depend in large part on the context and what other information may have been available. To be sure, fragments of the information in the complaint appear to be material, a word which is largely lacking in the court documents. For example, in one recorded exchange, CW-2 notes that information about AMD obtained from Mr. Longoria was “spot on,” suggesting it might have been material. The next day however the stock price for AMD dropped significantly because, according to CW-2, “so that, what happens is the news gets out … .” If the information is “out,” it may not be non-public. In other instances there are exchanges which at least suggest the traders were trying to find an “edge,” but perhaps not get “over the edge.” For example, at one point a client of the network asks if Galleon is a client and expresses relief the fund is not. At another point, Mr. Shimoon tells a Flextronics Employee he is disclosing too much.

In the end, the Shimoon case is built on information flow rather than the purchase and sale of securities and ill-gotten securities trading profits like traditional insider trading cases. The key to the cases may well be the nature of the information in the recorded conversations when viewed in context as the complaint repeatedly claims. While the disclosures by the corporate employees may violate internal codes of conduct, the question will be whether it is in fact material to an investor’s decision regarding the purchase or sale of securities. If not the case will be little more than an effort to re-draft the insider trading rules, turning internal corporate codes of conduct into violations of the conspiracy and wire fraud statutes. A similar effort by the government under the honest services fraud statute was recently rejected by the Supreme Court in Skilling (here).

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