The Fall Out From a Scandal: A New Round of Aggressive Insider Trading Cases?
The Report by the Senate Finance Committee titled “The Firing of an SEC Attorney and the Investigation of Pequot Capital Management” is less than kind to the SEC and its Enforcement Division. By all accounts, this is well deserved. As the conclusion to the report notes: “The investigation of Pequot Capital Management could have been an ideal opportunity for the SEC to develop expertise and visibility into the operations of a major hedge fund while deterring institutional insider trading and market manipulation through vigorous enforcement. Instead, the SEC squandered this opportunity through a series of missteps … .” Id. at 46.
Regardless of the reasons, the Enforcement Staff dropped the ball on a major investigation. The Office of the Inspector General, which conducted an internal investigation to determine what happened, did even worse. No doubt any corporate counsel that came to the Enforcement Staff with an internal investigation of an issuer that had the difficulties of the SEC’s Pequot inquiry or that of the OIG would have received very rough treatment. By its own standards, the Enforcement Staff deserved the same.
The Pequot inquiry is past. What remains are the detailed recommendations by the Senate Finance Committee for improving the Enforcement Staff. These include standardizing investigative procedures, reallocating resources to significant and complex matters and other internal procedures designed to ensure that improper influences do not alter the course of enforcement inquiries. As the SEC and its Enforcement Staff assess how to implement the recommendations in the Report, a key question of importance to many issuers, executives and market professionals is whether this will result in a renewed emphasis on insider trading. After all, the Pequot inquiry was an insider trading investigation into a major hedge fund. One result of all this could be marshalling of resources and a new emphasis on insider trading, hedge funds and market professionals.
Last time Congress questioned the SEC about insider trading, within weeks the agency responded with a series of significant insider trading cases. Last September for example, Congress held hearings on insider trading (see post of Sept. 27, 2006). By early this year the SEC was bringing some of the most significant insider trading cases it had brought in years. Coincidence? Perhaps. But then consider the fact that as those cases were being brought Enforcement Chief Linda Thomson noted that the once safe harbor of Rule 10b-5-1 plans used by many corporate executives might not be so safe. The Enforcement Staff is scrutinizing the plans and the trading under them based on an academic study which suggested they were being abused. This is, of course, precisely how the current option backdating scandal started.
If past history is any indication, one immediate result of the Pequot debacle may be a new emphasis by the Enforcement Staff on insider trading. A logical first target is hedge funds and other market professionals. Next up, however, may well be corporate executives trading under the once safe harbor of a Rule 10b-5-1 plan and others with access to inside information. This suggests that market professionals as well as corporate directors and officers should carefully examine compliance plans before trading to avoid what may well be intense scrutiny in a renewed insider trading program. After all, the best defense is a good offense. If the SEC did poorly in defending its investigation into insider trading at Pequot, a string of successes in insider trading investigations would be just the thing to deflect congressional critics.