THE RENEWED CAMPAIGN ON INSIDER TRADING: Part II: If This is A Return to the “Den of Thieves,” is the Answer Better Enforcement?

In a widely quoted comment, an SEC enforcement official recently noted that insider trading is “rampant.” Another SEC official stated earlier that there is an increase in insider trading among market professionals. Both of these comments are reflected in the ever increasing number of insider trading cases brought by the SEC. Indeed, the trend seems to be reminiscent of the days chronicled in James Stewart’s book, Den of Thieves, about the insider trading scandals of the 1980’s.

Perhaps the 1980’s have returned. Consider, for example, SEC v. Guttenberg, Case No. 1:07-cv-01774-PKC (S.D.N.Y. Filed March 1, 2007) and related cases (originally discussed here). There, the SEC brought insider trading cases against 14 defendants. The cases involved two basic insider trading schemes. One scheme is the UBS scheme which ran from 2001 to 2006 where UBS insider Guttenberg tipped two Wall Street traders regarding up coming UBS analysts’ recommendations. The two traders had downstream tippees at other firms and hedge funds.

The second scheme involved a Morgan Stanley attorney, her husband attorney and other professionals. There, according to the allegations, the Morgan Stanley attorney misappropriated M&A information and tipped others.

What is perhaps most significant about the cases is the defendants: a “who’s who” of Wall Street players: a UBS registered representative, a Morgan Stanley attorney, a Lyford Cay hedge fund manager, an Andover brokerage representative, a Chelsey Capital portfolio manager, a representative from Jefferies & Co. and others.

The criminal case, U.S. v. Jurman, Case No. 1:07-cr-00140-TPG (S.D.N.Y. Filed Feb. 26, 2007) (and related cases) contained many of the same Wall Street professionals as defendants.

A second significant case involving Wall Street professionals is SEC v. Barclays Bank, Civil Action No. 07-CV-04427 (S.D.N.Y. Filed May 30, 2007). There, a major Wall Street bank and its proprietary trader for distressed debt were named as defendants in an insider trading case. The complaint alleged illegal profits from trading in debt securities of bankrupt companies where the bank and its trader obtained the inside information from positions held on various creditors committees.

While the Barclays case raises significant questions about the use of so-called “Big Boy” letters, discussed here, what is perhaps more important is the fact that is was brought directly against a major Wall Street institution.

A third case brought this year named a fund manager as a defendant, SEC v. Frohna, Civil Action No. 07-C-0702 (E.D. Wis. Filed August 1, 2007). In this case, the fund manager is alleged to have received inside information from his brother, who was leading a major clinical study for a significant drug at XOMA. The fund, which held a large stake in XOMA, is alleged to have avoided a large loss based on information Mr. Frohna obtained from his brother about the study. While there are significant materiality questions raised by this case, which are discussed here, again what is perhaps more significant is the defendant: another Wall Street professional.

These cases and another involving two Wall Street professionals, SEC v. Smith, discussed here, follow last year’s block buster cases, SEC v. Anticevic, Case No 05 Civ. 6991 (S.D.N.Y. Filed August 5, 2006) and the related criminal case, U.S. V. Plotkin, Case No. 06 CR 380 (RLH) (S.D.N.Y.) (and related cases). These cases involved three overlapping insider trading schemes: one involving inside information obtained from on Merrill Lynch M&A deals; a second involving advance information on copies of Business Week; and a third involved inside information concerning a grand jury inquiry into Bristol Myers. Again, however, what is disturbing is the involvement of Wall Street professionals.

Collectively these cases raise significant questions regarding the reasons for the current wave of “rampant” insider trading. While many argue that the current generation of traders have forgotten the lessons of the past that explanation seems a bit to glib. No doubt the amount of money to be made is tempting. Perhaps this wave of rampant insider trading says something about compliance and enforcement. Prevention often begins with good compliance not only by Wall Street players, but also every company. At the same time, no compliance program is bullet proof. In the end, consistent, effective enforcement by the SEC is key to preventing “rampant” insider trading. While the SEC is clearly stepping up its efforts in this area and there is no doubt that investigation and proof of these cases is difficult, perhaps it is time to carefully reevaluate enforcement in this critical area.