The SEC, Insider Trading and Prosecutorial Obligations
Proving a close personal relationship between a corporate insider and a trader can be key to establishing illegal tipping. The relationship can support a claim by the SEC or the DOJ that the inside information was transmitted by the insider as a gift to the trader, establishing there was a breach of a fiduciary duty for a personal benefit. This point was repeatedly discussed during the oral arguments in Salman before the Supreme Court.
A close personal relationship can, however, be a double edged sword. That relationship can at times help explain conduct which might appear to be suspicious but which is in fact innocuous, ordinary. This was precisely the case in the Commission’s most recent insider trading trial which resulted in verdict for the defense. In the Matter of Charles L. Hill, Jr., Adm. Proc. File No. 3-16383 (Initial Decision April 18, 2017).
The facts — overview
The case centers on the tender offer by NCR Corporation for Radiant Systems, Inc., announced on July 11, 2011. Respondent Charles Hill is a real estate developer. John Heyman was the CEO of Radiant. His brother Andrew was the COO. Todd Murphy – a key witness in the case — is an artist. He is a long time personal friend of Andrew. In the Order the Division of Enforcement alleged that Andrew illegally tipped Mr. Murphy who in turn tipped Mr. Hill. Mr. Hill traded prior to the deal announcement through multiple accounts and sold his positions after the announcement, yielding seven figures. The Order alleges Mr. Hill violated Exchange Act Section 14(e). At the hearing the Division called five witnesses, including Mr. Hill, while Respondent called two, one of which was Todd Murphy.
NCR CEO William Nuti contacted John Heyman in May 2011, raising the possibility of acquiring Radiant. Following a meeting in New York NCR offered to acquire the firm in a letter dated May 12, 2012. A price in the $24 range was discussed. After a May 23 Radiant board meeting attended by Andrew, John told his NCR counterpart that the offer was not adequate but if the price was increased a deal was possible.
Radiant began due diligence during which the firm explored the prospect of being acquired by another firm. NCR also began due diligence. Andrew participated in that process, educating NCR’s representative about the firm’s business. Andrew later met William Nuti at a dinner in New York with his brother John. John anticipated that following a NCR-Radiant deal he would step aside and his brother would take over the operations of the acquired company. By May 26 Andrew assumed this would be the position going forward.
On June 1, 2011 John, Andrew and Radiant’s investment bankers met with other potential buyers. The next day John, Andrew, William Nuti and an NCR vice president discussed a variety of topics, including the post-merger organizational structure. Two days later there was a due diligence meeting with NCR, John, Andrew and Radiant’s investment bankers. Radiant ‘s board again rejected NCR’s proposal as inadequate on June 14.
The executives of both firms continued conversations. On June 30 Radiant agreed that it would deal exclusively with NCR. On July 6 Andrew flew to New York for a dinner meeting with William Nuti. After the meeting Andrew met with friend Todd Murphy. Both testified Radiant was not mentioned.
On July 11 Radiant’s board approved NCR’s bid at $28 per share. After the close of the markets the deal was announced.
Real estate developer Hill sold a restaurant site in February 2011. He intended to allocate $2.55 million of the proceeds to two other sites. By May 2011 both transactions terminated. In mid-May he visited SunTrust where his business accounts were located. At the time he had been close friends with Todd Murphy for years and had financially supported some of his art projects. He also knew Andrew through Murphy and that he worked at Radiant.
At SunTrust Mr. Hill was introduced to financial adviser Lynn Carter. During the conversation Mr. Hill stated that he had $1.1 million to invest. Ms. Carter proposed certain investments. Mr. Hill did not follow her advice. He also did not discuss Radiant.
Following his meeting at SunTrust, Mr. Hill decided to open a trading account at Vanguard. He was also the custodian of three accounts for his daughters. Those accounts had not purchased stocks from 2006 through 2011.
Mr. Hill testified that he did not invest in stocks during the financial crisis. He had, however, been following the Radiant for years, according to his testimony. Based on his analysis – no financial adviser suggested purchasing Radiant – Mr. Hill purchased 4,500 shares of the stock for his daughters’ accounts on June 1. Two days later he purchased 50,000 of the stock through his SunTust account. Later that month he acquired another 13,000 shares through his new Vanguard account. Finally, in July Mr. Hill made three additional purchases: on July 1 he acquired 20,000 shares through his Vanguard account, on July 5, 4,100 shares for his daughters and on July 8. 10,000 shares in his SunTrust account.
Following the deal announcement Mr. Hill sold 8,600 shares from his daughters’ accounts for about $240,000 and all 93,000 shares he held in his accounts for about $2.6 million.
The key participants here knew each other. John Heyman and Charles Hill met through their children who were in the same social circles. Andrew Heyman had met Charles Hill through Todd Murphy with whom who had been his close friends for years. Andrew and Charles Hill regularly communicated with Todd Murphy through text messages and phone calls.
Andrew testified at the request of the Division, noting that he made several million dollars from the merger. ALJ Grimes concluded that there was no doubt he was aware of the merger negotiations as well as the firm’s prohibitions on disclosing inside information and the adverse consequences that could ensure from revealing such information.
Andrew also testified about his long standing relationship with Mr. Murphy. The relationship traced to their time together at the University of Georgia. Todd Murphy was as close “to being a family member” as possible. Andrew had invested several hundred thousand dollars in business ventures with Mr. Murphy. Andrew “credibly and plainly testified that he did not tell Murphy anything about the possible merger with NCR,” the ALJ concluded. While he did respond to a number of questions by stating “I don’t recall” or with similar answers, the questions typically focused on specific details on specific dates – the kind of information that one typically does not necessarily remember.
Todd Murphy testified at the request of Respondent, not the Division despite its claim that he tipped Mr. Hill. Mr. Murphy “denied that he had any knowledge of Radiant’s merger with NCR before it was announced . . . [or that he was] told anything about it by Andrew, overhead Andrew discuss it, or . . . [saw] anything or inferring anything about the merger.” Although he met with Andrew in New York at a restaurant on June 6 – Andrew met with NCR executives for dinner earlier – he denied the two men discussed the deal. The two men had a series of communications during the deal negotiations. The overall pattern was consistent with that of their pre-merger texts and calls. ALJ Grimes found his testimony credible.
Finally, Mr. Hill denied that he had inside information. He acknowledged to being close friends with Mr. Murphy and to occasionally loaning him money. Likewise, he acknowledged communicating with Mr. Murphy during the deal negotiation, but denied that they discussed Radiant or the deal. Again, the pattern of the communications was consistent with that of their pre-deal discussion. ALJ Grimes found his testimony credible.
The Division argued that the circumstantial evidence, and in particular Mr. Hill’s trading pattern, coupled with his repeated communications with Mr. Murphy at a time he was communicating with Andrew, established insider trading in violation of Section 14(e). In this regard the Division pointed to the repeated large trades of Mr. Hill during the negotiations. Such “suspiciously timed trades constitute significant circumstantial evidence . . .” the ALJ noted. While the Division can meet its burden through circumstantial evidence — suspicion is not proof of insider trading. The trading pattern, standing alone may be suspicious but it is insufficient to establish insider trading, according to the Initial Decision.
Analysis of the repeated communications involving Andrew and Todd Murphy and then Messrs. Murphy and Hill do not change this fact. Those communications create opportunity but are not proof of tipping. There is no evidence that the men actually discussed the deal. To the contrary the pattern of communications by these men was wholly consistent with their pattern of text messages and phone calls before the deal negotiations began. As ALJ Grimes concluded: “the frequency of Andrew’s communications with Murphy in 2011 is not unusual, and, without more, is evidence of very little. . . the Division presented no direct evidence of any particular text message or phone call in which anything remotely suspicious was discussed. Instead, the only direct evidence it presented about the content of Murphy’s text message reflected entirely innocuous communications.” Accordingly, the proceeding was ordered dismissed for a failure of proof.
The SEC has brought a series of “suspicious trading” cases this year. In those cases the agency has presented trading patterns which suggest insider trading coupled with a request that the court freeze the trading profits while discovery is conducted. Filing such a complaint to preclude the dissipation of potentially illegal trading profits may be appropriate. Charging someone with insider trading on such a basis is not.
Here the SEC had little more than a trading pattern and a series of text messages and phone calls before and during the deal. As ALJ Grimes properly concluded that evidence does not prove insider trading. Yet here the agency not only charged Mr. Hill with violating the law it proceeded through a lengthy pre-hearing process and a costly trial.
There is no doubt that the SEC should aggressively prosecute insider trading and other violations of the law. That is the Commission’s mandate. But the hallmark of good, effective enforcement is fundamental fairness. Charging someone with violations of the law carries a stigma which last long after the case is dismissed; prosecuting that case through trial only increases that harm, grinding the stain and injury into the reputational fabric of the person prosecuted.
Where the agency has a solid case bringing charges but loses at trial that is one thing – the best and worst of cases can be won and lost. Where the agency does not have the evidence it is quite another. Under those circumstances the agency as prosecutor has a fundamental obligation to drop the case – not try for a face saving settlement – dismiss it with prejudice.
Here the SEC failed to live up to its obligations as a good, fair prosecutor. The SEC tacitly admitted it had no case, yet proceeded to trial. Failing to call Todd Murphy says it all. Mr. Murphy was the key link in the chain between insider Andrew with the inside information and Respondent Hill and his trading, according to the Division of Enforcement. There was no substitute, no excuse, for failing to call Mr. Murphy and either have him testify to being tipped, or if he denies it, demonstrating that those denials lack credibility. Here the Division did neither. As ALJ Grimes concluded it is “telling that, despite its burden of proof and its allegations that Murphy passed inside information to Hill, the Division rested without calling Murphy to testify. . . Instead, Hill called Murphy, who testified that he never learned anything from Andrew about Radiant’s possible merger with NCR.” (emphasis original). This is not the stuff of effective enforcement; it is the stuff of a irreparably damaged reputation for Mr. Hill and the carnage of breached obligations and lost credibility for the Commission.