TRENDS IN INSIDER TRADING ENFORCEMENT
Headline grabbing insider trading cases such as the up coming Galleon trial and the so-called “expert network” investigations are being lead by the Manhattan U.S. Attorneys Office, although in some instances the Commission has filed parallel actions. The trial and the investigation are built on blue collar tactics such as wire taps and confidential informants who are sometimes wired. In view of this there are questions about the future role of SEC enforcement in insider trading enforcement.
The answer to these questions may be reflected in the Commission’s most recent insider trading. In SEC v. Fan, Case No. C11-0096 (W.D. WA. Filed Jan. 18, 2011) the SEC brought an insider trading case which involves three family members. Defendants Zizhong (James) Fan and Zishen (Brandon) Fan and relief defendant Junhua Fan are all relatives. James was employed at Seattle Genetics as the manager of clinical programming. Seattle Genetics is a clinical stage biotech company which develops therapies for the treatment of cancer. Brandon resides in Chino Hills, California while Junhua lives in Beijing, China.
James and his team were involved in clinical trials for a drug known as SGN-35, a product to treat Hodgkin’s lymphoma. His direct reports had access to data about the trials in July and August 2010. Between August 24 and September 24, 2010 Brandon purchased over 2,750 Seattle Genetics options at a cost of $360,000. The contracts were acquired through Junhua’s account.
The complaint identifies three specific trades, matching them to events at the company in which James participated:
• On September 10, 2010 Brandon spent $45,000 for Seattle Graphic options due to expire on October 16. Two days earlier James attended a staff meeting to plan for the receipt and sequestration of the final results of SGN-35. He also learned that the company would issue a press release regarding the pivotal clinical trial on September 27 about the drug.
• On September 17 Brandon purchased $40,000 worth of options again set to expire on October 16. That same day James obtained the final data from the SGN-35 clinical trial.
• On September 24 Brandon purchased an additional 500 call options for $65,000. The purchase represented nearly 50% of all Seattle Genetics option contracts in that series purchased that day. The same day James attended meetings at which the results were finalized for a presentation about the drug to senior executives. The company also began preparing to disclose the results to the public.
On September 27 the company issued a press release and conducted a webcast to disclose the results. The price for company shares increased about 18%. Over the next month Brandon liquidated the options at a profit of $803,000.
The SEC staff contacted both defendants on January 13, 2011. Later that day $50,000 was transferred from the brokerage account to a domestic bank account in Junhua’s name. The next day there were two unsuccessful attempts to transfer a total of $300,000 in trading profits to an account in China. On that day James told his employer he was leaving for China. A request to transfer $500,000 was pending on January 18. The Commission filed its action the next day alleging violations of Exchange Act Section 10(b) and announced on January 21 that it had obtained a temporary freeze order over the accounts. The case is in litigation.
Fan is based largely on trading and facts regarding access to inside information. The Commission has sought to bolster those facts with a kind of tacit admission of guilt regarding efforts to move the trading profits following an inquiry by the SEC staff. In the past the Commission has filed similar actions shortly after the deal announcement to freeze trading profits which appeared to have been obtained from insider trading.
Those actions by the SEC contrast sharply with the recently filed criminal cases developed from the expert network insider trading investigation (here). Those cases are not based on trading by the defendants. Indeed, they do not even allege trading. The criminal charges are not insider trading but conspiracy to commit securities fraud. The factual allegations are not based on an analysis of trading but tapes of conversations supposedly involving the transmission of inside information obtained by confidential witnesses.
The difference between Fan and the expert network cases may suggest future trends in insider trading enforcement. The SEC may tend to take the lead in cases brought after the trades where an analysis of trading patterns, access to information and similar facts are critical and swift action is necessary to freeze trading profits. These cases would typically center on corporate executives and others who have access to inside information.
In contrast DOJ may tend to focus on areas where its blue collar techniques of wire taps and wired informants may be most effective. Viewed in this context criminal prosecutors could be expected to concentrate on market professionals and traders who use multiple sources of information in an effort can be expected to obtain an edge over the competition. Neither approach of course is exclusive. At the same time the SEC will undoubtedly bring civil actions which parallel criminal cases. DOJ can be expected to file criminal charges parallel to selected SEC cases. Together these approaches suggest very aggressive insider trading enforcement in the future.