Asset Management Intelligence - May 2015 - Insider Trading: More Confusion or Clarity?

Published: May 6, 2015
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With all the recent headlines related to insider trading, one would think that there would be a clear picture of what constitutes insider trading. This has always been a nagging question, especially for SEC regulated firms providing advisory and brokerage services in exchange for a fee. The source of frustration intensifies because guidance must be provided to employees through written procedures that contain controls to ensure a violation of federal securities laws does not occur. This is difficult when there is confusing, at best, guidance provided by the very same regulatory agency mandating these procedures and a process for ensuring compliance with procedures or face censure, fines or even worse, an enforcement proceeding. This raises two nagging questions:

What is the source of confusion?
What can be done to ensure your firm is not caught up in an insider trading scandal?

A primary source of confusion is the often conflicting opinions issued by courts hearing insider trading cases, many of which have been brought by United States Attorney in Manhattan, Preet Bharara. Mr. Bharara has a track record of securing 85 convictions and guilty pleas from traders, analysts and industry consultants. One of his most prominent cases was:

Anthony Chiasson and Todd Newman, co-founders of Level Global Investors, were convicted on charges stemming from being the two most-senior Wall Street traders in an eight-member “criminal club” that traded shares of Dell Inc. and Nvidia based on corporate secrets, and received 6- and-a- half years apiece.

In a turn of events late in 2014, the United States Court of Appeals for the Second Circuit issued a landmark opinion overturning the insider trading convictions relating to the insider trading in Dell and Nvidia stock. It also rendered a view that would cast a pall over what constitutes insider trading.

The Second Circuit’s landmark opinion reversing Newman’s and Chiasson’s convictions effectively narrowed the scope of insider trading liability. The court held that the Newman Chiasson “jury instruction was erroneous because … in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.” While the proposition that the exchange of confidential information for personal benefit is the fiduciary breach that triggers liability for securities fraud is not new, the question now is what is the standard that a personal benefit must meet? Previously, ‘any’ benefit would suffice; however, there appears to be a new standard of personal benefit that interjects a materiality standard, meaning the person must receive a material benefit. The Second Circuit Court’s opinion has thrown the SEC and U.S. Attorney’s Office into a tailspin, resulting in an inability or hesitation to move forward with new insider trading cases. The good news is the book is not yet closed. The U.S. Attorney’s Office for the Southern District of New York has filed a petition for a rehearing and further suggested a rehearing “en banc” (or before the entire bench rather than a panel), arguing that the panel got it wrong and in the process has threatened the integrity of the entire securities markets.

This process of proving the tippee’s motive and degree of personal benefit is difficult and confusing; what’s material to one person may not be material to another. This creates a degree of difficulty for groups such as investment advisers to private and registered funds, broker-dealers, banks and wealth management firms, attempting to thread the needle of continuing with business as usual and, at the same time, not violating federal securities laws.
The natural course of action for firms to take is to turn to their compliance department for advice on how to not violate the law. This is a daunting task and leads to our second question.

What can be done to keep your firm from being caught up in an insider trading scandal? The best approach is to keep it simple. Since it is almost impossible to address the nuances surrounding the legal interpretations of what constitutes insider trading, it would not be a productive use of time to attempt to sort it all out.   Simply be sure you are aware of business activities in high-risk areas, especially those that would most likely obtain possession of non-public information of a public issuer. For investment advisory firms, these areas would include portfolio management, trading, direct access to a public reporting company’s CFO, participation in creditor committees, access to virtual data rooms, outside business activities, industry conferences and personal relationships where access to non-public information is available, such as family or close friendship with an attorney at a law firm or a trader at a sell-side brokerage firm.

Lastly, be sure you have a tailored compliance program with well-trained compliance professionals performing risk-based forensic testing and monitoring, and compliance personnel embedded in high-risk business areas, such as trading, portfolio management and M&A departments. The chief compliance officer participates in senior-level meetings where sensitive firm decisions are made and ongoing reviews of department head activities is part of your supervisory oversight process to help uncover emerging and not previously identified conflicts of interest.   A well-structured compliance program and oversight process will send the right message to your regulator that you have done all that is possible to reasonably ensure a violation of federal securities laws do not occur.

Asset Management Intelligence - May 2015