Friday, March 18, 2011

Insider Trading Lessons For Executives

I am constantly amazed at the amount of insider trading cases brought by the Commission. While the SEC often goes overboard in their cases, and sues individuals who did nothing wrong, (see, Mark Cuban), the simple fact is there are far too many occasions where an individual, and in particular a corporate executive, is charged with insider trading.

I suppose that there is the thought that the trader will not get caught, and the allure of big profits is simply too much to ignore. However, in this day and age, it is extremely easy to track down insider trading.  The Commission has extensive tools at its disposal to do so. The simple fact is that the Commission will look at every account that purchased a stock prior to the disclosure of the material information. it will then subpoena the brokerage account statements, and then subpoena the individual to provide documents and a deposition.

The Commission will also start matching up that individual with the other accounts who purchased the stock, and investigate any connection between the executive and those other accounts. It will ask the executive about those accounts at the deposition. Keeping in mind that lying to the SEC is itself a crime (see, Martha Stewart) it is simply a matter of time before the SEC finds the executive's account, as well as the accounts of his wife and his buddies.

Many times the individual has made legitimate purchases. On more than one occasion I have been able to demonstrate to the Staff that my client was an active trader, and that he simply made the correct trade at the correct time, or that he had been following the stock and purchased it when he did because of various public information that he obtained, and could demonstrate that he had at the time of the purchase.

If there is any doubt about what I am saying, all one needs to do is to search the SEC press releases for the term "insider trading."   Yesterday brought the latest example. The Commission has filed charges against four executives and four of their families and friends with insider trading in advance of the the acquisitionof their company.

Granted, these are only allegations, but if your company is being acquired, you have to think long and hard about purchasing its stock in the days leading up to the announcement. If that is the case, and if you do that, the SEC will find out about it. They will, it is as simple as that, despite the black eye from the Madoff scandal.

Obviously, the defendants may have explanations and defenses, but why put yourself in that position? Presumably an executive of a public company already has stock in the company, the acquisition will, or should, increase the value of that stock, and there is a legitimate profit to be made. Heck, that is the profit that most entreperneurs are looking for - create a company, sell it to a bigger company, made big money.

The allure of the addtional profit by making additional purchases is certainly real, but the down side is tremendous. Putting aside the embarrassment of having your name in the paper and press as being accused of securities fraud, the Commisison will seek not only a return of the profits, but a penalty equal to three times the profit! And they will get those remedies. You will need to defend that claim, and ven if there is a legitimate business or investment reason to buy the stock during the acquisition discussions, the risk of being named in a SEC proceeding, and the cost of defending that proceeding, are significant.

Not to mention having your wife and friends dragged into the mess.  That will happen, because the SEC will also charge whomever it thinks received the information from you and purchased the stock. In yesterday's example, the Commission charged the executives and the friends and families of three of the four. The Commission is alleging that the group purchased nearly $600,000 in stock in the month prior to the announcement, and had a profit of $320,000.

Again, there are defenses to these claims, and the SEC is not always correct in its allegations, but the question is, is the $320,000 spread over 8 individuals worth the risk, knowing that the odds are that the SEC will in fact look into those transactions?

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