Federal Securities Law Source

Monthly Archives: May 2009

Mark Cuban Insider Trading Case

On Tuesday Dallas Mavericks owner Mark Cuban had his first hearing in an insider trading case brought by the SEC. In dispute is whether Cuban agreed to maintain the confidentiality of sensitive information about Internet search engine company, Mamma.com, only to then use such information to sell shares prior to public announcement of the information. The SEC alleges Cuban avoided more than $750,000 in losses by engaging in insider trading. The pleadings in the case are available here.

Some commentators claim the SEC is overreaching. Unlike traditional insider trading cases, Cuban was not a true insider such as a director, officer, or 10% shareholder, and he argues he was not someone who misappropriated confidential information. Cuban argues he was just a stockholder who received non-public information and traded on the basis of such information. Absent other facts, this is not illegal.

The SEC counters that Cuban had an oral agreement to keep information confidential and thus a duty that he breached when he traded on the confidential information. SEC Rule 10b5-2 states that a duty of trust or confidence exists in this context “whenever a person agrees to maintain information in confidence.” Cuban counters that this rule is either invalid or does not apply to business relationships.

The case highlights an important legal underpinning of insider trading: trading on non-public information is not illegal unless in doing so one breaches a duty of trust, either to one’s shareholders, employer, or the source of the information, depending on context. But …

SEC Surprise Exams of Investment Advisers

The SEC is considering rule amendments that would make it harder for an investment adviser to steal client assets and provide fake account statements. The rules are designed to give more protection to investors who give custody of their money to investment advisers, a practice that will always involve some level of trust and some potential for fraud.

One proposal is to subject investment advisers to a yearly “surprise exam” to make sure the investment adviser hasn’t misappropriated a client’s assets. Investment advisers don’t necessarily have physical custody of client assets, but they often have authority to withdraw client funds, or they may be affiliated with the bank or broker who does have physical custody.

If the rules are eventually adopted, an independent public accountant will be the third-party monitor. More controls and surprise exams mean more cost. The SEC/Congress should consider what is less expensive: surprise exams or a requirement that client assets be held by independent custodians.  …

Grant Thornton Executive Compensation Survey

Grant Thornton has a relatively recent (February 2009) survey on its website regarding executive compensation that reports 50% of companies surveyed are freezing executive base salaries for 2009 and 15% are reducing salaries. 227 companies responded to the survey, of which the “typical” company seems to be publicly traded with revenues below $100 million and 100-499 employees.

The numbers highlight a motivation problem for companies and their employees, namely how to structure a compensation program when bonuses, salaries, and stock prices are down. Companies that lower bonus targets, re-price options, and start “special retention programs” risk investor criticism for rewarding the executives who contributed to the company’s decline. Conversely, investors who recognize that a decline is not necessarily the result of poor executive performance often want to continue to motivate key employees.  …

FTC Extends Red Flag Rule Deadline, Promises Compliance Template

The FTC has extended the enforcement deadline of its Red Flag Rule to August 1, 2009, for most “creditors” under the Rule that are not already subject to enforcement as financial institutions.

The American Medical Association vows to use this extra time to lobby that doctors are not “creditors” under the Rule. The FTC disagrees for now, and even posts information specifically for health care providers on its red flag website.

The FTC promises to release a “template” to help companies with a low-risk of enabling identity theft to develop programs to identify red flags that signal potential identity theft. The AMA calls their own version of a template a “sample policy.”

Despite the AMA’s protesting, the health care industry may have an easier time complying than others given they already have to comply with the Health Insurance Portability and Accountability Act (HIPAA). Telecom, Utilities, car dealers, and retailers are starting from zero.  …

Illegal Insider Trading and the Healthcare Industry

The SEC announced yesterday charges against a former Citigroup investment banker who allegedly tipped his friends and family about upcoming mergers involving Citigroup’s healthcare industry clients, resulting in more than $5,000,000 in illegal insider-trading profits.

The case highlights a common insider-trading scenario: an employees uses inside information not to trade stock in his or her employer, but rather to trade stock in the employer’s clients.

In particular, privately-owned companies tend to think of illegal insider trading as a public-company problem, but often private companies and their employees are privy to information about public-company clients that can lead to insider trading concerns.

For example, the healthcare industry has a strong support industry of researchers, policy analysts, consultants, lobbyists, etc., all of whom potentially have access to material non-public information from their public healthcare clients that can be used to engage in illegal insider trading.

This raises a host of issues for private companies that service public companies, including:

  • Should we have a company policy regarding employees owning stock in our clients?
  • Should we accept stock as payment for services?
  • If an employee who knows a lot about the industry makes great stock picks in client stock, will it seem like illegal insider trading even if technically it is not?
  • If an employee pieces together a series of seemingly inconsequential non-public information and trades stock based on that information, what are the chances he or she will be accused of illegal insider trading?
  • Is there a difference between having a hunch something good will happen