M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Friday, July 30, 2010

Now that's insider trading!

You know, I can't understand why people risk so much (career, reputation, family) for so little.  How many times have you heard about the lawyer who gave in to the temptation to trade on client confidence only to reap $5,000 profit and an indictment.  Now, comes word of two guys who know what they are doing.  The SEC alleges that the Wyly brothers of Texas used a series of offshore trusts and corporations to engage in a monumental sized insider trading scheme to the tune of $750 million worth of stock and profits in excess of half a billion dollars!  On one series of transactions they allegedly earned more than $30 million. "Go big, or go home" as they say.  

According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, the public companies the Wylys used in the scheme were Michaels Stores Inc., Sterling Software Inc., Sterling Commerce Inc., and Scottish Annuity & Life Holdings Ltd. (now known as Scottish Re Group Limited)

 The SEC's complaint alleges that the Wylys and French knew or were reckless in not knowing their legal obligations as public company directors and greater-than-five-percent beneficial owners. The laws require such persons to report holdings and trading in their companies' securities on Schedule 13D and Form 4, which are filed with the SEC. The Wylys and French also knew or were reckless in not knowing that the investing public routinely uses such disclosures to gauge the sentiment of public companies' insiders and large shareholders about the financial condition and prospects of those companies, relying on those disclosures when making investment decisions.

The SEC alleges that the Wylys and French systematically and falsely created the impression that the Wylys' entire holdings and trading were limited to the fraction that they held and traded domestically. By depriving existing shareholders and potential investors of information deemed material by the federal securities laws, the Wylys were able to sell — in large-block trades alone — more than 14 million shares of issuer securities over a period of 13 years for undisclosed gains in excess of $550 million. The SEC further alleges that the sales generating most of these illicit gains were made pursuant to materially false or misleading SEC filings.

Read the complaint here.  My first reaction was, “Thank goodness the Wylys not lawyers.”  Then I realized that their alleged co-conspirator is French, the lawyer.  And, that their entire scheme would have been impossible without the help of a lawyer.  In fact, as far as I’m concerned if what has been alleged is true then the lawyer is at the heart of this decade long scheme.  It gets worse.  The lawyer was not content to simply set up and help run this conspiracy (while also sitting on boards), but he is alleged to have set up his own (smaller) network to carry out similar trades.  If you are a rising 3L studying for your MPRE next week, these guys as described in the SEC's complaint are not exemplary figures. 

I doubt ignorance of the disclosure rules will fly as an excuse (from the complaint):

Moreover, by the time the fraudulent scheme detailed herein commenced in early 1992, Sam Wyly and Charles Wyly each had over twenty years' experience as public company directors and Schedule13D and Form 4 filers; and Michael French had over twenty years' experience as a federal securities lawyer. They were each thus on abundant notice of the relevant SEC reporting obligations.

The SEC alleges that the Wylys with help from their lawyer used their positions as directors of public companies to trade on inside information in advance of mergers and other material corporate transactions.  You know, like during the Gilded Age, when public company directors routinely traded on inside information. 

In October 1999, after having agreed to put Sterling Software on the selling block, the Wylys had their Offshore System enter into a bullish offshore transaction in the form of a security-based swap agreement with Lehman Brothers that economically replicated the purchase of two million shares of Sterling Software for approximately $20.36 per share. Based on Sterling Software's closing price of$36.25 on February 14, 2000-the date that Sterling Software's agreement to be acquired by Computer  Associates was announced-the Wylys' illegal imputed profits from this transaction totaled approximately $31.7 million.

In what universe can someone think that this kind of activity would not violate federal securities laws?!  They probably knew it violated lots of securities laws, but that doesn’t seemed to have mattered much (again from the SEC's complaint).

As high level insiders of the Issuers, the Wylys and French were aware of the negative impact that sales by them of Issuer Securities-including the above detailed large-block sales-would potentially have on the Issuers' share prices if they were disclosed in accordance with law. In effecting these sales offshore, the Wylys and French were motivated by a desire both to avoid such declines and to eliminate any risk thereof. On March 24, 1995, for example, French wrote to Sam Wyly that filing of "insider sales reports ... seem to set everybody off" and that selling offshore without making such filings would facilitate "pull[ing] some gains out ... without attracting any attention." In September 2001, Sam Wyly elected to forgo an onshore collar transaction in Issuer Securities and instead attempted the same transaction offshore, in order to avoid any bearish signal to the market; and Charles Wyly, in September 2003, took a similar action for the same stated reason.

Hmm.  The best way for an insider to pull out some gains without attracting any attention is with a planned sale program.  Lots of firms have them.  Maybe the Wylys have heard about such programs.  On the other hand, planned programs are terrible if you want to make money on inside information about a pending transaction.  So, I can understand why one might neglect to pursue that option.  You’ve got to hand it to them.  They’ve got guts thinking that they could carry this out for so long.  ... And there’s a question worth asking.  How is it possible that the SEC, brokers, I-Banks, etc let them get away with this for so long?  I mean $500 million is still a lot of money.



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You state: "How is it possible that the SEC, brokers, I-Banks, etc let them get away with this for so long? I mean $500 million is still a lot of money."

I have one word for you: Madoff. The bigger the crime, the less likely that the SEC will even see it or understand it.

Posted by: David | Aug 3, 2010 4:13:34 AM

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