October 26, 2010
Insider trading on the railroad ...
Andrew Ross Sorkin flags this recent insider trading prosecution. It's of a breed of cases where the SEC is pursuing its "level playing field" theory of insider trading. Traditionally, there has to be a breech of a fiduciary duty tied to the trading in order to lead to liability of the insider trading laws. The SEC, obviously, hates that. They have pushed for years to get the court to adopt a level playing field theory that would permit prosecutions even in the absence of a fiduciary obligation. Such was the case last year in SEC v Dorozhko. That was the case of a hacker who stole inside information and was then prosecuted for trading on it. Clearly, hacking is a bad act. But, was it insider trading? The Second Circuit thought so.
Now comes the SEC's prosecution of this group of 5 railway engineers, railyard workers, and their families. Their crime? According to Sorkin, they were a little too observant for their own good.
(a) in early March 2007, FECR’s Chief Financial Officer requested that Gary Griffiths prepare a comprehensive list of all of the locomotives, freight cars, trailers and containers owned by FECR, along with their corresponding valuations, which she had never requested before;
b) Gary Griffiths became aware of the unusual number of Hialeah yard tours, which began on March 15, and he believed that the tours were being provided to investment bankers who were considering buying or investing in FECI; and
(c) shortly after the tours began, yard employees began asking Gary Griffiths whether FECI was being sold and whether their jobs would be affected by any such sale.
I don't know. It strikes me as a bridge too far. Although, this group did have the sense to go big - scoring $1.6 million in profits. Anyway, I don't imagine the SEC has exhausted its supply of inside-trading investment bankers to go after. It's a little odd that they would focus on this crew.
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The Second Circuit held in Dorozhko that deception in connection with the purchase or sale of securities occurred, even in the absence of a breach of a fiduciary-like duty to the information source, IF he made an affirmative misrepresentation to the information source's agent when he hacked the information the information on which he traded (e.g., by providing a false login ID). Dorozhko's deception was in lying, if he did, not in stealing. The Second Circuit remanded the case for the district court to decide whether Dorozhko lied, but he disappeared, so summary judgment was entered for the SEC.
Under Chiarella and Basic, the reason a breach of a fiduciary-like duty is required for a 10b-5 violation is that silence is fraud only if there is a duty to disclose. The sensible point made in Dorozhko is that affirmative misrepresentation is fraud even without a duty to disclose arising from a fiduciary-like relationship.
Here, the low level of the employees make this new case bad PR for the SEC. But even low-level employees (like Chiarella himself) are insiders, so how is this anything but a straightforward application of the classical theory?
Posted by: Vic | Oct 26, 2010 3:17:39 PM