M & A Law Prof Blog

More Bad Lawyers and Galleon

Well ... Galleon claims another lawyer scalp.  The SEC and the US Attorney's Office in the Southern District of NY announced that Brien Santarlas, another former Ropes & Gray attorney has pleaded guilty to criminal insider trading charges.  According to the USAO's criminal complaint: 

From June 2007 through May 2008, SANTARLAS conspired with others to steal material, nonpublic information ("Inside Information") from the law firm of Ropes & Gray for the purpose of buying and selling securities. In violation of his duty of confidentiality to the law firm and its clients, as well as Ropes & Gray's written policies and procedures, SANTARLAS stole Inside Information about several mergers and acquisitions of public companies for which Ropes & Gray was providing legal services, prior to the public announcements of the deals. Specifically, SANTARLAS stole Inside Information about the acquisitions of 3ComCorporation and Axcan Pharma, Inc., and provided it to his co-conspirators in exchange for thousands of dollars in cash payments. As a result of trading that was based on the Inside Information provided by SANTARLAS and his co-conspirators, other individuals collectively made millions of dollars in illegal profits. 

SANTARLAS, 33, of Hoboken, New Jersey, pleaded guilty today to one count of conspiracy to commit securities fraud and one substantive count of securities fraud. The conspiracy charge carries a maximum sentence of five years in prison and a maximum fine of the greater of $250,000, or twice the gross gain or gross loss from the offense. The securities fraud count carries a maximum sentence of 20 years in prison and a maximum fine of $5 million, or twice the gross gain or loss from the offense.

The SEC's complaint alleges that Santarlas together with Cutillo were part of the same insider trading network.  The SEC alleges that Santarlas stole inside information regarding pending acquisitions by stealing it from Ropes' electronic network.  For his trouble, Santarlas allegedly received $25,000.  Geez, not even enough to pay off his loans from Franklin Pierce.

If you read the SEC's complaint closely, you'll see that the SEC connects Cutillo directly to the trading network by way of phone calls.  Santarlas however is no where to be seen in the wiretaps.  One wonders how the FBI was able to tie Santarlas to the ring?  I have a guess.  When you look at a document on Ropes' document server, I guarantee you that a record is kept of who you are and whether you edited the document or simply viewed it.  It wouldn't be all that hard, if someone was looking at documents on the server to go in ex post and figure who it was.  Notwithstanding the fact that these guys were tech-types, turns out they weren't all that tech savvy.  

Turns out that's not the only way they got their information, according to Bloomberg, they they also eavesdropped on others’ conversations, and questioned unwitting lawyers at the firm to learn details of impending deals: 

- "Whatcha working on?"  
- "Oh, not much.  We're selling 3Com to a PE investor.  Too bad insider trading rules prohibit me from trading on that info."
- "Yeah, too bad."

One important lesson for Ropes I think is that they need to seriously reconsider their training programs.  

Both Cutillo and Santarlas (courtesy of the Way- Back-Machine) were litigation associates in Ropes' IP group.  I wonder whether litigation associates at Ropes are given adequate training with respect to their obligations under the insider trading laws?  I suspect that corporate and transactional associates have it pretty well drilled into them, but are the litigation associates sent to depo training instead of the insider trading sessions?  If so, that's turning out to be a really poor decision.  If everyone in the firms has access to confidential inside information at the tap of a few keys, then everyone ought to be trained the same with respect to how one treats that information.  Just saying.

-bjmq

  

Insider Trading in India

Here's a relatively recent empirical study of insider trading in India in advance of merger announcements, Merger Announcements and Insider Trading in India: An Empirical Investigation.  Shorter version:  insider trading is rampant.  Don't be surprised.  It's apparently rampant here.  Why shouldn't it be in India as well? 

Abstract: Insider trading activity is investigated prior to merger announcement in Indian capital market. An attempt is made to check it out whether trading takes place on the basis of asymmetric and private information. For examining the behaviour of stock prices a modified market model is used to estimate the parameters for the estimation window. These estimates are used to compute average return and cumulative average returns for the event window, which are measures of abnormal returns. Besides price run-ups, it is also common to see unusually high levels of share trading volume before public announcement of merger. Daily trading volume pattern of the target companies is also investigated. The analysis carried out in this study is based on a sample of 42 companies for which merger announcement date was announced during the period of 1996-1999. Based on the analysis for each company individually, we recommend investigation in six companies for existence of possible insider trading.

-bjmq

3Com Options Trading...More Insider Trading?

OK, it's almost too much to bear.  Someone stop the madness.  Bloomberg is reporting that 3Com options were trading at records volumes and a 26-month high just prior to today's announcement of 3Com's acquisition by HP.  

Almost 4,000 of the November $5 calls and 3,300 December $5 calls traded today, with almost all of the transactions occurring at noon. That compares with a total of six puts giving the right to sell 3Com shares. Hewlett-Packard, the world’s largest personal-computer maker, agreed to pay $7.90 a share in cash for 3Com, a 39 percent premium to today’s closing price.

You'd think people weren't paying attention to Perot Systems/Dell deal of just a few weeks ago.  As Zvi Goffer might say, trading short-term call options just before the announcement of a transaction is a ticket to the [expletive] big house. 

-bjmq

Update:  Bloomberg is not letting go of this story.  Good for them.

“I don’t believe in that much luck,” said Steve Claussen, chief investment strategist at OptionsHouse LLC, the Chicago- based online brokerage unit of options trading firm PEAK6 Investments LP, and a former market maker at the Chicago Board Options Exchange. “If you’re on the other side of someone buying calls and a takeover is announced, it’s like someone held you up at gunpoint. It’s like you’ve been robbed and you feel violated.”

...

More than 8,000 3Com calls changed hands yesterday, 17 times the four-week average. The most active were contracts conveying the right to purchase 3Com for $5 through Nov. 20, followed by December $5 calls. The shares rose 5.2 percent, the most since Sept. 28, to $5.68 in Nasdaq Stock Market composite trading prior to the announcement.

"Artie" was right to be spooked

Don't trade options.  Yes, that's right, but it turns out these guys weren't as smart as they thought.  Best not to share confidential information about your client's transaction with anyone.  From the DOJ's criminal complaint:

At one point defendant Drimal allegedly tells a confidential informant that the source for his inside information was a lawyer and that he had no idea why he [Cutillo] "was risking his legal career and possibly 'jail' by providing [inside] information."  Indeed. 

-bjmq

More Bad Lawyers...

The Galleon case takes more scalps.   From the SEC's litigation release.

The Securities and Exchange Commission today announced insider trading charges against nine defendants in a case involving serial insider trading by a ring of Wall Street traders and hedge funds who made over $20 million trading ahead of corporate acquisition announcements using inside information tipped by an attorney at the international law firm of Ropes & Gray LLP, in exchange for kickbacks. The SEC alleges that Arthur J. Cutillo, an attorney in the New York office of Ropes & Gray, misappropriated from his law firm material, nonpublic information concerning at least four corporate acquisitions or bids involving Ropes & Gray clients — the 2007 acquisitions of Alliance Data Systems Corp. ("ADS"), Avaya Inc. ("Avaya"), 3Com Corp. ("3Com"), and Axcan Pharma Inc. ("Axcan").

The SEC's civil complaint describes the scheme in detail, including a nice paragraph describing their "trade-craft": 

Arthur Cutillo is an attorney at the international law firm of Ropes & Gray. He has worked in the firm's New York office since 2005. Throughout 2007, he had access to, and learned of material nonpublic information concerning corporate acquisitions in which Ropes & Gray represented acquirers or bidders in proposed acquisitions. Cutillo owed a fiduciary or other duty of trust and confidence to Ropes & Gray and its clients to keep this information confidential and not to disclose or personally use this information.

...

Zvi [Goffer, former Galleon employee] traded on-this inside information and had numerous downstream tippees who also traded. As part of this illegal trading scheme, Cutillo, [Jason] Goldfarb, and Zvi at times used disposable cell phones in an attempt to conceal the scheme. For example, prior to the announcement of the 3Com acquisition, Zvi gave one of his tippees a disposable cell phone that had two numbers programmed in it labeled "you" and "me." After the announcement of the 3Com acquisition, Zvi destroyed the disposable cell phone he had provided the tippee by removing the 8IM card, biting it, breaking the phone in half) throwing away half of the phone, and instructing his tippee to get rid of the other half of the phone. 

I like the bit about the cell phones.  Clearly, these guys have been watching TV. One thing they didn't do was pay attention in law school when they should have learned about their obligations to clients and the insider trading rules.  Cutillo is a 2005 law school grad - four years.  That's a very short legal career.  I wonder what he'll do with the rest of his life.  

-bjmq

Bad Lawyers

This is a story with sad endings all around.  Last week, the SEC charged Canadian lawyer, Stanko Grmovsek with insider trading.  Here's the SEC's complaint.  The complaint alleges that Grmovsek was involved in a 14 year long conspiracy with his friend, Gil Cornblum, another Canadian lawyer, netting over $10 million in illicit profits.  Cornblum passed along confidential information regarding pending transactions to Grmovsek.  Cornblum was an associate at Sullivan & Cromwell and then a partner at Dorsey & Whitney (of O'Hagan fame!).   According to the complaint, while at Sullivan:

Comblum was not in Sullivan's mergers and acquisitions group. He worked in the general corporate practice area. He obtained information about M&A transactions involving Sullivan clients in one of three ways: (1) through discussions with other Sullivan attorneys at lunch or in the hallways; (2) by viewing memoranda or deal documents left outside offices, in fax rooms, or in copy centers; and (3) by accessing electronic documents' in files on Sullivan's document management system, often using passwords intended for use by the word processing department. 

At times during this period, Grmovsek would make wake-up calls from Toronto to Cornblum in New York at 4:00 or 5:00 a.m. to ensure that Cornblum arrived at Sullivan's offices to search for information prior to the arrival of other employees. For about four or five months during 1997, Grmovsek also lived with Cornblum in New York while attending film school. Cornblum provided material, non-public information to Grmovsek during phone calls or during discussions at night while Grmovsek was living with him.

While Cornblum was a partner at Dorsey & Whitney:

Comblum worked on the transactions involving three [...] U.S. issuers and obtained information about the other transactions in one of three ways: (1) through searches of files contained in NetDocuments, Dorsey's electronic database system; (:2) from conversations with other attorneys about their matters; and (3) through conflict checks.

From 2005 through 2006, Comblum provided information to Grmovsek during calls made from Gnnovsek's cell phone to Comblum's office phone. Beginning in 2006, Comblum began using pay phones to communicate with Gnnovsek in an effort to conceal their contacts. In addition, during 2006 and 2007 Gnnovsek was a frequent visitor to Comblum's office prior to weekly lunch dates. Comblum provided informnnation to Gnnovsek during these phone calls and lunch meetings.

Last week, Grmovsek pled guilty to insider trading and Cornblum committed suicide.

-bjmq

 

Don't Lie to the Feds

OK, so here's some more unsolicited advice: don't lie to the Feds.  If they're calling you and asking about your trades, there's a reason.  That's especially true if you have been engaging in insider trading in connection with a merger that you're working on.  The BLT has been faithfully following the story of lawyer Melissa Mahler.  It was a civil case, but now comes the criminal complaint.  Here is the relevant paragraph from the criminal complaint: 

10.       On or about November 29, 2004, two attorneys with the SEC’s Division of Enforcement in Washington, D.C. conducted a voluntary telephone interview of MAHLER.  Prior to asking MAHLER questions, the SEC attorneys advised MAHLER that it was a federal crime to make false statements to the SEC.  The SEC attorney asked MAHLER, among other things, whether MAHLER had placed an order to purchase 10,000 shares of TPCV stock on July 28, 2004, through the broker-dealer in Florida.  MAHLER falsely denied that she had placed the order to purchase10,000 shares of TPCV on July 28, 2004, when, in truth and in fact, MAHLER knew that she had placed the order to purchase those shares. … 

The false statements act (18 USC Sec. 1001) is very broad in its application, and that makes it relatively easy to prosecute.  For example, it doesn't require scienter or all the complexities of whether there was inside information or not.  All it requires is that the Fed prove you willfully (1) make a material (2),  false statement (3) in a matter within the jurisdiction of the executive branch (4).   For prosecutors looking to make a case, it's much easier to prove false statements to investigators than it is to prove insider trading.  So, it's a go to charge in cases like this.

Martha Stewart learned this lesson the hard way.  It appears that Ms. Mahler is about to as well.

If you are interested in the intricacies of the false statements act, take a look at Steven Morrison's When is Lying Illegal? When Should It Be? A Critical Analysis of the Federal False Statements Act, John Marshall Law Review (2009).  Here's the abstract:

First, this article explores the element of section 1001 that requires a false statement. Other articles have accepted the meaning of this element. What is “false,” however, is open to debate. Second, this article explores section 1001 in light of how we communicate. It notes that lying is prevalent in society and especially within the criminal justice system, and also argues that even when we’re not lying, we engage in “purposive communication,” which is a form of deception necessary for effective communication. I also discuss what lies are, and what types of lies there are. I do so to show that the conduct that section 1001 prohibits in a black-and-white way is actually a multicolor phenomenon. Third, I discuss section 1001’s materiality element. No other article has discussed this element in detail, even though, as I show, it is the central controversial element of section 1001 and is the source of the statute’s problems as well as its potential solution. Furthermore, I discuss the varying interpretations of the materiality element among jurisdictions. For example, some circuits have adopted what amounts to an objective reasonable person standard, while others have adopted a subjective standard. As I show, this variation goes to the heart of what section 1001 prohibits. Fourth, I discuss two different versions of the definition of materiality applied by section 1001. One version requires that the false statement be capable of influencing a government agency “to which it is addressed,” and another version need only be capable of influencing some government agency. This is a meaningful difference that hasn’t been explored in other articles or resolved in the courts or Congress. Fifth, I discuss the materiality analysis established in United States v. Gaudin, which may solve the “to which it is addressed” split. Courts have largely ignored Gaudin’s analysis, as have other commentators.

-bjmq

SEC Charges Insider in EMC-DOCX Deal

Here's the SEC's complaint.

DOCX executives asked Xie in late November 2007 to participate in a meeting with EMC representatives concerning a plan to further extend the pre-existing partnership between EMC and DOCX. DOCX executives asked Xie to compile information about DOCX’s source code and other documents in anticipation of the meeting with EMC. Xie also worked on the project with a due diligence firm hired by EMC.

On December 7, 2007 at a meeting between EMC and DOCX employees in Oakland, Xie made a presentation and answered related questions. After the meeting, Xie asked his DOCX supervisor what would happen if someone were to buy DOCX shares in a time period when they thought something was going to happen to that company. Xie’s supervisor told Xie that would be a bad thing to do, that it could be traced, and that it was prohibited and illegal. As late as December 19, 2007, Xie continued to work with EMC and EMC’s due diligence firm.

Yeah, you know what's coming next...

Xie began acquiring shares of DOCX common stock prior to the December 7th meeting, while preparing due diligence materials for EMC. These initial purchases of 6,892 shares were made at prices ranging from $8.39 to $8.68. Despite the warning from his supervisor on December 7th, Xie continued to acquire DOCX common stock up to the day before the merger announcement, purchasing an additional 3,607 shares. In total, between December 3, 2007 and December 26, 2007, Xie purchased 10,499 DOCX common shares for prices ranging from $8.10 to $8.81.

Sigh.

-bjmq

Perot Systems Employee Charged With Insider Trading

...well, that was quick.  From the SEC's litigation release this morning:

The SEC alleges that [Reza] Saleh made increasingly large purchases of Perot Systems call options contracts based on material, non-public information that he learned in the course of his employment with, or duties for, two Perot-related private companies and Perot Systems. Immediately following the tender offer announcement on Monday, September 21, Saleh sold all of the call option contracts in the accounts and reaped approximately $8.6 million in illicit profits.

Later that same morning, SEC staff with assistance from the Options Regulatory Surveillance Authority identified Saleh as a suspicious trader. Soon after being contacted by SEC staff, Saleh acknowledged to a Perot Systems director that he knew about the impending transaction when he traded.

-bjmq

Update:  Friday's WSJ has a sympathetic profile of Mr. Saleh.  Turns out he led a critical role in Ross Perot's rescue of EDS employees from Iran following the revolution in 1979.  That's too bad.  He'd have been better off if he wasn't so greedy.

Perot Systems Option Trading Raises Questions

By way of warning, I tell students in my Acquisitions Workshop that it's always a bad to start your legal career by engaging in insider trading.  Then we launch into a discussion of the David Li (News Corp/WSJ case) and the too-good-for-Hollywood Pacjin case and the Edelman case.  

The key lesson of the discussion is, obviously, that M&A lawyers need to learn discretion when it comes to their clients' confidences and pending transactions. If you have inside information about a pending transaction, of course, you don't trade on it.  Moreover, a discrete lawyer doesn't blab all about the transaction to their seat-mates on flights across the Pacific and certainly doesn't tell their good-for-nothing boyfriend about it.  

The second, less obvious, lesson is that if you are going to trade on inside information, well then, for heaven's sake don't trade options!  

Someone with inside information about the just announced Perot Systems/Dell transaction is going to learn that second lesson the hard way.  Bloomberg is reporting a spike in options trading just prior to announcement of the deal:

Calls volume climbed to 2,539 contracts, or 242 times the four-week average, according to data compiled by Bloomberg. Only 10 puts traded that day, the data show. The shares, which rose 0.1 percent to $17.91 on Sept. 18, surged 65% to $29.62 at 11:03 a.m. New York time today.

Options are usually so thinly traded that anyone greedy enough to try to make money on inside information by trading options ahead of an M&A announcement is just asking for trouble.  I suppose since one can make much more money on an equivalent investment using options rather than stock it's just too much to resist.  Better yet, if you've got inside information, sit on it.  

-bjmq

Another Lesson for Young M&A Lawyers

 I’ve told students in my Acquisitions Workshop repeatedly that insider trading is no way to start a long and fruitful career.   Of course, none of them think that they’ll be so stupid as to do anything like that.  But I remind them, it doesn’t always happen like in the movie Wall Street.  Dennis Berman’s column in the WSJ (Insider Affair) gives us yet another example of how easy it is to make the kind of poor decisions that can end up in jail time.

 Last May, the SEC charged James Gansman, a former partner at E&Y, and his mistress, Donna Murdoch with insider trading.  Here’s the civil complaint.   The DOJ also filed criminal charges in the matter.  Gansman bragged to Murdoch about deals he was working on, likely to impress her and win her affections, who knows.  In one case he tipped to Murdoch “news of a coming takeover to be used in one of Murdoch’s children's stock-market simulation games at school.”  It appears that Gansman was rather indiscrete with information that his clients wanted treated “super strictconfidential” [sic].

 Of course, Gansman never actually traded or made any money himself.  He may have even believed that Murdoch was loyal to him and would keep his confidences.  Unfortunately for him, that wasn’t the case.  Murdoch traded on much of the information that she got from Gansman and made more than $500,000 in profits.   She even shared tips with her father who also apparently traded on the information.  The fact that Gansman didn’t profit financially as you’ll remember from law school is not enough to shield one from liability in tipper/tippee cases.  Gansman is now going to jail, convicted on six counts of securities fraud.

 Lesson for young M&A lawyers:  If you’re working on a deal, don’t talk in elevators, don’t brag to friends or significant others. Oh, and even if they did pay for your legal education, your parents don’t really need to know what deal your working on. 

 -bjmq

EADS Report on Insider Trading

The always excellent White Collar Crime Prof Blog has a post on the preliminary investigation by the French financial regulator Autorité des marchés financiers (AMF) indicating that a number of senior executives at Franco-German aircraft manufacturer European Aeronautic Defense & Space Co. NV (EADS) sold shares before the announcement of problems with the company's largest development project ever, the A380.  As the White Collar Crime Prof notes, "Insider trading cases in [France] are fairly uncommon, at least as compared to the United States.  It will be interesting to see how the investigation develops, especially when it involves a company with the political significance of EADS."