Wednesday, February 1, 2006

Insider Trading Based on Recklessness

The SEC filed a settled civil insider trading action against Victor Menezes, a former senior executive at Citigroup, for exercising options and selling shares in the company before a negative earnings announcement.  In late March 2002, Menezes, who was then head of Citi's Emerging Markets division and CEO of Citibank, N.A., leaned that the Argentina debt crisis would have a substantial negative impact on the company's quarterly results.  On March 28, the last day on which he could exercise options and sell shares before the pre-earnings report blackout period, Menezes exercised options on 825,960 Citigroup shares and immediately sold 597,000 of the shares to cover the exercise cost and taxes.  The sale price was $49.99, and on April 15, when the negative earnings announcement came out, the stock dropped to $45.92.  Menezes, who has since retired from Citi, settled the matter by agreeing to pay $2,680,157.77, comprised of disgorgement of $1,567,557, pre-judgment interest of $328,822.77, and a $783,778 civil penalty.

The SEC's Complaint (here) does not allege that Menezes acted with an intent to defraud, but relies solely on an allegation (which will not be disputed) that his conduct was reckless.  The Complaint stated:

As CEO of Citibank and CEO of Citigroup's Emerging Markets division, Menezes owed a duty to Citigroup and its shareholders not to misuse information that he learned in the course of his employment by Citigroup. Menezes was reckless in not knowing that the information he learned about Citigroup's projected Argentina losses and its projected failure to meet consensus earnings estimates was material, nonpublic information. He also was reckless in not knowing that, because the options exercise included the sale of 597,000 Citigroup shares on the open market, he could not engage in the transaction while in possession of such information.

Menezes retained over 200,000 Citigroup shares after the transaction, which is not what one would expect of a person who traded on material nonpublic information.  The claim of only recklessness certainly indicates that the case could not be charged as a criminal violation, and if Menezes were to fight this one I wonder whether the SEC would prevail.  The payment is substantial, and this may truly be a situation in which it  was simpler to settle the case by paying the money rather than risk a trial.  It's not your typical loss avoided case, however, where the seller keeps over 200,000 shares of the company's stock, is not accused of tipping anyone else, and makes the sale a fairly substantial amount of time (over two weeks) before the news will hit. (ph)

Civil Enforcement, Insider Trading, Securities | Permalink

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