Wednesday, September 27, 2006
The SEC filed a civil insider trading case against Graham Lefford for using confidential information he gleaned from faxes about a pending deal to buy a company. The faxes were sent to the summer house he managed that was owned by Robert Sillerman, the creator of American Idol, who bought a shell company, Sports Entertainment Enterprises, Inc. (SPEA), to use it as a vehicle for licensing Elvis Presley products. Other media reports describe Lefford as the butler at Sillerman's South Hampton summer home. According to the SEC's complaint (here), Lefford signed an agreement with Sillerman to maintain the confidentiality of all business and financial information he learned while managing Sillerman's summer home in South Hampton. The SEC Litigation Release (here) states:
Lefford found out about Sillerman's acquisition of SPEA from one or more of the several deal-related documents that were faxed between Sillerman's office in Manhattan and his South Hampton residence that summer. Within minutes of faxing Sillerman's signed authorization for the SPEA acquisition back to Sillerman's office, Lefford bought 5,000 shares of SPEA stock at 12 cents per share. The price of SPEA stock shot up by over 9,000% after Sillerman's acquisition of SPEA and the Presley deal were both announced in December 2004, and Lefford made $48,525 in total profit on his $600 investment when he later sold all his SPEA stock.
While the total gain is rather small, the investment return is something that certainly catches the eye, and may have triggered the SEC's interest in pursuing the matter. The confidentiality agreement likely relieves the Commission from having to prove that the master-servant relationship, to use the traditional terminology, creates a fiduciary duty between Lefford and Sillerman to keep the information confidential. Lefford denies that he traded on material nonpublic information and is fighting the action at this point.
The same day the SEC filed the complaint, the Senate Judiciary Committee held a hearing on whether the SEC and Department of Justice are bringing enough insider trading cases. There have been a number of deals recently, many of them involving going-private transactions, in which there was suspicious trading in advance of the announcement, particularly in call options. SEC Enforcement Division Director Linda Thomsen explained in her prepared statement (here) that suspicious trading is not necessarily illegal insider trading, or at least proving it can be very difficult.
It is important to understand how difficult it is to build an insider trading case. They are unquestionably among the most difficult cases we are called upon to prove, and despite careful and time-consuming investigations, we may not be able to establish all of the facts necessary to support an insider trading charge. The challenge is not to establish facts that show suspicious trading—the surveillance records alone are often sufficient to establish that much. The real challenge is to establish that a particular individual was in possession of material non-public information and in fact traded on it in breach of a duty, and to establish those facts based on admissible evidence that can withstand challenge at trial.
Piecing together an insider trading case can be a complex and painstaking process. It is rare to find a “smoking gun;” virtually all insider trading cases hinge on circumstantial evidence. It is quite common for insider traders to come up with alternative rationales for their trading—rationales that the staff must refute with inferences drawn from the timing of trades, the movement of funds and other facts and circumstances. And because many insider trading cases involve secret communications between two people – the tipper and his tippee – assembling compelling circumstantial evidence is often difficult. In some cases, such as when a corporate insider trades on company information or when an outsider steals nonpublic information, there are no communications at all to use as evidence at trial, but only the facts of the wrongdoer’s access and trading. Building an insider trading case based on circumstantial evidence can be frustrating, risky and time-consuming. Because of these challenges, we also have to accept that a number of the insider trading investigations we open may not result in a filed enforcement action—not for any lack of diligence on the part of the staff, but for lack of evidence.
Pressure from Congress will likely trigger more investigations and perhaps even more cases, although that could result in more questionable prosecutions and civil enforcement actions. Insider trading may be easy to spot, but as Thomsen points out that does not necessarily mean it is easy to prove. (ph)