M & A Law Prof Blog

Insider trading review -- 2011

MoFo has the definitive overview of insider trading prosecutions over 2011: Galleon, Octopussy, Kluger, all of it.  Get it here.

-bjmq

Galleon 2.0: Watch it live

You can watch Preet Bharara's press conference announcing the Galleon 2.0 insider trading arrests here (1:00pm, ET):

 

"A circle of friends who formed a lucrative club...to make $62 million in profits ..." That's as big as Galleon. That made all that money on trades related to Dell.  Wow.

Three of the seven defendants have already pleaded guilty and are cooperating.

Bharara says that the group's trading in advance of Dell earnings announcements was "the big illegal short". Too cute.

"But cheating on the test and getting away with it are two different things."

Here is the civil complaint filed by the SEC against Level Global, Diambondback Capital, and the seven individual defendants in the criminal case.

-bjmq

Hedge funds, M&A, and private information

In their new paper, Hedge Funds in M&A Deals, Dai, et al find evidence "consistent with informed abnormal short selling" by hedge funds prior to M&A announcements. The authors observe larger stakes where there is evidence of private information.  I'm shocked. ... Actually I'm not really shocked, given what's come out over the past year or two.

Abstract: This paper investigates recent allegations regarding the misuse of private insider information by hedge funds prior to the public announcement of M&A deals. We analyze this issue by using a unique and comprehensive data set which allows us to analyze the trading pattern of hedge funds around corporate mergers and acquisitions in both the equity and derivatives markets. In general, our results are consistent with hedge funds, with short-term investment horizons (henceforth, short-term hedge funds) taking advantage of private information and engaging in trading based on such information. We show that short-term hedge funds holdings of a target’s shares in the quarter prior to the M&A announcement date are positively related to the profitability of the deal as measured by the target premium. In addition, we also find that the target price run-up before the deal announcement date is significantly greater for deals with greater short term hedge fund holdings. We also find evidence consistent with informed abnormal short selling and put buying in the corresponding acquirer’s stock prior to M&A announcements. This is particularly evident when hedge funds take larger stakes in target firms. In addition, we show that such a strategy is potentially very profitable. We consider alternative explanations for such short term hedge fund holdings in target firms; however our results seem inconsistent with these alternative explanations but rather, seem to be consistent with trading based on insider information. Overall, our results have important implications regarding the recent policy debate on hedge fund regulation.

-bjmq

Representative plaintiff sanctioned for improper trading

After Calix, Inc. announced its acquisition of Occam Networks, Inc. in September 2010 the by now usual lawsuit appeared to challenge the transaction. One of the representative plaintiffs in this case was Michael Steinhardt, a hedge fund investor, described as "one of the most successful investors in the history of Wall Street" and an Occam shareholder.  The suit alleged that the directors of Occam violated their fiduciary duties to the corporation when they agreed to sell the corporation to Calix at an "unfair price."  OK, so far, so good.  Well, not good, but expected. You know what I mean.  In any event, the plaintiffs pursued their case and were permitted to take discovery subject to a confidentiality order. That order read, in part:

Confidential Discovery Material, or information derived therefrom, shall be used solely for purposes of this Litigation and in an appraisal proceeding that Plaintiffs in this Litigation may file . . . . Confidential Discovery Material shall not be used for any other purpose, including, without limitation, for any business or commercial purpose or for any other litigation or proceeding. Confidential Discovery Material Parties and non-parties who receive Confidential Discovery Material shall not purchase, sell, or otherwise trade in the securities of any company, including but not limited to Occam and Calix, on the basis of confidential information contained in the Confidential Discovery Material to the extent such information is still confidential at the time of such purchase, sale or trade. 

Of course, with an order like this and with sophisticated investors like Steinhardt, you can only guess what happened next.  That's right, after Steinhardt was in possession of confidential information (via one of his co-plaintiffs) he began to short Calix common stock. When the Calix defendants found out that Steinhardt had shorted their stock they moved in the Delaware Chancery Court for sanctions against him. 

Last Friday, Vice Chancellor Laster sanctioned Steinhardt for trading in violation of the confidentiality order (Steinhardt Sanctions Opinion).  The sanctions Steinhardt and his funds for improper trading include:

 (i) dismissal from the case with prejudice and barred from receiving any recovery from the litigation; 
(ii) requirement to self-report their improper trading to the SEC;
(iii) requirment to disclose their improper trading in any future application to serve as lead plaintiff; and
(iv) an order to disgorge their trading profits (approximately $500,000).

Lesson?  If you are going to be a representative plaintiff in one of these transaction related lawsuits, you can't trade in the stock of the either the acquirer or the target during the pendancy of the litigation.  That seems pretty straightforward.  You'd have thought Steinhardt would have already known that.

-bjmq

Bad lawyer pleads on insider trading charge

Matt Kluger, the former Wilson/Skadden/Cravath/Fried Frank associate, who was engaged in a 17 year insider trading scheme together with two co-conspirators pleaded guilty today.  He faces up to 20 years in prison.  

-bjmq

Fmr. Ropes lawyer gets 6 months

Brien Santarlas who along with another former Ropes & Gray lawyer, Arthur Cutillo ,was convicted as part of the Galleon insider trading investigation was sentenced yesterday to 6 months in prison. Cutillo was previously sentenced to 30 months in prison. Here's the original criminal complaint in that case (US v Goffer, et al).

-bjmq

 

There oughta be a law!

What would you do if Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson gave you a confidential briefing on the day before the 2008 financial crisis - a briefing in which they said everything was going to hell?  Well, if you are Rep. Spencer Bachus (R-AL) the anwer is clear - you rush out and buy Proshares Ultra-Short QQQ the next day. 

I suppose insider trading is illegal unless you are congressman.  Unfortunately, this isn't even a new story!  See papers from Donna Nagy and Stephen Bainbridge on congressional insider trading. Moving on. 

-bjmq

Another target for Galleon prosecutors

Raj Gupta was arrested early this morning at his home by FBI agents and has been charged with insider trading as part of the Galleon investigation.  He posted $10 million in bail and was released this afternoon.  Here's the criminal complaint.

-bjmq

 

Insider trading wrap

It looks like the Galleon investigations and trials are wrapping up.  Raj Rajaratnam was sentenced last week to 11 years. Danielle Chiesi just started her 30 month sentance at "Camp Cupcake".  Octopussy got 10 years, and his fellow small fish (Cutillo, Goldfarb, etc) got prison terms ranging from 2.5 to 3 years.  The prosecutors wanted to send a message about insider trading and it's fair to say that ... well ... message sent.  With the help of data collected by the WSJ, I generated the sentencing chart below:


It seems pretty clear that the sentences generated in the Galleon cases while not outrageous, are stiffer than the norm since 1992. It's worth noting the other 10 year insider trading sentence handed out went to Hasif Naseem who orchestrated a ring with friends overseas to trade ahead of pending merger announcements in the following transactions: TXU Corp., Hydril Company, Trammell Crow Co., John Harland Col, Energy Partners Ltd., Veritas DGC Inc., Jacuzzi Brands, Caremark Rx, Inc., and Northwestern Corporation. So, the Rajaratnam sentence, though heavy, may not be entirely at odds with sentences handed out in similar cases in recent years. 

-bjmq

"You gambled and you lost."

Ten years for Zvi Goffer - Octopussy.  By almost any stretch, that's a lengthy sentence for insider trading.

-bjmq

More on Insider Trading and Relationships of Trust and Confidence

A commenter on my previous post on the hazards of telling your no-goodnik boyfriend material, non-public information asked whether it made a difference in the analysis if the person with whom you are sharing material, non-public information is a spouse.  

In short, it doesn't.  It just hurts more to learn that they person you have decided to spend the rest of your life with is a jerk.  Christie Hefner, former CEO of Playboy, is probably learning that right now.  Last week, the SEC charged Hefner's husband with insider trading:

The Securities and Exchange Commission today filed a civil injunctive action in the U.S. District Court for the Northern District of Illinois charging William A. Marovitz, the spouse of former Playboy CEO Christie Hefner, with illegal insider trading in Playboy stock in advance of public news announcements.

The SEC alleges that on five occasions between 2004 and 2009, Marovitz traded based on confidential information that he misappropriated from Hefner, who was the CEO of Playboy during most of the trades at issue. Marovitz bought and sold Playboy stock in his own brokerage accounts ahead of public news announcements despite instructions from his wife that he should not trade in shares of Playboy and a warning from the general counsel of Playboy about his buying or selling Playboy stock. In total, Marovitz gained profits and avoided losses of $100,952.

According to the SEC’s complaint, between 2004 and 2009 Marovitz misappropriated confidential, non-public information about Playboy from Hefner. Hefner made clear to Marovitz in 1998, both personally and through Playboy’s general counsel, that she expected him to keep any information he learned from her about Playboy confidential and not to trade based on this information. 

The SEC doesn't particularly care aboout the legal status of the relationship -- husband/wife, boyfriend/girlfriend, boyfriend/boyfriend, father/son, it doesn't really matter.  What matters is that between the two people there is a "relationship of trust and confidence" and that the recipient knows or should know that he is receiving material, non-public information and should not trade on it.  

If the recipient (e.g. the CEO's spouse) consoles his wife about an upcoming negative earnings release ("It's okay, honey, you've done everything you could.  Anyway, you know I love you.") and then goes out and trades on that information ... well ... first of all, he had betrayed the trust that the spouse has put in him.  In short, he's a jerk.  The SEC also considers that a violation of a fiduciary duty to the spouse in this case sufficient to trigger liability under the misappropriation theory of insider trading.

So, it's a tough call.  You work 18 hours a day.  When you come home, your spouse wants to know what you've been doing all day that justifies you missing your children's school plays, dinners with family and friends, etc.  Discretion is the textbook answer, but that's not easy.  More often than not, we tell our significant others everything and then trust that we've made the right choice.  Sometimes we're right, sometimes we're not.

-bjmq  

 

Another school year, more lessons for young lawyers

Apologies for the relatively long hiatus.  Blogging is more work than it seems at times and sometimes one needs a little break.  In any event, the current administration is continuing to teach lessons to the current generation of idiot inside traders.  Law students -- there are real life lessons to be learned from the experience of a young woman who interned at Walt Disney in 2009.   

Lesson number one:  Don't share material non-public information with your no-goodnik boyfriend. Why?  Isn't it obvious by now?  Cause he probably doesn't love you as much as he loves money.  

The allegations that the SEC is making against Toby Scammell are really just head-shaking.  One wonders not just where the moral compass is, but what happened to common sense.  

First, Scammell's girl friend was working as an "extern" at Walt Disney during the summer of 2009.  She was assigned to work on the deal team that was taking the lead on the acquisition of Marvel.  For her, this was apparently an important career opportunity.  She shared her good fortune with her boyfriend of two years, Scammell.  She discussed with him whether or not she should delay applying to business school so she could include the Marvel acquisition experience in her application.  She discussed with him the timing of the deal - because it apparently impacted on plans they had to attend a wedding together.  She let him access her Blackberry where she kept work-related e-mails, etc. 

Of course, it turns out that Scammell was less than a loyal boyfriend.  The SEC alleges that Scammell made over 3000% profit on short term call options in Marvel that he purchased on the basis of the inside information he misppropriated from his girlfriend.   Not only that, but his purchases of short term call options swamped the market - making it more than a little obvious to investigators that something was up:


Apparently, Scammell had only purchased options once before -- long-term Google call options in which he lost 99% of his investment.  So, his purchases of short term Marvel options was highly unusual.

Of course, with all insider trading prosecutions, the real challenge for the government is scienter.  Well, it appears that Scammell went out his way to help the government with its case:

Googling "insider trading"?!  C'mon.

Why does it matter that he didn't mention his trades and profits to his brother?  Oh, I forgot to mention that Scammell was managing the finances of his brother who was serving Iraq.  The SEC alleges that Scammell was hard up on funds, so he accessed his brother's account to get cash to fund his option purchases.  

I'm sure this guy was planning on telling his brother about the profits ... at some point.  In fact, Scammell's brother didn't learn about the profits Scammell made with his funds until the SEC called him months later to ask him about it. 

There are real lessons for law students and young associates in this story.  First, discretion is the watch-word.  Just because you happen to love your boyfriend, doesn't mean that he won't trade on your inside information.  Don't believe me?  Just ask Scammell's girlfriend.  

It's no way to start a professional career.

Here's the SEC complaint.

-bjmq

Is this unlawful?

According to this story from Bloomberg, the SEC

sued a Michigan man, claiming he traded on information he learned from a houseguest about the impending acquisition of Brink’s Home Security

Apparently, the

investment banker for Tyco International Inc., the buyer, inadvertently left behind a draft presentation on the deal.

According to the SEC, months later, the homeowner discovered the draft. Another month or so after the discovery, the homeowner intuited from changes in the banker’s travel schedule that the transaction was imminent.

According to the SEC, the homeowner profited from trading in Brink’s stock after the public announcement of the deal caused its price to jump 30 percent.

The homeowner's lawyer said his client has settled the case and will turn over his profits and pay a fine.

Obviously the facts are incomplete, but I wonder if Professor Bainbridge would have advised the homeowner to fight the case.

MAW

Galleon rundown

The New Yorker has a very good piece running down the whole Galleon insider trading story.  You read the whole thing home, but if you can't, read this.  It's got everything in just a couple of paragraphs - wires, prepaid phones, and trading on your own account minutes after getting inside information...

In October, 2009, Rajaratnam and Kumar flew to Trinidad with their wives to attend a wedding. On their way home, they stopped in Miami to spend two days at Rajaratnam’s beachfront condominium. On the evening of October 6th, the men went out in Rajaratnam’s boat, then returned to shore and took a swim. They were lounging on deck chairs, reading and chatting, when Rajaratnam’s phone rang. Excusing himself, he walked down the beach to talk. Five minutes later, he came back, excited. “That was a Cisco executive,” he said. “Cisco is buying Starent”—an information-technology company. Kumar had never heard of Starent, and he wondered which Cisco executive was calling Rajaratnam.

Rajaratnam then gave Kumar a warning: a man named Ali Far, who had worked at Galleon, was rumored to be wearing a wire. “I have to be really careful,” Rajaratnam said. “I can’t believe he’s doing that and betraying me.” He instructed Kumar to start using unregistered prepaid cell phones for their calls. When they returned to the condominium, Kumar opened his laptop, went into his Charles Schwab brokerage account, and bought three hundred shares of Starent, worth about eight thousand dollars. The deal was announced a week later. It was Rajaratnam’s last known inside trade.

-bjmq

Groupon wha?

OK, so let me get this straight.  Last year, Groupon turned down a $6 billion acquistition offer from Google.  Now the company is planning an IPO that values the company at $30 billion. The company also lost more than $400 million last year.  And, insiders plan to sell up to $345 million worth of their own stock as part of the planned $750 million IPO. What do they know that we don't?

Did I miss something?  Are sock-puppets back in fashion again?  Aren't companies supposed to have profits before going public?  Didn't we resolve that question already?  Maybe this is why I did get rich during the dot com bubble.  None of it made any sense back then and it still doesn't the second time around.

Here's the Groupon S-1.  Have fun.

-bjmq

 

Disbarred lawyer on the stand

This is how it starts (Bloomberg):

[Brien] Santarlas told jurors he and [Arthur] Cutillo began passing tips after a conversation over drinks in the summer of 2007.

“While we were making good money, it seemed like nothing compared to what they were making on Wall Street,” Santarlas said. “Art made the suggestion that there’s other ways to make money.”

A friend of Cutillo’s knew a trader who would pay for tips about corporate acquisitions, Santarlas said Cutillo told him.

“My understanding was the trader would buy the stock and he could essentially make money when the acquisition was announced publicly,” Santarlas testified.

Santarlas said he picked up information from talking with colleagues, trolling office printers for deal-related papers and searching Ropes & Gray’s document management system for keywords including “3-Com” and “merger.”

-bjmq

Pictorial summary of allegations

The SEC is alleging that the insider trading scheme began in 1994 while this guy was a summer associate and continued until very recently.  That's really incredible.  This guy apparently sat through a legal ethics class, presumably a corporate law class, and a securities reg class at NYU where he went to law school.  I'm sure he was taught all about insider trading laws while there.  Presumably, he also took and passed the MPRE where there is undoubtedly an emphasis on client confidences and the obligations of the profession.  I'm also assuming he sat through countless CLE sessions at the various firms he worked where people were admonished to take client confidences seriously and where they were presumably instructed on their obligations with respect to inside information.  All that ... and still ...

Here's a pictorial of today's allegations against the former M&A lawyer at WSGR(c/o the SEC):

-bjmq

More bad M&A lawyers...

This from NBC News:

The FBI has arrested a banker and a Washington, D.C., attorney on insider trading charges, law enforcement officials said.

Garrett Bauer was arrested Wednesday morning and was taken to the FBI offices in New Jersey. He is expected to be arraigned in federal court in Newark on the securities fraud charges. 

Washington, D.C.-based attorney Matthew Kluger [WSGR bio care of The Wayback Machine.  Nothing dies on the Internets] was also charged, officials said. 

...

Officials said for years, attorney Kluger revealed information about mergers his prominent law firm, Wilson, Sonsini, Goodnick and Rosato, was working on and they said Bauer was able to trade on that information.   

Investigators said they believe more than $30 million in illegal profits were made over the years.

This arrest comes as some Justice Department officials have called insider trading on Wall Street "rampant."

According to Reuters, authorities are describing this as a "decades long scheme."  Goodness.

-bjmq

Update:  The WSJ has uploaded the Criminal Complaint here and the  Civil Complaint here.

 

From the wiretaps...



Hmm.  Seems like a clever fellow...

 

Riiiigghhht....

 

 

More Sokol musings

By now, everyone and his brother has had an opinion on the l'affaire Sokol.  I've poked around a little and given it some thought.  I think there are two issues.  First is the corporate opportunity issue.  I think that's pretty clear.  The second, and more ambiguous issue, is the potential insider trading liability.  I have thoughts on that one, but I'm clearly still in the elevator stage of my thinking there.

I found it amusing that in his CNBC "defense" of his trading, Sokol took away from his experience the conclusion that in the future it would be better for managers not to share opportunities with their employers.  Uh... no.   That's not the right answer.  The Lubrizol deal presents a pretty straightforward example of a corporate opportunity.  Here's the clearest statement of the doctrine from Broz v Cellular Info. Systems:

The corporate opportunity doctrine, as delineated by [Guth v Loft] and its progeny, holds that a corporate officer or director may not take a business opportunity for his own if: (1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation's line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation. The Court in Guth also derived a corollary which states that a director or officer may take a corporate opportunity if: (1) the opportunity is presented to the director or officer in his individual and not his corporate capacity; (2) the opportunity is not essential to the corporation; (3) the corporation holds no interest or expectancy in the opportunity; and (4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity. 

Now, this doctrine is not a 'check-the-box' approach to corporate opportunities.  Rather, directors must consider all of elements as a whole.  In any event, Sokol apparently first learns about the Lubrizol in his corporate capacity at a meeting with Citigroup bankers who are pitching potential  acquisition targets for Berkshire Hathaway.  The bankers say they are "shocked" that Sokol bought shares after their meeting with them.  It's hard to imagine too many things that will shock a group of bankers pitching deals, but there you have it. In any event, Berkshire Hathaway is clearly in a financial position to exploit the opportunity to acquire Lubrizol.  Berkshire Hathaway is in the business of making acquisitions of promising targets and has an expectation that when such opportunities are presented to its agents that it [Berkshire Hathaway] will have first crack at them.  Finally, when Sokol acquired $10 million worth of Lubrizol stock a week before presenting the deal to Buffet, he clearly put his thumb on the scale and put himself in conflict with Berkshire with respect to doing the deal.  At the very least, he should have recused himself and not taken the lead with respect to the deal. 

I think the case that Sokol, by buying ahead of Berkshire and then pushing the deal on his employer violated his duty of loyalty to the corporate by usurping a corporate opportunity.  So what measure of damages is appropriate?  Disgorgement of the approximately $3 million of profits he made on his $10 million investment would seem right.  He should turn that over to Berkshire on his way out the door.

Now ... on the question of whether Sokol's trading constistutes insider trading, I haven't convinced myself to pull the trigger on that yet.  But ... I don't think there is any question that when Citigroup presented a list to Sokol of potential targets for Berkshire that the content of this list was material information.  I mean ... would a reasonable investor find it useful to know that of the thousands of companies out there, that Citigroup was pitching twenty or so to Warren Buffet's guys and that a deal might be in the offing?   Let me venture a guess that if Rajaratnam knew what Sokol knew, he'd be trading on it and that can't be good for Sokol.  

The Deal Professor has some very relevant thoughts on the question of materiality.  They're right on point and worth reading.

-bjmq

 

Insider trading at the top of Berkshire Hathaway?

If what people are saying is true ... well ... wow.   Here's Berkshire Hathaway's press release and excerpts:

Finally, Dave brought the idea for purchasing Lubrizol to me on eitherJanuary 14 or 15. Initially, I was unimpressed, but after his report of a January 25 talk with its CEO, James Hambrick, I quickly warmed to the idea. Though the offer to purchase was entirely my decision, supported by Berkshire’s Board on March 13, it would not have occurred without Dave’s early efforts.

That brings us to our second set of facts. In our first talk about Lubrizol, Dave mentioned that he owned stock in the company. It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings.

Shortly before I left for Asia on March 19, I learned that Dave first purchased 2,300 shares of Lubrizol on December 14, which he then sold on December 21. Subsequently, on January 5, 6 and 7, he bought 96,060 shares pursuant to a 100,000-share order he had placed with a $104 per share limit price.

Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest.  Furthermore, he knew he would have no voice in Berkshire’s decision once hesuggested the idea; it would be up to me and Charlie Munger, subject to ratificationby the Berkshire Board of which Dave is not a member.

As late as January 24, I sent Dave a short note indicating my skepticismabout making an offer for Lubrizol and my preference for another substantial acquisition for which Mid American had made a bid. Only after Dave reported on the January 25 dinner conversation with James Hambrick did I get interested in theacquisition of Lubrizol.

Neither Dave nor I feel his Lubrizol purchases were in any way unlawful.  He has told me that they were not a factor in his decision to resign.

Dave’s letter was a total surprise to me, despite the two earlier resignation talks. I had spoken with him the previous day about various operating matters andreceived no hint of his intention to resign. This time, however, I did not attempt to talk him out of his decision and accepted his resignation.

Berkshire Hathaway announced its acquisition of Lubrizol on March 14, 2011 for $135/share.  Just last week, the WSJ lauded Sokol's early role in helping Berkshire make the Lubrizol deal happen and pointed to that as evidence that Sokol would eventually succeed Buffet:

David Sokol, considered a possible successor to Warren Buffett at Berkshire Hathaway Inc., identified chemicals maker Lubrizol Corp. as a potential acquisition and took the lead in early negotiations to buy the company, according to a regulatory filing late Friday that detailed how last week's $9 billion deal came about.

It was Mr. Sokol, a Berkshire executive, who plucked Lubrizol from a list of 18 chemical companies that bankers at Citigroup Global Markets had compiled in December 2010 as possible acquisitions at Mr. Sokol's request, according to the filing. ...

Mr. Sokol's early involvement in the deal is further evidence that he has become an important lieutenant for Mr. Buffett in recent years, and may give more ammunition to followers of Berkshire who consider him the front runner to eventually succeed Mr. Buffett as Berkshire's CEO. Mr. Buffett had already tapped Mr. Sokol to turn around Berkshire's fractional-jet business, NetJets, and sent him to China to meet with executives at battery-maker BYD Inc. before investing in that company.

 Dennis K. Berman of the WSJ attributed Sokol with the following previous quotation:

“Integrity is not complicated. If it seems to be, you probably do not belong on our team."

If nothing else, Sokol may be liable for usurping a corporate opportunity with his early purchases.  For a guy like Sokol it's small money, but really embarrassing for him at the very least.

Wow.  

-bjmq

 

 

Update:  Not all that impress with the "Well...Charlie did it, too" defense.