Insider Trading

[Groovenstein]

Here's the Dirks opinion:

http://caselaw.lp.findlaw.com/scripts/getc...ol=463&page=646

There's a nice little summary of the Court's holdings towards the top that may also help answer some questions.

[Proverb]

...or should have known of the breach.

The above posts answers nearly all my questions.

One thing...

What objective standard defines when a tippee, "should have know."

Thanks again.

[DavidOdden]

What objective standard defines when a tippee, "should have know."

That's a bit tricky, but there are these expressions like "reasonable man" and "ordinary diligence". If a person is presented with evidence that has a certain level of credibility, which tells you that passing the information is a breach of fiduciary duty, then you "should have known". For example if I knew that a certain neighbor was on the board of directors of Worthifood Corp. and he informed me "You really should invest as much as you can in Worthifood Corp. within the next 2 weeks, before October 1, 1999, and don't tell anyone I said so", then you should know that he is violating his fiduciary duty. This doesn't mean that is how the "should have known" standard works legally (oh, crud, yet another mystery to unravel), but that is, at least, how it make some sense.

[Groovenstein]

What objective standard defines when a tippee, "should have know."

This is too heavy a research task for me to do in the near future, but my guess is that, as David suggested, you'd find it being phrased as "whether a reasonable person in the tippee's position would have known that . . . ".

These should have known, reasonable person issues tend to be decided by the "facts and circumstances of the particular case." In other words, they're very fact-dependent. (This is largely why it'd be a hefty research task for me right now.)

If you want to figure out whether a certain situation fits the bill, one of the first things you do is compare it to previous cases (and wear some earplugs to drown out Scalia's shuddering at the thought).

If you're lucky, you'll find some hard-and-fast rules in those cases. For example, "We hold that where a tippee and tipper have a parent-child relationship, there is a rebuttable presumption that the tippee should have known for purposes of Dirks liability." I made that up, but you might see a court somewhere finding that someone under a certain set of facts should have known as a matter of law.

If you want to find some summaries on the issue, hop over to UNLV's law library and ask someone at the reference desk to help you. Start with something like American Jurisprudence 2d, find the book on Corporations, and look at the table of contents to find the sections you need.

[Groovenstein]

Anyone reading this, please remember that none of what I've said should be legal advice for you. There are so many other equally complicated rules that might apply to a particular transaction (e.g. Rule 14a-3 for tender offers), that not only do you need a lawyer to help you, you need a securities lawyer. This is not a field for the general practicioner.

Plus, what the hell are you doing relying on what a student says anyway?

[scottkursk]

One thing...

What objective standard defines when a tippee, "should have know."

Speaking from personal experience, there is no objective standard to "should have known." Hindsight is assumed to be 20/20 when you are dealing with the SEC.

Lou Holtz the Notre Dame coach got off of a charge saying that he overheard some people discussing a merger at a football game and therefore didn't know that they were in breach of their fiduciary duty. He managed to win the case but barely from what I remember. As David points out, you may or many not even know if they are violating their fiduciary duty. The assumption again is like that of the IRS during an audit and you are effectively trying to prove why you are not guilty. And dealing with the SEC is very much like dealing with the IRS. They are equally pleasent.

[Groovenstein]

Lou Holtz the Notre Dame coach got off of a charge saying that he overheard some people discussing a merger at a football game . . .

What I'm about to say doesn't address the "should have known" question, but is important to consider in these overhearing situations.

There may be a contractual arrangement that creats a duty to disclose. For example, between employer and employee whereby anything an employee overhears on the job must be disclosed to the employer. My teacher used the example of a first-class flight attendant overhearing passengers talking business.

[DavidOdden]

For example, between employer and employee whereby anything an employee overhears on the job must be disclosed to the employer.  My teacher used the example of a first-class flight attendant overhearing passengers talking business.

That's hypothetical, right? Like, there does not exist an airline anywhere in the free world which has suich a requirement. Right? Except for a requirement to report a suspected crime, I would be utterly shocked if any employer had such a rule. Also appalled.

[Groovenstein]

That's hypothetical, right?

I don't remember. Ordinarily, I might give someone with as much experience as this professor the benefit of the doubt when it comes to devising a reasonable hypothetical. However, in my experience law professors do sometimes have whacked-out hypotheticals.

So, my memory is inconclusive, and in this context I think the safe default is to the hypothetical side.

However, I would not share your shock (surprise yes, but not shock) if this turned out to be true somewhere out there (not necessarily airlines). I've heard of some weird rules in loosely analagous circumstances.

For example, when I was doing my undergrad in Boston my friend told me that his friend from MIT said (double hearsay alert) that MIT owns anything you invent while you're a student there.

This next one I know is true. Every law review article I've ever read says the copyright is in both the author and the law review, even if the author has no connection with the school that I can discern.

Why would the hypothetical airline policy appall you? I'm not appalled initially, but I'll certainly consider your argument. It seems to me like the company has paid to put the employee where the employee is, and thus anything the employee gets as a benefit of that (like a stock tip) the company can contract a claim to. Keep in mind also, in this specific example, I believe the teacher only mentioned a duty to disclose to the company. As far as I can remember, the employee could still invest himself if he wished.

[DavidOdden]

Why would the hypothetical airline policy appall you?  I'm not appalled initially, but I'll certainly consider your argument.  It seems to me like the company has paid to put the employee where the employee is, and thus anything the employee gets as a benefit of that (like a stock tip) the company can contract a claim to.  Keep in mind also, in this specific example, I believe the teacher only mentioned a duty to disclose to the company.  As far as I can remember, the employee could still invest himself if he wished.

My shock comes as a trusting customer. Supposing I were discussing secret business arrangements with a colleague and we are speaking of vital trade secrets. I would not speak of these matters out loud if I thought that someone else might hear; of course, I assume that the attendants are bound by professional ethics and company policy to not hear or act on secret information which they pick up on in the line of duty. I have an even stronger assumption along those lines when it comes to any email I might send (that my local sysadmin is not reading all of my mail and the ISP isn't sniffing my info either); also I assume that the phone company isn't listening in on my conversations to harvest marketable info. Of course this is just an assumption. I'd have to dig into those little 6-pt really long terms of service documents where they say things like "We promise not to sell your information or..", to see whether they overtly say "if, in the course of normal business (of transporing you from place to place), we come into profitable information, we will feel free to use it and we will compell our employees to tell us of such information". If so, that's a good lesson in caveat emptor. At any rate, it's about "normal assumptions", and my take on society is that if an employee overhears information in the course of doing their job, they are obliged to not exploit that information. I wouldn't say that the employer has paid to put the employee where they are: rather, they paid to get the employee to do thrir job (service me), and the employee needs to be in my vicinity to service me. Admittedly, I don't actually hang out in a society where there is such a thing as secret information. But if I knew of such a practice by a company (and it mattered to me), I would take my business elsewhere, especially if such a policy were hidden from customers.

The copyright thing I know. I dunno about law reviews, but ling journals send you an agreement that you have to sign to turn over copyright, or permission to use, as the case may be. My journal licenses articles for 10-20 years, because we don't claim that we wrote the articles.

[shane]

There are two issues in regard to the law and material non-public information

1. Should the government have the right to protect individual investors from ignorance

2. Should the insiders have the right to trade on insider information

Of course the answer to the first one is no, but the government believes it is their right to do that on the premise they are protecting the rights of the investor, an egalitarian principle. The second has nothing to do with the govt, but with the owners of the business and should be determined and chosen by each individual investor.

There is no question that some insider trading is decietful and fraudulent, which is already covered by law. But the ultimate question is similar to the the altruism issue because it is a destructive outcome of it. AR said something along the lines it is not a question of whether we should or should not give a bum a dime, but whether we have the right to exist if we don't. So, it is not a question of whether insider trading is right or wrong, it is whether the government has the right to regulate it or not.

The company is the property of owners and therefore should be decided how to be used by the owners.

Furthermore, material non-public information is as such.

Material information - information that may affect the price of a security (uggh) including dividend declaration, M&As, gain or loss in contracts, offers that involve tender offers, earnings reports, or anything else you can think of

non-public - rule of thumb is the general investors must have time to react to it so this one completely escapes me because I am sure it would take some "general" investors days to respond (there are companies that specialize in disemminating this type of information like Business Wire which was just acquired by Warren Buffet)

Up to now I have been discussing "insider trading" as it applies to company execs and close entities. You can also become an inside trader if you use inside information that (and this applies more to the general money managers)

1. breaches a fiduciary obligation

2. is misappropriated (stolen, recieved fraudulently, etc)

3. relates to a tender offer

4. recieved in confidence

5. an unreleased analyst recommendation

[Groovenstein]

There is a 5-minute video here from Fox News (scroll down to "Taking Stock") discussing how Congress is not prohibited from insider trading. To any Congressmen reading this, let me say that there are not enough profanities in the English language to accurately describe what you are. You people can forcefully acquire information from businesses and then trade on it. Not even the biggest corporation in America could do that in the laissez-faire society you are so afraid of. You can also turn the business world upside-down with one bill. Judges have to recuse themselves from cases in which their impartiality might reasonably be questioned. They also have to keep tabs on their financials to make sure there're no potential conflicts. Congressmen should have to do the same thing. In effect, that means Congressmen should be forbidden from owning stock. You don't like it? Stay in the private sector where you don't get to wield guns.

Every single one of you can go to hell.

[softwareNerd]

Thanks for the link to the video. I agree that, in today's context, Congressmen should not own stocks directly. At most, stock should be held through some type of blind trust. Not trusting our current crop, I'd say that there should be restrictions even on such trusts.

[jrs]

For example, when I was doing my undergrad in Boston my friend told me that his friend from MIT said (double hearsay alert) that MIT owns anything you invent while you're a student there.

I worked as a computer programmer at a business where the CENTRAL point of the employment contract was that anything that I invented or authored during my employment OR FOR A YEAR THEREAFTER was the property of the company. I refused to sign until they removed the part about a year thereafter.

[writeups]

Thanks for the link to the video. I agree that, in today's context, Congressmen should not own stocks directly. At most, stock should be held through some type of blind trust. Not trusting our current crop, I'd say that there should be restrictions even on such trusts.

I disagree with that entirely. Stocks are generally just one facet of a persons wealth - we own homes, office buildings, rental properties, bonds, managed futures accounts etc. Why should someone in Congress be forced to delegate the decision making of his property, his wealth, to another through a blind trust. There have been many problems with blind trusts primarily because people can't stand not having power over their own wealth. When Secretary of the Treasury Paulson sold $500 million of Goldman Sachs stock because it was a conflict of interest I was disgusted. How is the conflict of interest between a wealthy politician who could make decisions that would primarily benefit the wealthy any different from the conflict of interest between a poorer politician voting on issues that would increase government support to those in his position. As long as the conflict of interest is declared, then there is nothing wrong with the politician continuing to have control over his wealth and if his decisions benefit his position greatly then thats life - get over it because we all make decisions that are good for our own interest and someone like Paulson, if he advised Bush to further decrease taxes on the wealthy then the US economy would benefit along with him as the wealthy are those who have the largest stock of capital and if they can keep a larger portion of what they earn they'll move it from tax free municipals and other investments primarily made because of distortions created by taxes and invest it, increasing the amount of capital goods in the economy and increasing production and the standard of living. Let them just disclose their holdings and be treated like individuals not slaves to conflict of interest rubbish.

[softwareNerd]

We have situation where politicians have more power than they ought. In our system, many of their decisions are necessarily arbitrary. That is what makes conflicts of interest an issue. Your argument basically reduces to this: since we cannot remove all conflicts of interest, we should remove none.

[writeups]

Exactly, but acknowledge them as such. But the US could remove many of them (special interest groups, lobbyists) by reducing government intervention in the form of subsidies, tariffs, regulation etc as that is what empowers politicians - the ability to dole out money to special interest groups.

[adrock3215]

*** Mod's note: From another thread. Merged with this one. - sN ***

I think Yaron's case was even more fundamental than this. That a market as such is actually "made" by people trading on the information they have. That the pricing that results, results from the action of people trading on their information or hypothesis. So the idea that one could bar people in the know from trading and that the "market" somehow still has a relation to actual values is highly suspect. Ignorant people can't make a market in anything. One cannot protect ignorants by barring those "in the know" from trading in the market because it is those in the know that "make" a market.

I agree with you here. I haven't seen what Brook has written on this topic. What would be propose to do with a CEO who trades on inside information not yet released to the public? For example, a CEO may know that his company's most recent quarter is a wash and will adversly affect the value of his stock. He may decide to sell out his holdings of the stock before the information is made public. I assume Brook holds that this sale is in effect making the market for the stock. However, a very few amount of the CEO's hundreds of millions of shareholders will know that the order to sell a million shares (or whatever amount the CEO holds) was the order ticket of the CEO. As far as shareholders know, it could be any large holder selling. How would the shareholder know to pay more attention to this particular large sale than any other large sale?

Edited November 16, 2007 by softwareNerd
Added "moved/merged" annotation

[airborne]

How would the shareholder know to pay more attention to this particular large sale than any other large sale?

You don't.

However, when insider trading is allowed large holders(investment firms, hedge funds) will gain better information then the average investor and will also join the selling. This is much more beneficial to the small investor then restricting people and firms trading on their information. free "insider trading" will result in less unexpected volatile gap-downs, giving an informed rational investor more time to react appropriately.

CROX and HANS are tickers that come to mind, fire up the charts on yahoo. Although this activity is more common at the end of a bull market(we have been in one for five years now!) if you go back before SarbanesOxley and analyze charts on earnings you will find such activity alot less common.

Any financial graduate have some opinion on options backdating? recent scandals include Kobi Alexander who is hiding in Namibia...

Edited November 16, 2007 by airborne

[softwareNerd]

... opinion on options backdating?...

In a sense, one could argue that options-backdating is a way to fool the owners (i.e. a form of fraud). However, the truth is that the back-dating is really done to fool the IRS. Though the government prosecutes it like fraud against shareholders (and against their nebulous notion of the investing public), in essence, it is tax-fraud. I blogged about it a few times.

[KendallJ]

However, a very few amount of the CEO's hundreds of millions of shareholders will know that the order to sell a million shares (or whatever amount the CEO holds) was the order ticket of the CEO. As far as shareholders know, it could be any large holder selling. How would the shareholder know to pay more attention to this particular large sale than any other large sale?

Why is another large sale less impactful? The fact is that large shareholders are insiders as well. Anyone who owns a 2-3% position in my company for instance is known by name to the CEO and investor relations and they are kept abreast of company actions just as are large institutional holders and analysts. The reason is that they are significant voting blocks and the company management needs to keep them bought into the company strategy.

And moves that big have significant changes on the market regardless. In fact, when most large share holders sell of large chunks for no particular reason than they want to cash out (i.e. when there is nothing wrong with the stock) it is in their interest to announce it well in advance so that they don't upset the market when they do it. As a result any large moves made in a less than public fashion are assumed to be due to some reason that someone knows.

[airborne]

SoftwareNerd thankyou! I googled it a few times before and just found a bunch of crap.

[airborne]

In fact, when most large share holders sell of large chunks for no particular reason than they want to cash out (i.e. when there is nothing wrong with the stock) it is in their interest to announce it well in advance so that they don't upset the market when they do it.

It is in the interest of large holders to have a public keen on the stock before they sell(to dump on). Institutional selling can take a few months to complete and many times news/media/analysts are most "bullish" about a stock while it is being sold by such institutions(such manipulation though is arguably unethical). Not all institutions do this however. Eitherway it doesn't matter because a sound investor will have enough evidence to realize something is wrong with a stock when it begins to be sold heavily(assuming he's studied the markets).

Edited November 17, 2007 by airborne

[KendallJ]

It is in the interest of large holders to have a public keen on the stock before they sell(to dump on).

I'm not sure I understand this question. It doesnt matter, because if you're selling off a large block of stock the "keen interest" of ignorants only lasts a short way into the sale. Seems to me as though pump and dumps are usually done on smaller stocks for which there is less trading volume, and liquidity. I dont' think you can get away with it on a large scale and with well known public companies. THere are a lot of people in whose interest it is not that will work against you to prevent it.

Being ignorant in OTC and penny stocks is a dangerous recipe. These really are for insiders.

[airborne]

Being ignorant in OTC and penny stocks is a dangerous recipe. These really are for insiders.

Yes, and for scammers.

dont' think you can get away with it on a large scale and with well known public companies.

you can't....