Tough insider-trading policies help avoid risky situations

Amid the government intensifying its focus on the timing of executives’ stock trades and how corporations manage nonpublic information, legal experts say public companies need to review their insider-trading policies regularly with officers, directors and employees. Insiders should remember that even a chat in an elevator or a bar can open Pandora’s box.

“Most public companies … have a certain amount of exposure in the area of insider trading,” says Thomas Willett, a member of Harris Beach PLLC. “Not only are they potentially themselves liable as control persons for insider trading, but they also run the risk of … reputational harm and damage if their insiders are engaged (in the practice.)”

Spelling out the policies in an employee manual does not go far enough, says Carolyn Nussbaum, managing partner of Nixon Peabody LLP’s Rochester office and member of the securities and governance litigation team.

“You’ve got to train and train—and train some more—because people don’t really understand that not only is it illegal for them to use this information, but it’s illegal for them to tell their siblings (or) their dinner guests that the reason that they’re late for dinner is because they’ve been working on this really big deal with a company that … they hint at who it is,” Nussbaum says.

Training also is necessary because the term “insider trading” encompasses both legal and illegal activities.

Insiders may buy and sell stock in their own companies legally as long as they report trades to the U.S. Securities and Exchange Commission. Illegal insider trading generally refers to buying or selling a security, in a breach of a fiduciary duty, while in possession of material, nonpublic information about the security. The SEC also considers “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate the information as potential violations.

Many insider-trading cases of late have stemmed from merger-and-acquisition activity and involve a broad spectrum of players “who end up with information in advance of the announcement of a deal,” says John Lowe Jr., partner at Hiscock & Barclay LLP.

Stockbrokers, bankers, investor relations executives, various types of legal professionals and even a group of amateur golfers are among the individuals the SEC has recently charged.

Some corporate-insider cases involve tippers who innocently blabbed about their company’s impending acquisition.

“But generally, when we see employees of law firms and investment banks … who are participating in insider trading, they are doing so in violation of their organization’s policies,” Lowe says.

Training efforts that present various scenarios to officers, directors and employees, and provide a forum for them to ask questions, help lessen organizations’ exposure, Nussbaum says.

“There’s a second aspect to it that’s equally important,” she adds. “Companies need to make sure—particularly those in the financial area—that they have very strong compliance programs.”

Releasing sensitive information on a need-to-know basis also helps minimize exposure, Willett says.

“Most public companies maintain so-called ‘quiet periods,’ during which it’s suggested or required that officers and directors, and sometimes all employees, refrain from trading,” he adds.

Those periods typically occur before the end of a financial quarter and shortly after the release of quarterly results.

Some public companies also have pre-clearance procedures in place that require insiders to get approval for their trades “from somebody—either in-house counsel or the corporate secretary,” Willett says.

Techniques the government now uses to pursue those involved in insider transactions have changed in the past few years, Willett says.

Wiretapping, for instance, proved crucial in the 2011 conviction of Raj Rajaratnam, co-founder of New York City-based hedge fund Galleon Group LLC. Jurors listened to more than 45 court-authorized phone recordings of the billionaire pressing sources for nonpublic information.

While the investigative methods have changed, laws against illegal stock trading largely have not. Section 10(b) and the corresponding Rule 10b-5 of the Securities Exchange Act of 1934 contain broad language that protects the public and investors against fraud and other forms of market manipulation.

“And I think the SEC is … very comfortable with the (statutory) weapons it has to fight insider trading,” Lowe says. “The hard part is detection.”

Some research maintains that the prevalence of illegal insider transactions is only now coming to light.

According to a study by New York University’s Stern School of Business and McGill University that examined 1,859 corporate mergers and acquisitions from 1996 to 2012, roughly 25 percent showed signs of abnormal trading within 30 days before the deals were announced. The odds that those trading red flags occurred by chance would be roughly “three in a trillion,” the study’s authors contend.

The report also reveals that the SEC litigated less than 5 percent of the deals analyzed in the sample period. The agency moved slowly when it did pursue cases, typically waiting more than two years to announce the first litigation actions.

Yet in some arenas, scrutiny of insider trading is growing. New York Attorney General Eric Schneiderman, for instance, has gone after trading venues that offer a timing advantage—sometimes only a fraction of a second—to high-frequency traders who then react before the rest of the market can.

“And in the high-frequency world, you can make money in those few seconds in getting your trades in ahead of somebody else,” Nussbaum says.

Rising interest in connecting the dots across international borders also may nab more wrongdoers.

“And (now) there’s much greater cooperation globally among securities commissioners and prosecutors,” Nussbaum says.

Sheila Livadas is a Rochester-area freelance writer.