David R. Chase, P.A.
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The SEC will consider several factors in assessing the relative strength or weakness of an insider trading case. In my thirty years of securities law experience, both as a SEC Division of Enforcement attorney who investigated and prosecuted illegal insider trading, and as an insider trading defense lawyer for the last twenty-five years, I keenly understand what factors the SEC evaluates in assessing the strength and weaknesses of a potential insider trading case. Such factors include:
The closer in time the trade to the news announcement, the more suspicious the SEC becomes. Typically, in the days, or sometimes weeks, before the public announcement of the corporate event (for example, an acquisition or merger), the details of the transaction are known and agreed to. This allows a trader who has inside information (known as material, nonpublic information or MNPI) about the terms of the deal to capitalize on not only when the announcement will be made, but also on the pricing of the deal. On the other hand, if the trade is made substantially before the news release, particularly if the deal is still under discussion and final terms have not yet been reached, it will be more difficult for the SEC to make a case. In other words, the closer on the timeline a trader purchases as the deal is being formalized and its essential terms agreed to, the stronger an inference of illegal insider trading the SEC will make.
This is a critical question for the SEC to answer. In certain cases, the SEC will have established that the targeted trader knew an individual, or several, who possessed the MNPI. In that scenario, the SEC’s task is to demonstrate — either through direct or circumstantial evidence — that the inside information was, in fact, transmitted to the trader and then traded upon. Direct evidence, for example, would be emails or text messages reflecting the transmission of the MNPI, perhaps coupled with the sworn, corroborating testimony of the individual who provided it (the tipper).
Circumstantial evidence would be of a lesser quality and strength. An example would be that the tipper and trader (the tippee) both attended the same business event the night before the trade. While not in and of itself conclusive proof that MNPI was passed, the fact that the trade was made the very next day, coupled with certain other factors (discussed below), may be enough for the SEC to recommend an insider trading charge. The takeaway here is that the SEC does not need a proverbial “smoking gun” to bring an insider trading enforcement action; rather, it need only a sufficient quantum of direct and/or circumstantial evidence to prove by a preponderance of evidence (more likely than not) that illegal insider trading took place. Securities and Exchange Commission v. Matthew Panuwat, 4:21-cv-06322 (N.D. Cal. 2021). However, the Department of Justice, which possesses criminal authority (the SEC does not), must prove insider trading beyond a reasonable doubt, a far higher standard of proof. Salman v. United States, 580 U.S. 39 (2016).
If yes, this can be viewed by the SEC as particularly suspicious and begs the question: “why now ?”. This is not to say that a truthful and plausible answer cannot be provided, but it certainly will cause the SEC to carefully scrutinize the trade with a somewhat jaundice eye. If, however, the trader has a history of trading in the stock, and has an established record of following it, it may make it much more difficult for the SEC to prove illegal insider trading, all things being equal. This of course makes sense as the trader can credibly argue that the purchase under scrutiny was in the normal course and entirely consistent with his past trading history.
While the purchase or sale of common stock and options are both securities for insider trading purposes, option purchases may be more indicative that a trader possessed MNPI. This is so because options, particularly if they are short-term and out-of-the money, allow the trader to make a highly leveraged bet that the company’s stock price will significantly move (either up or down) within a defined time period. So, by way of example, if I knew Company A was going to purchase Company B in two weeks on a date certain, and I also knew the purchase price and other material terms, I would want to maximize the value of this MNPI by loading up on short-term, out-of-the money call options pegged to the announcement date. If I did not have MNPI, this purchase would be highly speculative, extremely risky and likely to result in a total loss due to the options’ expiration. The SEC understands this well, and would likely view this structured option purchase as compelling circumstantial evidence that I had the precise details of the non-public deal, absent a plausible, alternative explanation. This, however, is unlike a straight-up purchase of common stock, where I could hold the shares even if the deal cratered and not be subject to the risk of the total loss of my investment.
If yes, the SEC’s concerns will be heightened. The SEC will examine the targeted trader’s investment history to determine whether the trade(s) in question is consistent with past activity, or whether it marks an unusual departure from the historical norm. For example, if for the last five years the trader has only purchased and held mutual funds or ETFs, the purchase of a single stock would illicit the inquiry of why now and why this particular stock. The concerns would be magnified if the trader had never previously purchased the stock. On the flip side of the coin, a trading history that is consistent with, or substantially similar, to the trade in question gives the trader the opportunity to offer a credible, innocent explanation for the transaction and thus can effectively chip away at the SEC’s prosecution theory.
If so, this may be considered by the SEC as a compelling data point in its analysis of potential illegal insider trading. The reason is plainly obvious. By way of illustration, If the trader had a net worth of $500,000 and invested $450,000 in one stock purchase, the SEC will likely strongly infer that the trader possessed MNPI when making the trade. Why else would one reasonably be expected to risk almost the entirety of his life savings on a single stock purchase, particularly so if the trader had no prior investment history with the company. This is a fact that is difficult to defend. If, though, the trader invested only a relatively small percentage of his net worth, or liquid net worth, counsel can argue that the trade is inconsistent with the possession of MNPI as if the trader had it, he would have invested substantially more. It is important to understand that the SEC will bring insider trading prosecutions based on relatively small profits. I am often asked by clients why the SEC would bother to utilize its limited resources on such a “small case.” The reason: the SEC regulates through deterrence that it achieves by publicizing the insider trading cases it brings (there are no confidential settlements with the SEC), regardless of the amount of profit made or loss avoided.
Emails and/or text messages can make an insider trading case for the SEC depending upon their content. In some cases, believe it or not, tippers and tippees will explicitly discuss the MNPI and the upcoming news announcement. This is seen with purportedly “encrypted” electronic communications that turn out to be not quite so encrypted. Often, however, code words are used or language that is suggestive but not explicit. In other situations, there will be no such communications prior to the trade in question, but after-the-fact electronic discussions. These can be just as damaging as those exchanged prior to the trade, or even worse, especially if they evidence efforts to conceal or mislead. Recall that Martha Steward did not go to jail for engaging in illegal insider trading, but rather for lying about it to federal agents. This offense violates 18 U.S.C. § 1001, the federal false statements statute, and can result in substantial fines and possibly jail.
If yes, then the SEC will be able to add an additional building block to its potential insider trading case. From such records, the SEC will view the timing of the communication as a piece of circumstantial evidence tending to support the theory that a conversation was had where MNPI was transmitted. It is important to note that the mere fact that telephone records reflect a call does not mean that MNPI was discussed; in fact, the call proves nothing by way of the call’s content or even the parties to the call. Moreover, if the tipper and tippee speak daily in the normal course, the existence of the call(s) near in time to the trade have much less evidentiary value. This also holds true for business or social calendars that reveal the tipper and tippee were at the same event shortly before the trade. Again, it is some useful circumstantial evidence for the SEC, but it has its limits: it cannot definitively demonstrate, alone, that the two ever spoke at the event, let alone were there at the same time. Bottom line: the absence of close-in-time telephone calls does not kill an insider trading case for the SEC, but it does take off the table yet one more potentially suspicious fact it can use.
If so, this can be very problematic from a defense perspective. As the SEC has to prove the tipper received a “benefit” for the tip under the law, a tippee’s cash payment to the tipper after-the-trade, without a plausible reason, will no doubt be viewed by the SEC as a financial quid-pro-quo for the MNPI. In Salman v. United States, 580 U.S. 39 (2016), the U.S. Supreme Court held that a tipper must receive a “personal benefit” for disclosing material, non-public information, which can include pecuniary gain, reputational benefit, or a gift to a friend or family member. This is also true for irregular cash withdrawals, as the SEC will demand answers as to the purpose and use of the cash. At times, the payment or “benefit” is not obvious but takes form in somewhat subtle forms, like professional favors or the like. This amorphous concept of “benefit” gives a SEC defense attorney room to maneuver as the current state of the law is far from black and white. In the SEC defense world, where there is grey, there is hope.
When defending clients accused of insider trading, David Chase provides:
If you are under SEC investigation for insider trading, your choice of attorney can make the difference between walking away unscathed or facing charges. With the SEC aggressively pursuing insider trading cases, you need a seasoned, fierce advocate by your side.
As a former SEC prosecutor and a dedicated SEC defense attorney, David is nationally recognized for his insight and knowledge in SEC investigations. David has been widely quoted in the media on insider trading, and has written extensively on the topic.
Do not go at it alone and wait until it’s too late. Early intervention by experienced counsel can often influence the direction of an investigation and may even prevent charges from being filed.
Contact David today at 800-760-0912 if you are in need of a insider trading attorney to schedule a free and confidential consultation.