There’s an old French proverb, “plus ça change, plus c’est la même chose”, which translates into “the more things change, the more they stay the same” and that’s the way I feel about insider trading. Every few years, the topic seems to rear its ugly head long enough for prosecutors to make some headlines before moving on to other offenses.
In the past few weeks insider trading has come back into the news. Federal prosecutors recently unveiled a sweeping investigation centered upon the use of so called “expert networks” and involving subpoenas to SAC Capital, Janus Mutual funds, Fidelity Investments and Wellington Management. The current round follows about a year after the indictments announced in connection with the investigation of Galleon Hedge Fund and there appear to be a number of links between the two cases.
Insider trading issues are always going to be part of Wall Street as there is an inherent conflict of interests between our regulatory scheme and what motivates professional investors. The regulations seek to ensure fair and honest markets where all investors play on an even field. On the other hand, investors seek to gain an “investment edge” either through superior analysis or by figuring out insights to what may be happening at the company in question by piecing together disparate snippets of information. Given that there are significant amounts of money involved, Wall Street analysts are always going to push as hard as they can to gain an investment edge, up to, and sometimes over, the ethical line.
It doesn’t help matters that the current regulations and case law regarding insider information are not crystal clear. To greatly oversimplify things: If you are in possession of material, nonpublic information and you received it as a result of a duty to the corporation, or from someone who has such a duty, or if you have misappropriated the information in violation of a fiduciary duty, you can’t buy or sell the securities of that company. However, the mosaic theory, first enunciated by the federal courts in Elkind v. Liggitt & Myers, Inc., holds that analysts can assemble seemingly disparate non-material information into a material piece of information; that is, information that leads to a decision to buy or sell the stock. Of course, if some of the mosaic of information was obtained as a result of violations of duty to the company discussed above, things become somewhat less clear.
And there we have what I believe to be the crux of the current crop of insider trading cases. If you listen to the defendant’s attorneys you hear a constant drumbeat of mosaic this and mosaic that, portraying their clients as simple analysts who gain insight into companies by dint of digging harder than anyone else. If you listen to the prosecutors, what you hear is a tale of misappropriation of information that was known to be from sources that had a duty not to disclose the information, even if the piece of information was not material in and of itself. To my knowledge, there is no clear case law that governs in such a situation. Judges and juries are going to have to figure this one out, followed by inevitable appeals.
If we’re lucky, there eventually may be some clarifying language that will help people understand what they can and cannot do - what lawyers like to refer to as a “bright line” test. If we’re really lucky, the courts will give it a handy catch phrase such as “fruit of the poisonous tree” or “clean hands doctrine” that will help investors know what they can and cannot do.
Goodness knows, the securities laws could use some simple, clear rules that everyone can understand.