Regulators Continue to Face Challenges Pursuing “Insider Trading”

In recent months, the SEC has seen some highly reported insider-trading trial losses, including cases brought against Nelson Obus, co-founder of Wynnefield Capital Inc., and Manouchehr Moshayedi, founder of computer storage device maker STEC Inc. The verdicts, which came down on May 30, 2014 and June 6, 2014, respectively, follow on the heels of another highly reported defeat in October 2013, where the SEC lost an insider trading case against Dallas Mavericks owner, Mark Cuban. In the wake of these losses, the SEC has faced criticism that it is “seeking to regulate through litigation” and is engaging in “systematic regulatory overreach without accountability”. Time will tell whether these losses will ultimately hurt the SEC’s credibility or cause it to reconsider taking such an aggressive approach moving forward – but in the immediate term the SEC appears to be moving ahead with charges filed in June 2014 in the San Francisco federal court against four California residents allegedly involved in a $12M insider trading scheme involving Ross Stores stock options.

Following the losses, Andrew Ceresney, head of the SEC Enforcement Division, appeared at an event before members of the Washington, D.C. bar in June 2014 and indicated that the SEC may start filing some insider-trading cases in administrative proceedings rather than before the federal court. Touting administrative proceedings as streamlined with a more sophisticated trier of fact, Ceresny indicated his belief that the SEC would move in this direction in appropriate circumstances. While Ceresney insisted that bringing insider trading trials in-house was not a reaction to the SEC’s recent string of losses, it appears that the SEC’s appetite for insider trading trials – notoriously difficult to prove absent wire tap evidence or cooperating witnesses – may be waning.

Meanwhile, a recent study by New York University’s Stern School of Business and McGill University released in May 2014 investigated insider trading activity in equity options prior to the announcement of M&A transactions. The study looked at 1,859 corporate transactions from 1996 to 2012, and concluded that roughly 25% of all transactions studied had abnormal trading patterns in the 30-day period prior to the transactions’ announcement. The authors noted that the SEC litigated only about 4.7% of the 1,859 deals covered by the study, and found that the SEC is likely to examine cases where the targets are large, and experience substantial abnormal returns after the announcement, and where the acquirers were headquartered outside the US. Considering the pervasive evidence of insider trading documented by the study, the authors concluded “the modest number of civil lawsuits for insider trading options made by the SEC appears small in comparison”.

In Canada, the Ontario Securities Commission has confirmed they will continue to take an aggressive approach to “insider trading”. In a speech by Howard Wetston, Chair of the OSC, on March 27, 2014 before the Toronto Region Board of Trade, Wetston acknowledged that “the failure to vigorously prosecute insider trading can undermine investor confidence in the quality of our capital markets”. In that same speech, Wetston indicated that he believes the OSC needs a broader range of enforcement sanctions than those available under the tribunal process – and should be pursuing quasi-criminal or criminal cases in the courts to exploit incarceration as a deterrent. With regard to “insider trading”, however, Wetston admitted that the OSC was missing key tools to assist in effectively enforcing prohibitions against insider trading, including the use of wiretaps for trading and tipping offences under the Criminal Code, and urged their inclusion.

The reality of limited financial resources, perceived insufficiently effective investigative and enforcement tools, and an inadequate national structure to coordinate oversight of enforcement activity, puts pressure on regulators, other law enforcers and prosecutors to yield meaningful results. On the other hand, aggrieved investors and other stakeholders seem to be willing to take action in the absence of visible action by securities regulators and other law enforcers, as evidenced recently in two high-profile civil cases involving allegations of stock option manipulation that have recently been commenced in Canada by investors.

Image courtesy of Flickr by Alberto Carrasco Casado