Friday, November 21, 2008

Difficulties in Insider Trading Actions

One usually tends to lament that the Indian securities regulator, SEBI, has been unsuccessful yet in its prosecution of insider trading cases. Several high profile cases were initiated by SEBI only to be overturned by the appellate authorities. This tends to be on account of the fact that insider trading cases are difficult to prove.

A new case initiated by the Securities and Exchange Commission (SEC) in the US highlights some of these difficulties even in that regime (which has a treasure trove of judicial precedents in insider trading cases). The Deal Professor has an interesting take on the action:

“The S.E.C. complaint alleges that Mr. Cuban learned about a planned PIPE (private investment in public equity) offering by Mamma.com, in which he was the largest individual shareholder with 600,000 shares. PIPE deals are a sure-fire sign that a company’s finances are in bad shape, and the market’s response to such transactions is almost always negative.

According to the commission, although Mr. Cuban was told that the information was confidential, he sold all his shares to avoid the hit they were sure to take after the announcement of the PIPE deal. The “loss avoided” is estimated at $750,000 — a pittance to someone like Mr. Cuban, who made his money by selling Broadcast.com to Yahoo for $1 billion.

Mr. Cuban’s Mamma.com sale occurred in June 2004, more than four years ago. What took so long to bring the case? News reports indicate that the S.E.C. did not learn of the transaction until early 2007, so the case was already old before it got started. No criminal charges have been filed. Indeed, criminal charges can often slow down a securities case because the prosecutors need to conduct their own investigation.”
Aside from the insider trading issue, the report also questions whether securities regulators ought to be focusing on more pressing matters rather than pursuing dated insider trading actions:

“The S.E.C. needs to establish its presence as the market policeman, there to protect investors. Yet in recent years the commission, whether by choice or legal restriction, allowed wide swaths of the market to go largely unregulated. The courts rejected the S.E.C.’s assertion of authority to regulate hedge funds. The commission let Wall Street firms increase their leverage and employ their own internal risk assessment models, allowing them to invest heavily in mortgage-backed securities and other real estate investment vehicles. That decision allowed companies like Lehman to put themselves at risk when the housing market cratered. There was no cop within a hundred miles of that decision.

So the commission decides to pick a fight with Mark Cuban in a case that may not be all that easy to win. The typical insider trading case involves someone with a fiduciary responsibility to a company, such as an officer, employee or outside adviser, who trades in the shares. Mr. Cuban was an investor in Mamma.com, and its management sought to interest him in the PIPE deal, which did not make him very happy. But owning shares in a company does not make one a fiduciary, and there are no restrictions on the right to sell one’s shares.”

3 comments:

Emil said...

The author here speaks of the difficulties faced by Regulators in Insider Trading Actions. I would like to draw attention to a consent order passed by SEBI, this week, wherein a settlement was reached between SEBI and Apollo Tyres (along with others) for one crore (10 million) Indian Rupees. This settlement was reached in a proceeding initiated by SEBI against Apollo Tyres (along others) for the alleged Insider Trading done in the shares of Apollo Tyres during the period October 29 - November 17, 2003. This proves the fact that in spite of the difficulties faced by the regulator in insider trading actions, SEBI has been acting effectively in insider trading actions.

Umakanth V said...

Emil, thanks for your comment and for pointing to the consent order passed by SEBI in the Apollo case (http://www.sebi.gov.in/consentorders/apolloorder.pdf). The positive aspect of the Apollo order (and other consent orders in general) is that it forces parties to settle cases rather than to go through a tedious litigation process, thereby enabling SEBI to recover settlement amounts. This in itself could have potential deterrent effects against violations such as insider trading. However, the downside of such settlements is that the alleged violators settle “without admitting or denying the charges”. Hence, as these actions do not go into litigation before courts or appellate authorities, the Insider Trading Regulations would not be subject to interpretation and development through case-law.

There is an instance of SEBI in fact succeeding before the SAT in pursuing an insider trading action. This is in the case of Rajiv Gandhi (passed on May 9, 2008) – the order is available on the SEBI website (http://www.sebi.gov.in/satorders/RajivBGandhi.pdf). In case readers are aware of any other cases on insider trading in the recent past, we very much welcome their comments/observations.

santanu said...

"The typical insider trading case involves someone with a fiduciary responsibility to a company, such as an officer, employee or outside adviser, who trades in the shares. Mr. Cuban was an investor in Mamma.com, and its management sought to interest him in the PIPE deal, which did not make him very happy. But owning shares in a company does not make one a fiduciary, and there are no restrictions on the right to sell one’s shares.”


All i would like to state in this regard is that the test involved in proving an insider trading is whether the person violating the law has made use of unpublished price sensitive information.... whether to make profit or to avoid loss ... or even without intention to make profit or avoid loss....