The stability of the global banking system is a top-of-mind concern for everyone right now. And as the world worries about bank liquidity and the safety of their deposits, a handful of executives have been using access to insider information to turn staggering profits by selling off company stock.
In the aftermath of a tumultuous one-week stretch that saw the collapse and rescues of banks including Silicon Valley Bank, Signature, Silvergate Bank, First Republic Bank and Credit Suisse, regulators are raising concerns about executives profiting from sales of company stock in the weeks and days leading to the crisis. Silicon Valley Bank executives and directors have sold out of $84 million in stock over the past two years, including a $3.6 million sale by the CEO just days before the bank’s collapse. Insiders at First Republic Bank have sold $11.8 million worth of stock so far this year, including on March 6, two days before the bank collapsed. And the buying and selling activity is not limited to the banks in crisis. NASDAQ reports that insiders from other banks are using falling stock prices stemming from the upheaval as an opportunity to snap up more company stock.
Some of these transactions were covered under pre-approved executive trading plans. And not all banks are required to report insider sales to the SEC, based on reporting rules that go back to the Securities Act of 1933, which exempts banks from registering their securities. But regardless, given the magnitude of the crisis, regulators are concerned. The New York Times reports that the United States Justice Department and the SEC have opened investigations into the collapse of Silicon Valley Bank. One of the anticipated targets of the investigation is the sale of company stock by company executives right before the collapse. According to DLA Piper, "government regulators have extensive access to trading records and information and are able to identify connections between trading activity and public and private communications regarding the events surrounding the closure of the banks." Read about how MNPI Remains a High Risk Area for Compliance.
More Scrutiny for Insider Trading Plans
Executive insider trading plans have been on the regulatory radar even before the banking disruption of the last few weeks. Rule 10b5-1 is an affirmative defense to insider trading that allows financial services and corporate insiders to set up good faith plans for the future buying and selling of company stock. SEC Chair Gary Gensler has described the trading plans as leading to “real cracks” in the SEC’s insider trading regime. In December of 2022 the SEC adopted amendments and updated disclosure requirements to Rule 10b5-1 to strengthen and enhance investor protections against insider trading.
Regulators will be taking a hard look at the timing of the executive's stock transactions to evaluate if the trading plans were entered into in good faith - or if the executives knew undisclosed material information about the financial health of their bank and its imminent collapse. In opening remarks to a SEC Commission meeting, Gensler said that “we will investigate and bring enforcement actions if we find violations of the federal securities laws”. DL Piper also notes that in addition to scrutiny of 10b5-1 plans, regulators may also evaluate whether a firm's disclosures and organizational documents adequately made known any potential conflicts of interest.
Even if investigations find no violations under current laws, the industry can expect a higher level of regulatory scrutiny around insider sales. U.S. President Joe Biden released a statement calling on Congress for regulators to impose tougher penalties on the executives of failed banks, including clawbacks of past compensation, noting that “Congress must act to impose tougher penalties for senior bank executives whose mismanagement contributed to their institutions failing." And legal implications aside, there’s no denying the reputational damage and resulting lack of faith in the system from consumers toward both the institutions and individuals involved.
Expect More Regulations
On March 14, U.S. Senator Elizabeth Warren (D-Mass.), a member of the Senate Banking, Housing, and Urban Affairs Committee, delivered a speech on the Senate Floor calling for changes to banking laws, focusing on strengthening the "weakened rules that permitted banks like SVB and Signature to load up on risks, run up their profits, pay their executives giant bonuses, and eventually blow the banks to pieces."
In a March 28 statement before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, Vice Chair for Supervision Michael S. Barr provided remarks on concerns around Bank oversight and raised the distinct possibility of additional regulations in the future. Barr stated that Silicon Valley Bank was a "case of textbook mismanagement" with "inadequate risk management and internal controls". Barr also noted "that recent events have shown that we must evolve our understanding of banking in light of changing technologies and emerging risks".
A report from the Federal Reserve on the bank's failings was made available to the public on April 28. The report reiterated that the failure was due to mismanagement including the failure of senior leadership to manage interest rate and liquidity risk and the board of directors' lack of oversight of senior leadership and failure to hold them accountable for their actions. The Fed accepted responsibility for the failure as well, noting that regulators were slow to identify issues and failed to effectively address issues once they were identified. The report promises both stronger supervision and stronger regulation moving forward. The report also called for better oversight of incentives for bank management, recommending setting tougher minimum standards for incentive compensation programs and better ensuring that banks comply with the standards already in place. See how MCO helps firms ensure that there's executive accountability for regulatory obligations and effective business oversight.
A separate report from the FDIC on Signature Bank was equally scathing, blaming poor management, lack of governance, and failure to develop and maintain adequate risk management practices and controls for the institution's collapse. And to head off another collapse, on May 1 First Republic Bank was taken over by the FDIC and JP Morgan Chase assumed all of the bank's deposits and substantially all of their assets.
Expanding the Scope of Insider Trading
The ProPublica report Wealthy Executives Make Millions Trading Competitors’ Stock With Remarkable Timing and CNBC's interview with the article's reporter Robert Faturechi identified multiple instances where executives made millions with well-placed trades of competitor stock, noting that “executives at companies can also have access to non-public information about rivals, partners or vendors through their business”. ProPublica analyzed a dataset of stock trades leaked from the IRS and isolated anomalous instances where corporate executives bought and sold stock in close competitors with fortuitous timing. There’s an inherent conflict of interest when executives are making money by buying and selling competitive stock. The report points out that even when legal, these trades allow executives to win even as their companies lose.
There’s been some regulatory enforcement on trading a competitor’s stock using MNPI. In 2021 the SEC charged a biopharmaceutical employee with insider trading. The complaint alleges that the head of business development knew that his firm was going to be acquired by an industry giant. Another firm was favorably described as a competitive company by investment bankers involved in the acquisition discussions. The employee bought stock in the company minutes after learning highly confidential information concerning the merger, anticipating that the competitor's stock would go up as well.
In the press release accompanying the action, Gurbir Grewal, Director of the SEC's Enforcement Division stated "Biopharmaceutical industry insiders frequently have access to material nonpublic information about mergers, drug trials, or regulatory approvals that impacts the stock price of not only their company, but also other companies in the industry, The SEC is committed to detecting and pursuing illegal trading in all forms."
MyComplianceOffice offers financial services firms a fully integrated, comprehensive compliance management platform that helps firms identify conflicts across firm transactions (deals, loans, research, trades), employees, and third parties, addressing:
Employee compliance monitoring & conflicts of interest
Compliance governance and oversight
Third party due diligence and risk management
Trade surveillance and suitability monitoring, including transactional conflicts of interest and MNPI and insider list management
Ready to learn more about how MCO helps firms manage the risk of insider trading? Contact us for a demo today!