Insider Trading Review: A Guide for CCOs.

A Guide for Compliance Officers:

Insider Trading Over view

Presenter Brandon Ortiz of Blue River Partners will provide an analysis of the key elements of insider trading, highlight important recent enforcement actions all CCO's should know, and share a discussion of best practices for CCO's in 2016 from how a solid compliance program can mitigate risks to how to spot telltale signs.

Brandon Ortiz

Mr. Ortiz is a Managing Director at Blue River Partners where he manages the implementation and administration of the firm’s compliance service offerings to alternative asset managers, which include fund launch, ongoing compliance program management and individual compliance project services.



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Full Transcription Below

 "it takes a long time in this industry to generate and build that reputation. It takes one headline to kind of destroy that"


Today we're going to go through insider trading. We're going to talk a little bit about the overview of what insider trading is, theories and situations of insider trading as have been defined by the courts. We will go through discussions as to where the courts have been in the past in terms of their analysis, where they are today, and then hit on what is the most prevalent topic, which is the benefit test and the Supreme Court's analysis of that. That is coming soon. We'll end with a discussion of how CCO's can address this type of material nonpublic information, potential insider trading within their organizations, how they can mitigate risks, et cetera.

What is insider trading?

Insider trading generally refers to buying or selling a security and breach of a fiduciary duty or other relationship of trust or confidence per the SEC. It's doing that while in possession of material nonpublic information or MNPI, as we've all learned through our days in this industry with respect to security. I'll be using MNPI throughout the presentation just to simplify the definitions and the discussion.

Insider trading violations also include tipping such information, securities trading via person that's been tipped, and securities trading by those who misappropriate such information.

Disclose or Abstain

Talking a little bit about theories and situations with insider trading. Initially we start with the classical theory aka disclose or abstain theory. Under the so-called classical theory of insider trading, a corporate insider, which can be either permanent, an officer or director, or a temporary employee like a consultant working on a deal or something in that context, violates a duty to corporate shareholders. Either discloses intent to trade or to abstain from trading on the basis of material nonpublic information. The tippee of a corporate insider assumes the tippers duty to shareholders. If the tippee knows or should know that the tip constitutes a breach of the tippers duty.

We'll talk a little bit more about definitions here shortly, but the tipper obviously is the person in this case that's inside that's giving the information, and the tippee is the person who's receiving that information and in the context of insider trading is trading all that information.

The breach of a duty in the context of the tipper and the tippee as I just described to the shareholders, constitutes the deception necessary for liability under the anti-fraud statute in the classical insider trading cases.


Moving onto the misappropriation theory. It covers individuals possessing insider information who are prohibited from trading on such information because they owe a duty to a third party. Not so much the corporation as described in the classical theory, but a third party. The relationships that give rise to obligations of confidentiality are listed in rule 10B5-2. I won't go into all of those examples, but for the purposes of giving a few, if you agree to maintain information in confidence, so contractually through an NDA or something of that nature is an example of that.

Another situation where insider trading is involved can be in the context of a private company itself. Stiefel Laboratories case is an example. The CEO in that context, he purchased shares of the company from employees while making misrepresentations to the employees about the value price of those shares. He should have disclosed the MNPI or abstained from offering securities for purchase in the company.

The last piece here is illegal insider trading. If you are an insider, you purchase or sell securities of your own company in a pre-planned manner, persuade to 10B5-1. Or if you overhear a conversation in a coffee shop or at a football game, you don't have a duty to ignore while at a public location. It's a little bit different than someone actually overtly telling you or passing on MNPI to you. It's not illegal to be in the right place at the wrong time, or wrong place at the wrong time depending on how you look at it in that context.

Definitions within Insider Trading

Moving onto the definitions. Very important here obviously as we move through the case log in discussing the key tenets of those cases of these definitions. As I mentioned before, we kind of talked about tipper and tippee. The tipper provides material nonpublic information. It's generally someone who passes insider information to another person who uses it to trade. You're just as culpable as the person who uses it for his or her own account in the context of being a tipper. The tippee received the material nonpublic information.

The definitions of material and nonpublic in the context of MNPI are highly important obviously. With respect to being material, the information that a reasonable person would consider significant when deciding whether to purchase or sell the companies securities. Classic advisers act, very broad, there's no bright line test there. It's something we should all keep in mind, particularly internally, when managing our own compliance programs. That is a very broad test there so it's important that from my perspective you take a conservative view of in the context of materiality.

Nonpublic. If the information is not readily available to the marketplace, it's not disseminated via media or other outlets of Bloomberg Terminal, in the Journal, something of that nature, then it would be considered nonpublic.

Insiders. Generally officers, directors, employees of a company, or anyone who enters into a special confidential relationship as a result of receiving MNPI. The penalties with respect to insider trading, we've seen this in the media over the past 10 years, SAC capital, various examples of folks who have had both civil and criminal penalties brought against them.

SEC penalties for Insider Trading

We'll talk a little bit more about the results of recent cases and what that's meant in terms of people getting some of those penalties back from the SEC. From a general standpoint there is both civil and criminal penalties in the context of insider trading, so discouragement of profits, fines of 3X profit, criminal fines, jail sentences of up to 20 years. I guess the key is you'll be barred from working in the industry. Even certain of these examples are folks who have been receiving some of their fines back from the SEC. These folks have been put out of business. These folks aren't able to work in the industry anymore, and even if they could their reputation kind of precedes theme.

I think that's important to keep in mind as we move through discussions in these cases. The analysis of where we are with respect to insider trading is that it doesn't really change our perspective as CCO or compliance professionals in the way we handle potential MNPI internally and insider trading internally, because when you get to the analysis itself that we're going to be discussing, you're kind of already behind the eight ball. You're already in a position where you don't want to be.

I guess that goes to the last point, their reputational damage. It takes a while for investigations to be completed. It can be the announcement of the insider trading investigation, as I've just mentioned can put a firm out of business so it takes a long time in this industry to generate and build that reputation. It takes one headline to kind of destroy that, so it's important to keep in mind.

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