When the WSJ performs a study and publishes the results on the front page, it often has consequences. It’s worth remembering that it was a study reported in the WSJ about stock option backdating that kicked off the option backdating scandal of the mid-2000s (see, e.g., this news brief, this news brief and this news brief). Now, the WSJ has conducted a new front-page analysis of trading by insiders under Rule 10b5-1 plans that “shows that executives benefit when sales happen quickly after the plans’ adoption.” Academics and the SEC, the WSJ observes, suggest that “some corporate insiders might be using nonpublic information to game the system.” Under SEC Chair Gary Gensler, the SEC has already proposed new rules to “freshen up,” as Gensler likes to say, the rules on 10b5-1 plans, including mandatory cooling-off periods after adoption or modification of the plan—an aspect of the proposal designed to address precisely this issue. The WSJ analysis found that about 44% of the trades reviewed (about 33,000 stock sales), would not have been permitted under the cooling-off periods proposed in the SEC rule. The SEC has targeted April 2023 as the target date for adoption. (See this PubCo post.) In the light of some of the results shown, will the new study reinforce the SEC’s inclination to adopt its new proposal?
In August last year, the SEC announced that it had filed a complaint in the U.S. District Court charging Matthew Panuwat, a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company. But this isn’t your run-of-the-mill insider trading case. Panuwat didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction. No, according to the SEC, he engaged in what has been referred to as “shadow trading”; he used the information about his employer’s acquisition to purchase call options on a separate biopharma company, Incyte Corporation, which the SEC claimed was comparable to Medivation. According to the SEC, Panuwat made that purchase based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. Incyte’s stock price increased after the sale of Medivation was announced. The SEC charged that Panuwat committed fraud against Medivation in connection with the purchase or sale of securities, with scienter, in violation of Rule 10b-5; he had, the SEC charged, breached his “duty to refrain from using Medivation’s proprietary information for his own personal gain” and traded ahead of the announcement. The SEC sought an injunction and civil penalties. (See this PubCo post.) In November, Panuwat filed a motion to dismiss the complaint under Rule 12(b)(6), calling it “an unprecedented expansion” of the Exchange Act. Last week, the Court denied the motion.
On Tuesday, the SEC announced that it had filed a complaint in the U.S. District Court charging a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company. But it’s not what you might think. The employee didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction. No, according to the SEC, he used the information about his employer’s acquisition to purchase call options on a separate biopharma company, Incyte Corporation, which the SEC claims was comparable to Medivation. According to the SEC, the employee made that purchase based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. Incyte’s stock price increased after the sale of Medivation was announced. The SEC charged that the employee breached his “duty to refrain from using Medivation’s proprietary information for his own personal gain” and traded ahead of the announcement, in violation of Rule 10b-5. Will the SEC succeed or is the factual basis of the charge just too attenuated?
Most everyone knows that trading on the basis of material non-public inside information is likely to get you in trouble with the law, but charitable giving on the basis of MNPI—maybe not so much. As reported in this article in the WSJ, a new study from a group of business and law school professors looked at “insider giving,” or, as the study authors describe it, “opportunism posing as, or at least muddled with, ordinary philanthropy.” In essence, according to the WSJ, with insider giving, the donor “tim[es] the donation of a stock to a charity around inside information about the stock. That way, you take a tax deduction before bad news sends the share price tumbling or after good news sends the price higher—and the gift delivers a bigger deduction than you would have gotten otherwise.” The donation is not only tax deductible, it’s also exempt from capital gains tax that would be due on the appreciation in value upon the sale. One of the authors characterized these donations to the WSJ as “suggest[ing] more than chance….The fact that large shareholders can determine or choose—with pinpoint accuracy—the average maximum price over a two-year period when they give gifts is surprising.’” The study authors argue that the practice is “far more widespread than previously believed,” and relied on by insiders, including large investors. Insider giving, they conclude, “is a potent substitute for insider trading.” It’s worth remembering that it was a study reported in the WSJ about stock option backdating that kicked off the option backdating scandal of the mid-2000s (see, e.g., this news brief, this news brief and this news brief). Could “insider giving” be the new option backdating scandal?
In 2015, an academic study, reported in the WSJ, showed that corporate insiders consistently beat the market in their companies’ shares in the four days preceding 8-K filings, the period that the researchers called the “8-K trading gap.” The study also showed that, when insiders engaged in open market purchases—relatively unusual transactions for insiders—during that trading gap, insiders “are correct about the directional impact of the 8-K filing more often than not—and that the probability that this finding is the product of random chance is virtually zero.” The WSJ article reported that, after reviewing the study, Representative Carolyn Maloney, a member of the House Financial Services Committee, characterized the results as “troubling” and said she was preparing legislation to address the issue. Five years later, in January 2020, by an unusually bipartisan vote of 384 to 7, the House passed HR 4335, the “8-K Trading Gap Act of 2019.” A substantially similar bill was introduced in the Senate. But then, the bill disappeared into the vapor. Now, a similar bill, the ‘‘8–K Trading Gap Act of 2021,” has been introduced by Maloney in the House as H.R. 4467, and in the Senate by Senator Chris Van Hollen as S.2360. According to Van Hollen, “Time and again we’ve seen corporate executives take advantage of the 8-K trading gap by selling off bundles of shares prior to a major announcement. It’s clear this gap gives corporate insiders a massive unfair advantage over the public….Our legislation will close this harmful loophole and provide fairness to everyday shareholders. I’ll be working with my colleagues on the Banking, Housing, and Urban Affairs Committee to move this legislation at once.” Although Congress certainly has a full legislative plate, with the Dems now controlling both houses of Congress, will the bill finally make its way through Congress?
Last week, in a bipartisan move, Senators Chris Van Hollen and Deb Fischer reintroduced the “Promoting Transparent Standards for Corporate Insiders Act.” According to the press release, the legislation is designed to address concerns that some insiders “may be abusing loopholes in this system, which hurts everyday investors and reduces confidence in the integrity of our capital markets.” The bill would require the SEC to conduct a study to determine whether Rule 10b5-1 should be amended, report back to Congress within 180 days and amend Rule 10b5-1 within a year consistent with the study’s findings.
On Tuesday, the Insider Trading Prohibition Act passed the house by a pretty big bipartisan majority—350 to 75. Currently, there is no explicit statutory prohibition on insider trading and prosecutors have relied on general fraud statutes to pursue charges. The bill would add to the Exchange Act a new Section 16A that would define insider trading and make it illegal. In an interview with Reuters, the bill’s sponsor, Jim Himes, said that “the legislation does not expand insider trading law but simpliﬁes and codiﬁes the law as articulated by courts through decades of opinions.” A version of the bill passed the House in 2019 by an even stronger vote, but never made it through the Republican-led Senate. No,w with Democrats in charge, will the bill be passed and signed into law?
In this paper, Gaming the System: Three ‘Red Flags’ of Potential 10b5-1 Abuse, from the Rock Center for Corporate Governance at Stanford, the authors examined data from over 20,000 Rule 10b5-1 plans to investigate the extent of insider trading abuse. The study found that some executives did use 10b5-1 plans to conduct “opportunistic, large-scale selling that appears to undermine the purpose of Rule 10b5-1” and highlighted three “red flags” that could be used to detect potentially improper exploitation of Rule 10b5-1. Although the authors acknowledge that they could not determine for certain whether any insiders that avoided losses or otherwise achieved “market-beating returns” actually traded on the basis of material nonpublic information, they contended that average trading returns of the magnitude they found in the study “are highly suspect and, as such, these red flags are suggestive of potential abuse.”
Commissioners Peirce and Roisman criticize “unduly broad view” of “internal accounting controls” in Andeavor
In October, the SEC settled charges against Andeavor, an energy company formerly traded on the NYSE and now wholly owned by Marathon Petroleum, in connection with stock repurchases authorized by its board in 2015 and 2016. (See this PubCo post.) Pursuant to that authorization, in 2018, Andeavor’s CEO had directed the legal department to establish a Rule 10b5-1 plan to repurchase company shares worth $250 million. At the time, however, Andeavor’s CEO was on the verge of meeting with the CEO of Marathon Petroleum to resume previously stalled negotiations on an acquisition of Andeavor at a substantial premium. After Andeavor’s legal department concluded that the company did not possess material nonpublic information about the acquisition, Andeavor went ahead with the stock repurchase. Rather than attempting to build a 10b-5 case based on a debatably defective 10b5-1 plan, the SEC opted instead to make its point with allegations that Andeavor had failed to maintain an effective system of internal control procedures in violation of Exchange Act Section 13(b)(2)(B). On Friday, the SEC posted the joint statement of SEC Commissioners Hester Peirce and Elad Roisman, who voted against the settled action, explaining the reasons for their dissents. In sum, they contend that, in the action, the SEC took an “unduly broad view of Section 13(b)(2)(B).”
A couple of weeks ago, the SEC settled charges against Andeavor, an energy company formerly traded on the NYSE and now wholly owned by Marathon Oil, in connection with stock repurchases, authorized by its board in 2015 and 2016. Pursuant to that authorization, in 2018, Andeavor’s CEO directed the legal department to establish a Rule 10b5-1 plan to repurchase company shares worth $250 million. At the time, however, the company’s CEO was on the verge of meeting with the CEO of Marathon Oil to resume previously stalled negotiations on an acquisition of Andeavor at a substantial premium. Of course, a 10b5-1 plan typically doesn’t work to protect against insider trading charges if you have material inside information when you establish the plan, and the SEC’s order highlights facts that, from the SEC’s perspective, make the information appear material—at least in hindsight. But wait—this isn’t even an insider trading case. No, it’s a case about inadequate internal controls—at least, that’s how it ended up. Instead of attempting to make a 10b-5 case based on a debatably defective 10b5-1 plan, the SEC opted instead to make its point by focusing on the failure to maintain effective internal control procedures and comply with them. Companies may want to take note that charges related to violations of the rules regarding internal controls and disclosure controls seem to be increasingly part of the SEC’s Enforcement playbook, making it worthwhile for companies to emphasize, in the words of SEC Chair Jay Clayton, the practice of “good corporate hygiene.”