Question about insider trading/Martha Stewart [Archive]

adios

03-23-2004, 12:36 AM

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It seems to me that as far as the whole ImClone fiasco goes, she did not actively pursue info on the whole FDA thing, but that it fell into her lap.

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Yes I believe that's right.

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In a case like that, do you still have to hold on to your stock while its value plummets?

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The way I read the insider trading laws the answer is yes. In her case Baconovic, her broker, told her that Waksal the ImClone CEO and founder was selling. I'm fairly certain this is why the government couldn't make an insider trading case against her because she didn't actually have material information about the impending FDA letter regarding Erbatux (spelling?). I know that Waksal plead guilty to insider trading violations and that he informed relatives about the FDA letter and advised them to sell. However, in order for Waksal to sell he would have had to announce his intentions to sell given his status with the company. In fact he couldn't sell his shares upon further rewiew. Here's the SEC description of the Waksal case:

SEC Charges Former ImClone CEO Samuel Waksal With Illegal Insider Trading (http://www.sec.gov/news/press/2002-87.htm)

SEC Charges Former ImClone CEO Samuel Waksal With Illegal Insider Trading
FOR IMMEDIATE RELEASE
2002-87

Washington, D.C., June 12, 2002 —The Securities and Exchange Commission today filed charges against Samuel Waksal, the former CEO of ImClone Systems Inc., for illegal insider trading. In its complaint, the Commission charges that Waksal received disappointing news late last December that the U.S. Food and Drug Administration would soon issue a decision rejecting for review ImClone's pending application to market its cancer treatment drug, Erbitux. The SEC further charges that Waksal told this negative information to certain family members who sold ImClone stock before the news became public and that Waksal himself tried to sell shares of ImClone before the news became public.

In its lawsuit, filed in federal court in Manhattan, the Commission seeks an order requiring that Waksal disgorge the several million dollars in losses avoided by those family members he tipped, and that he pay civil penalties and prejudgment interest. It also seeks an order permanently enjoining Waksal from violating the securities laws, and barring him from acting as an officer or director of a public company.

Specifically, the Commission's complaint alleges as follows.

On the evening of Dec. 26, 2001, Waksal learned that on Dec. 28, 2001, the FDA would issue a Refusal to File (RTF) letter to ImClone rejecting consideration of its Biologics Licensing Application for Erbitux.

The same evening and early the next morning, Waksal called certain family members to alert them that ImClone would be receiving this bad news.

As soon as the market opened the next morning, Dec. 27, these family members sold more than $9 million of ImClone stock. In total they sold more than $10 million of ImClone stock over the next two days.

Also starting that evening, Dec. 26, and through Dec. 28, Waksal himself tried to sell 79,797 shares of ImClone stock worth nearly $5 million. He was unable to do so only because two different broker-dealers would not execute the orders.

As expected, the FDA faxed ImClone the RTF letter at about 4 p.m. on Dec. 28, 2001. At 6 p.m. that day, ImClone publicly announced the FDA decision. By the close of trading on Dec. 31, the next trading day, ImClone's stock price had dropped 16%, from $55.25 to $46.46.

By selling before the announcement that ImClone had received an RTF letter from the FDA, Waksal family members avoided losses of several million dollars.
The Commission's complaint alleges that based on this conduct, Waksal violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Commission's investigation is ongoing. The Commission acknowledges the assistance of the U.S. Attorney's Office for the Southern District of New York in the investigation of this matter.

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And what and what not does "insider trading" constitute?

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Defining Illegal Insider Trading (http://www.investopedia.com/articles/03/100803.asp)

Defining Illegal Insider Trading
Reem Heakal (Investopedia.com)

When hearing news stories about illegal insider trading activity, investors usually take notice because it's an activity that affects them. Although there are legal forms of insider trading (more of which you can learn about in our articles "Uncovering Insider Trading" and "When Insiders Buy, Should You Join Them?"), the better you understand why illegal insider trading is a crime, the better you understand how the market works. Here we discuss what an illegal insider is, how it compromises the essential conditions of a capital market, and what defines an insider.

What Is It and Why Is It Harmful?
Insider trading occurs when a trade has been influenced by the privileged possession of corporate information that has not yet been made public. Because the information is not available to other investors, a person using such knowledge is trying to gain an unfair advantage over the rest of the market.

Using non-public information for making a trade violates transparency, which is the basis of a capital market. Information in a transparent market disseminates in a manner by which all market participants receive it at more or less the same time. Under these conditions, one investor can gain an advantage over another only through acquiring skill in analyzing and interpreting available information. This skill is based on individual merit and awareness. If one person trades with nonpublic information, he or she gains an advantage that is impossible for the rest of the public. This is not only unfair but disruptive to a properly-functioning market: if insider trading were allowed, investors would lose confidence in their disadvantaged position (in comparison to insiders) and would no longer invest.

The Law
In August 2000, the United States (US) the Securities and Exchange Commission (SEC) adopted new rules regarding insider trading (made effective in October of the same year). Under Rule 10b5-1, the SEC defines insider trading as any securities transaction made when the person behind the trade is aware of non-public material information, and is hence violating his or her duty to maintain confidentiality of such knowledge.

Information is defined as being material if its release could affect the company's stock price. The following are examples of material information: the announcement that the company will receive a tender offer, the declaration of a merger, a positive earnings announcement, the release of the company's discovery such as a new drug, an upcoming dividend announcement, an unreleased "buy" recommendation by an analyst, and finally, an imminent exclusive in a financial news column.

In a further effort to limit the possibility of insider trading, the SEC has also stated in Regulation Fair Disclosure (Reg FD), which was released at the same time as Rule10b5-1, that companies can no longer be selective as to how they release information. This means that analysts or institutional clients cannot be privy to information ahead of retail clients or the general public. Everyone who is not a part of the company is to receive information at the same time.

Who Is an Insider?
For the purposes of defining illegal insider trading, a corporate insider is someone who is privy to information that has yet to be released to the public. If a person is an insider, he or she is expected to maintain a fiduciary duty to the company and to the shareholders and is obligated to retain in confidence the possession of the non-public material information. A person is liable of insider trading when he or she has acted on privileged knowledge in the attempt to make a profit.

Sometimes it is easy to identify who insiders are: CEOs, executives, and directors are of course directly exposed to material information before it's made public. However, according to the misappropriation theory of insider trading cases, certain other relationships automatically give rise to confidentiality. In the second part of Rule 10b5-2, the SEC has outlined three non-exclusive instances that call for a duty of trust or confidentiality: (1) when a person expresses his or her agreement to maintain confidentiality, (2) when history, pattern and/or practice show that a relationship has mutual confidentiality, and (3) when a person hears information from a spouse, parent, child, or sibling (unless it can be proven that such a relationship has not and does not give rise to confidentiality).

Partners In Crime
In insider trading that occurs as a result of information leaking outside of company walls, there is what is known as the "tipper" and the "tippee." The tipper is the person who has broken his or her fiduciary duty when he or she has consciously revealed inside information. The tippee is the person who knowingly uses such information to make a trade (in turn also breaking his or her confidentiality). Both parties typically do so for a mutual monetary benefit. A tipper could be the spouse of a CEO who goes ahead and tells his neighbor inside information. If the neighbor in turn knowingly uses this inside information in a securities transaction, he or she is guilty of insider trading. Even if the tippee does not use the information to trade, the tipper can still be liable for releasing it.

It may be difficult for the SEC to prove whether or not a person is a tippee. The route of insider information and its influence over people's trading is not so easy to track. Take for example a person who initiates a trade because his or her broker advised him or her to buy/sell a share. If the broker broker based the advice on material non-public information, the person who made the trade may or may not have had awareness of the broker's knowledge--evidence to prove what the person knew before the trade may be hard to uncover.

And He Told Two People, And So On And So On…
Oftentimes, people accused of the crime claim that they just overheard someone talking. Take for example a neighbor who overhears a conversation between a CEO and her husband regarding confidential corporate information. If the neighbor then goes ahead and makes a trade based on what was overheard, he or she would be violating the law even though the information was just "innocently" overheard: the neighbor becomes an insider with a fiduciary duty and obligation to confidentiality the moment he or she comes to possess the non-public material information. Since, however, the CEO and her husband did not try to profit from their insider knowledge, they are not necessarily liable of insider trading. In their carelessness, they may, however, be in breach of their confidentiality.

Conclusion
Since illegal insider trading takes advantage not of skill but chance, it threatens investor confidence in the capital market. It is important for you to understand what illegal insider trading is because it may affect you as an investor and the company in which you are investing.