UK: Risky Business: Trafficking In Insider Information About Customers

Last Updated: 28 February 2011
Article by Adam J. Wasserman, Margaret A. Bancroft and Claude M. Tusk

The Department of Justice and the Securities and Exchange Commission have been jointly cracking down on the use of "expert" consulting networks that they say paid company employees to provide funds with material inside information about their employers. The Department of Justice has brought well publicized actions charging criminal violations of federal insider trading laws and the SEC has followed suit, alleging civil violations of the same laws.1 These cases, however, also bring to light an important variation on the theme. In several instances, the government alleges that employee "experts" were paid for providing material information about their employer's customers. This article examines the federal insider trading law as it relates to tipping information about suppliers and customers. It suggests that investment advisers inform their employees that the government is treating material nonpublic information about a company's customers obtained from a company employee as encompassed within federal insider trading prohibitions, especially when the disclosure violates the policies of the employer.

Key excerpts from the SEC Amended Complaint in SEC v. Longoria are attached.

In SEC v. Longoria et al.,2 the SEC charged "expert" consultants engaged by Primary Global Research LLC ("PGR") with illegally tipping material nonpublic information about their employers to certain of PGR's hedge fund clients. But the charges go further. They also charged two of the employees with tipping material information about companies their firms did business with, including Apple Inc., Research in Motion Ltd. ("RIM") and Omnivision Technologies, Inc.

The complaint alleges that a Dell, Inc. employee, in violation of Dell's policy, disclosed information about Dell as well as information about two of Dell's suppliers whose contracts with Dell were significant to the suppliers and, therefore, material to the financial prospects of the suppliers. The complaint similarly asserts that a Flextronics International Ltd. employee disclosed material information about orders placed by RIM, Apple and Omnivision with Flextronics in contravention of Flextronics's policy prohibiting disclosure of confidential information about Flextronics or its customers, suppliers, or other business partners.3

It is significant that the two "experts" charged with providing material nonpublic information about their employers' business partners did so in violation of articulated employer policies. The SEC complaint, in this respect therefore did not have to rely on an assertion that employees should have understood that their employers expect that they will not disclose nonpublic information about customers or suppliers to third parties.

However, the notion that an employee must not appropriate information obtained from his employer, including information about suppliers and customers, for his benefit may well be viewed by the government and private litigants, among others, as an emerging norm. Increasingly, customers demand that their business with a company be treated as confidential and increasingly companies are adopting policies, such as those adopted by Dell and Flextronics.

The Supreme Court's recognition of the misappropriation theory of insider trading in U.S. v. O'Hagan4 provides a basis for the Department of Justice and the SEC to treat tipping by an employee of material nonpublic information about an employer's business partners as a violation of federal insider trading law.

In O'Hagan, the government brought a criminal insider trading charge against a partner in a law firm who came to know from his status as a partner in the firm that the firm was engaged to represent a takeover bidder. Acting on that information, he traded in options on the target company's shares counting on those options to be in the money when the tender offer became public. The Supreme Court majority held that although the partner owed no duty to the target company, he owed a duty to his firm and its client, which were the sources of the information, and therefore could be held liable under Rule 10b-5 for fraud in connection with a securities transaction for "misappropriating" confidential information in breach of this duty.

O'Hagan and its misappropriation theory lie at the heart of the SEC's complaint in the Longoria case as it relates to tipping material nonpublic information about Apple, RIM and other publicly traded companies by employees of firms that did business with these companies.

The conduct condemned by O'Hagan falls squarely within Rule 10b5-2 adopted by the SEC in 2000. The preliminary note to the Rule states that it provides "a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the 'misappropriation' theory of insider trading under" Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The preliminary note to the Rule makes clear that the law of insider trading can also be established by judicial opinions, permitting courts to expand the scope of the requisite duty of trust or confidence beyond the Rule. However, Rule 10b5-2 states that the misappropriation of material nonpublic information in breach of a duty of trust or confidence includes circumstances in which "a person agrees to maintain information in confidence." The Dell and Flextronics policies provide a basis for the government to argue that the accused employees so agreed.

Moreover, a second formulation of a duty of trust or confidence found in Rule 10b5-2 covers circumstances where the person communicating the "material nonpublic information and the person to whom it is communicated have a history, pattern or practice of sharing confidences such that the recipient of this information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain confidentiality." This language in and of itself, as elaborated by the government and by judicial decision, could well come to encompass evolving norms, creating a duty of confidence and trust inherently owed by employees to employers that includes keeping confidential information about customers and suppliers.

In light of the spotlight that has been shone on tipping information about an employer's business partners in the Longoria matter, advisers should sensitize their employees to the concept that acting on such tips may lead to charges that the adviser or its employees have violated federal insider trading laws.

In addition, the publicity given to tipping material nonpublic information to third parties about customers and suppliers may cause more customers and suppliers to insist that their counterparties agree that they will keep the information confidential and take steps to insure that this is understood by their employees. Customers and suppliers may go further and prohibit the counterparties from trading on the information.

The Longoria complaint also illustrates that soliciting such information from current employees poses heightened risks. Several PGR "experts" were current employees who were in possession of information that if publicly known would have clearly moved the price of their employer's stock or that of the business partner of the employer. For example, the complaint alleges that an AMD employee provided his company's "top line" quarterly revenue and profit margin information prior to its release of that information in quarterly financial announcements. In order to mitigate risk some expert networks have chosen to deal with this issue by prohibiting an employee who is engaged as an expert from taking on an assignment concerning his own company and some advisers have adopted policies which prohibit their staff when considering trading in a company from talking to any current employee of that company or anyone who was an employee in, say, the last six months. Of course, most of the information conveyed by Longoria would have been public six months later; generally, whatever material nonpublic information an employee may have at the time employment terminates will have become stale after six months. While former employees may harbor material nonpublic information that is still nonpublic six months after their departure, this is much less likely.



EXTRACT — SEC v. LONGORIA, et al.

Defendants mentioned in the Extract:

Mark Anthony Longoria, Supply Chain Manager, Advanced Micro Devices, Inc.

Daniel L. DeVore, Global Supply manager, Dell Inc.

James Fleishman, Vice President of Sales, Primary Global Research

Bob Nguyen, Technology Analyst and Semiconductor Vertical Manager at PGR

Winifred Jiau, a Consultant for PGR

Walter Shimoon, Vice President of Business Components in the Americas at Flextronics

Samir Barai, the founder of Barai Capital

Noah Freeman, an employee of two unnamed hedge funds

1. This case involves insider trading by ten individuals and one investment adviser entity, all of whom are consultants, employees, or clients of the so-called "expert network" firm, Primary Global Research LLC ("PGR").

2. Longoria, DeVore, Jiau, and Shimoon were all employed by technology companies and also served as PGR consultants, or "experts," who used their access to material nonpublic information regarding technology companies to facilitate widespread and repeated insider trading by numerous hedge funds and other investment professionals. Each obtained material nonpublic information about sales, earnings, or performance data, concerning various public companies, and shared that inside information with hedge funds and other clients of PGR who traded on the information. Each also received cash compensation from PGR in return for providing the inside information.

3. Fleishman and Nguyen were PGR employees who facilitated the transfer of material nonpublic information from PGR consultants to PGR clients and, in certain instances, acted as conduits by receiving material nonpublic information from PGR consultants and passing that information directly to PGR clients.

******

5. The defendants obtained, disclosed, and/or traded on material nonpublic information about the sales, earnings, and performance of numerous public companies, including Actel Corporation ("Actel"), Advanced Micro Devices, Inc. ("AMD"), Apple Inc. ("Apple"), Dell, Inc. ("Dell"), Fairchild Semiconductor Corporation. ("Fairchild"), Flextronics International Ltd. ("Flextronics"), Marvell Technology Group Ltd. ("Marvell"), Omnivision Technologies, Inc. ("Omnivision"), Research in Motion Ltd. ("RIM"), Seagate Technology PLC ("Seagate"), and Western Digital Corporation ("Western Digital").

6. Altogether, hedge funds and other traders reaped approximately $30 million in illicit profits or losses avoided as a result of the disclosure of material nonpublic information alleged herein.

******

33. Although PGR bills itself as an "independent investment research firm" with a roster of expert consultants, who provide "intelligence on trends, issues, regulations and dynamics" affecting particular industries and companies, PGR's expert consultants routinely provided material nonpublic information to traders including corporate revenues, sales forecasts, and other confidential data that PGR's expert consultants obtained or misappropriated from their respective employers.

34. On its website, PGR stated that its consultants "are forbidden to disclose any material, non-public, confidential or proprietary information belonging to any previous or current employers." Despite this representation, however, PGR's employees affirmatively sought out experts who had access to and were willing to share inside information and promoted such experts to PGR clients who were trying to gain access to such inside information.

******

36. Numerous PGR clients each paid hundreds of thousands of dollars per year for access to PGR's "experts" and the firm had total revenues of approximately $18 million between 2007 and 2009. PGR's business was also very lucrative for PGR consultants, whom the firm paid between $150 and $1,000 per hour. In many instances, PGR consultants, including the defendants herein, made tens of thousands of dollars per year.

37. From approximately February 2008 through February 2010, Nguyen facilitated the delivery of material nonpublic information to PGR clients by, among other things, soliciting industry insiders willing to share inside information to join the PGR network, promoting these insiders as "experts" to PGR clients, and directing PGR clients who were searching for a particular piece of inside information to the PGR consultant who could provide it.

38. Nguyen, who specialized in handling consultants in the technology and semiconductor industries, met with prospective consultants to assess their ability and willingness to provide material nonpublic information. When soliciting consultants for PGR, he made clear that their telephone conversations with PGR clients would not be monitored or recorded. He also pointed out that the consultants' last names would not be published on PGR's website, and offered that a consultant could further guarantee his anonymity by assuming a pseudonym.

******

40. From time to time, PGR clients who did not want to speak directly to certain consultants requested that PGR employees funnel inside information to them. Nguyen, Fleishman, and other PGR employees acted as conduits in such conveyance of inside information.

41. Fleishman also knowingly participated in this scheme to provide inside information to PGR clients. As Vice President of Sales, Fleishman was responsible for soliciting new clients and ensuring service to existing PGR clients. In order to obtain new clients for PGR, Fleishman routinely directed prospective clients to set up "trial" sessions with PGR's most popular "experts," including defendants DeVore and Longoria, who Fleishman knew would share valuable inside information that would entice prospective clients to subscribe for PGR's "services." To assuage prospective clients' concerns that this illegal activity would be detected, Fleishman assured them that PGR would not monitor or record their calls with the PGR experts.

******

43 At times, Fleishman also played a direct role in conveying inside information by emailing inside information that PGR had obtained from its experts to various PGR clients.

44. Fleishman knew that some PGR experts were providing PGR clients with inside information and that the PGR experts were not authorized by their employers to share this information.

45. For instance, Fleishman was told by a PGR client that Longoria and DeVore had shared sales forecasts, revenues, and other detailed inside information about their own companies with the client. Fleishman did not express any surprise or concern, but instead only indicated that he was pleased that the client had obtained the information that he was seeking.

46. In a separate conversation with the same client, Fleishman explained to the client that PGR helped its experts preserve their anonymity by not releasing their last names or contact information and confirmed that anonymity was necessary to "protect [PGR experts] from investor relations" officials at the companies where they worked. The unspoken reason why PGR needed to "protect" its experts from investor relations officials was because these so-called experts were not authorized to share their respective companies' inside information with outsiders and they would face serious repercussions, including losing their jobs, if it was discovered that they had done so. *

******

50. On at least a few occasions, Nguyen and Fleishman knowingly participated in this insider trading scheme by arranging to pass material nonpublic information directly to PGR clients.

51. For instance, in March 2009, Nguyen had a call with DeVore during which DeVore disclosed specific material nonpublic information about Dell, Seagate, and Western Digital. Nguyen then emailed a detailed summary of the information DeVore had provided to Fleishman and another PGR employee. In the email, Nguyen used the words "handle w/care" in the subject line because the email contained very specific information, including numbers relating to Dell's internal sales forecasts and the pricing and volume of Dell's purchases from suppliers such as Seagate and Western Digital, which Nguyen knew to be "inappropriate."

52. Fleishman, in turn, e-mailed the specific information that DeVore had provided to multiple PGR clients. Subsequently, Fleishman informed Nguyen that he had passed the information on to various clients and that they thought the information was great and wanted more. Later, in July 2009, Nguyen and Fleislunan passed substantially similar information that they had received from DeVore to various PGR clients.

53. From 2007 through 2010, DeVore was a PGR consultant who provided material nonpublic information to PGR clients.

54. During this period, DeVore, a Global Supply Manager at Dell, was responsible for placing orders and negotiating with suppliers that sell hard disc drives and other equipment to Dell, and was privy to information concerning Dell's internal sales forecasts as well as information about the pricing and volume of Dell's purchases from its suppliers.

55. Although the Dell forecast, pricing, and purchase information was marked "confidential" and DeVore knew that he was not supposed to share the information with people outside of the company, he regularly provided this information to PGR clients who, he understood, would use the information to trade in the securities of Dell and its suppliers.

56. DeVore's conduct was in clear violation of the Dell Code of Conduct, which states that employees "should not use information obtained internally for [their] own personal gain or to support an outside business venture." The code also specifically states that Dell employees "should refrain from using any material inside information about Dell or any other company (such as supplier or vendor) to trade any stock and should not provide 'tips' or share material inside information with any other person who might trade the stock." The code specifically lists unannounced "vendor contracts" and "procurement plans" as examples of inside information.

******

58. In March and July 2009, DeVore provided Nguyen with material nonpublic information concerning Dell sales forecasts as well as inside information concerning the terms of Dell's purchase of computer disc drives from two leading suppliers of such equipment, Seagate and Western Digital. During this period, Dell was a key client of both Western Digital and Seagate, and the information that DeVore provided concerning Dell's purchases was therefore highly material to the success of both companies. As discussed herein, PGR employees, including Nguyen and Fleishman, passed this inside information along to PGR clients.

59. In addition to providing Dell sales forecast and purchasing information to PGR, DeVore regularly provided the same inside information directly to PGR clients. DeVore provided material inside information concerning Dell and its suppliers—including Seagate and Western Digital—which was not available through public sources.

******

62. Since 2001, defendant Shimoon has been the Vice President of Business Development for Components in the Americas at Flextronics. In that position, Shimoon managed a group that provides components to a broad range of consumer products including smart phones, digital cameras, and printers.

63. Flextronics customers include RIM, Omnivision, and Apple.

******

65. From at least the second half of 2008 and throughout 2009, Shimoon provided detailed information on Flextronics and its customers, including Apple, Omnivision, and RIM, to defendant Nguyen (a PGR employee) and to PGR's hedge fund clients.

66. For example, during an August 2008 call, Shimoon advised Nguyen that Shimoon "handle[d]" RIM, Apple, and Palm for Flextronics and that he talked to those companies "weekly if not daily." In the same call, Shimoon stated that RIM was expecting its guidance to double year over year for the next few years.

67. During an October 2008 call, Shimoon told Nguyen that RIM had just launched a new phone for which Flextronics was the only contract manufacturer. Shimoon told Nguyen what Flextronics expected RIM's orders to be in the fourth quarter of 2008 and the first two quarters of 2009. Shimoon also informed Nguyen that Flextronics was the sole source for Apple iPhone chargers and that Flextronics was seeing another four to six million unit increase in demand. Non-disclosure agreements between Flextronics and Apple governed this type of information.

68. In March 2009, Shimoon advised Nguyen that Apple was developing a new type of iPhone and provided specific quarterly order information that Flextronics was receiving from Apple for the new product. Nguyen understood that this information was nonpublic at the time, and this type of information was also governed by non-disclosure agreements between Flextronics and Apple.

******

72. On October 1, 2009, Shimoon had a telephone call with a PGR client in which Shimoon divulged a variety of material nonpublic information regarding Apple. Shimoon conveyed Apple's actual sales figures for iPhones for the third quarter of 2009 and forecast sales figures for iPhones and iPods for the fourth quarter of 2009. Shimoon also told the PGR client that Apple expected to produce a new iPhone the following year that would include two cameras, and Shimoon provided details about the types of cameras the iPhone would include Finally, Shimoon informed the PGR client that Apple was working on yet another new product, code-named K48, that was so secretive that Apple employees could be fired for talking about the product with persons who did not already know about it. Non-disclosure agreements between Flextronics and Apple governed all of this type of information.

******

74. On November 5, 2009, Shimoon had a telephone call with Nguyen during which he shared material nonpublic information about Apple's production forecast for 2010. According to Nguyen's notes of the call, Shimoon conveyed that Apple was planning to manufacture twice as many smart phone handsets in 2010 as it had in 2009. Based on the Apple forecast, Shimoon projected that Omnivision, a company that supplied miniature cameras to Apple, would thrive, potentially doubling its sales to Apple in 2010.

75. On the same telephone call, Shimoon and Nguyen also discussed the recent insider trading case brought against employees of the Galleon hedge fund and the importance of PGR not recording telephone calls between PGR experts and PGR clients. Shimoon told Nguyen, "that would really suck if you [PGR] recorded all the calls."

******

83. Shimoon's provision of material nonpublic information to PGR and its clients clearly violated Flextronics' Code of Business Conduct and Ethics, which recognized that "[c]onfidential information is information that is disclosed by Flextronics or its customers, suppliers or other third parties with the expectation that it be maintained as confidential and only be used for a specific business purpose" and that Flextronics employees "are obligated as a condition of our employment by Flextronics to safeguard the confidential information of Flextronics and its customers, suppliers and other parties with whom we do business."

84. Flextronics' Code of Business Conduct and Ethics also clearly communicated to Flextronics' employees that they were "prohibited from communicating or 'tipping' material, nonpublic information to anyone else that might trade in Flextronics securities (or any other publicly traded securities)."

85. From at least 2007 through at least 2009, AMD employee Longoria provided material nonpublic information regarding AMD's sales, revenues and profit margins to PGR clients.

86. As a manager in AMD's desktop global operations group, Longoria had access to sales figures for the company's various operational units. In addition, Longoria obtained AMD's financial results—including "top line" quarterly revenue and profit margin information—prior to the company's release of such information in quarterly financial announcements. Longoria obtained that information from another AMD employee who worked in the company's finance department.

87. Longoria shared this inside information—which he understood to be material and nonpublic—with multiple PGR clients who, in turn, traded in AMD securities based on such inside information.

88. Longoria's disclosure of such inside information violated AMD's employee code of conduct, which specifically requires AMD employees to "keep confidential all non-public information that they possess regarding AMD or any other company prior to its disclosure."

******

99. Defendant Jiau was a "private" PGR expert, meaning that PGR only made her available to a small number of PGR clients including Freeman and Barai, who had introduced Jiau to PGR and arranged to make payments to her through PGR.

100. In exchange for these payments, Jiau, who had contacts at Marvell and other technology companies, regularly provided Freeman and Barai with material nonpublic information regarding Marvell and other technology companies. The information that Jiau provided included company-specific financial results that the companies had not yet announced to the public.

101. In late May 2008, Jiau participated in at least two teleconferences with CW-4 and the Portfolio Manager of Hedge Fund #1 during which she passed along inside information concerning Marvell's first quarter revenues and other financial metrics in advance of Marvell's announcement of these results on May 29, 2008.

102. On the second of these two teleconference calls, for example, Jiau specifically told Freeman and Barai that Marvell's quarterly revenues would be $804 million, that Marvell's gross profit margins would be 51.6%, and that the company's earnings per share would be $0.11.

******

104. After market-close on May 29, 2008, Marvell released its quarterly results for the first quarter of 2008, including revenues of $804 million, gross profit margins of 52% and earnings per share of $0.11, almost exactly as Jiau had stated. These results, which were significantly better than market analysts expected, caused the stock price to increase 23% (from $14.08 per share at market-close on May 29 to $17.36 per share at market-close on May 30).

Footnotes

1 Violations of Section 17(a), and Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.

2 Amended Complaint, SEC v. Longoria et al., No. 11-CV-0753 (S.D.N.Y. 2011). This complaint consolidates facts alleged in several of the recent criminal cases brought by the DOJ.

3 The complaint also alleges that this disclosure violated non-disclosure agreements between Flextronics and Apple.

4 521 U.S. 642 (1997).

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