United States: Divided SEC Affirms Dismissal Of Insider Trading Case

Last Updated: July 27 2017
Article by Nihal S. Patel

Most Read Contributor in United States, September 2017

Divided SEC Affirms Dismissal Of Insider Trading Case

A divided SEC affirmed an earlier ruling (see previous coverage) by an administrative judge that the SEC Division of Enforcement ("DOE") did not demonstrate sufficiently that a former trader had engaged in insider trading.

The DOE alleged that a former trader at Wells Fargo traded on the basis of information he received from an analyst colleague about research reports that had not yet been published. According to the DOE, the trader allegedly bought stocks in a proprietary account of the firm in advance of the research reports, and sold the stocks at a profit after observing the anticipated price movements.

SEC Commissioner Michael Piwowar determined that the evidence was insufficient to prove that the trader acted on insider tips in executing the transactions at issue. Commissioner Piwowar concluded that telephone records, statistical analysis, and other circumstantial evidence did not meet the SEC's burden for ruling that the trader traded on nonpublic information.

SEC Commissioner Kara Stein disagreed with the determination by Commissioner Piwowar. She cited the "uncanny" timing of the trades, the expert analysis, the communications between trader and analyst, and the explanations offered by the trader as sufficient basis for concluding that the DOE established, by a preponderance of the evidence, that the trader had acted on the basis of material nonpublic information.

Since Commissioners Stein and Piwowar were the only two participants in the decision, the split ruling confirmed the administrative judge's dismissal of proceedings against the trader.

Commentary / Nihal Patel

The debate between the two commissioners largely centers on whether the relevant trades were done on the basis of material nonpublic information. Perhaps the most notable fact on which there is disagreement is as to the conversations between the trader and the analyst. While the record showed that trader and analyst spoke over the phone in the time before the relevant reports were to be published, Commissioner Piwowar noted that the two spoke "almost every day," pursuant to a firm policy that encouraged active communication between traders and analysts.

In some ways, the Commissioners are engaging in a policy debate over whether this type of regular communication between traders and analysts is a good thing. On the one hand, it makes sense that an expert on a particular company who works at the same firm as a person trading in the securities of such company should discuss the company. On the other hand, such communications raise the risk that material nonpublic information (i.e., changing recommendations not yet released) also would be passed along in these communications. Firms that permit this type of communication should consider the risks, and whether appropriate safeguards and training programs are in place to ensure that relevant material nonpublic information is not being passed along, and that, where it is being passed, personnel are not using the information for profit – in particular, for short-term trades in advance of the publication of research reports.

Commentary / Steven Lofchie

The different positions taken by the two Commissioners demonstrate how difficult it can be to prove a negative; in this case, that the trader had not relied on inside information. Commissioner Stein asserts in her dissent that the trader executed an overnight trade six out of eight specific times that the analyst changed his ratings, which Commissioner Stein describes as "uncanny" compared to the trader's ordinary activities. Conversely, in finding fault with the expert testimony presented by the DOE, Commissioner Piwowar pointed out that there were in fact 71 instances in which the analyst had changed his rating, valuation or earnings estimates; thus, the six overnight trades were completely ordinary based on a baseline of 71 research changes. Commissioner Stein's dissent does not make clear why it was appropriate for the prosecution to focus on the eight ratings changes that it did; the trader's behavior is only "uncanny" if one determines that there were only eight relevant situations (and not 71) where the trader might have received inside information from the research analyst.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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