Insider Trading

1
Insider Trading

• Todays Insider Trading Suspect May Wear a Lab
  Coat
• -New York Times, August 9, 2005

2
What is Insider Trading?

• Buying or selling a security
• In breach of a fiduciary duty (or other
  relationship of trust or confidence)
• While in possession of material, nonpublic
  information about the security.
• Includes tipping which is providing inside
  information to another who buys or sells stock
  based upon this information.

3
Breach of Fiduciary Duty or Duty of Trust and
Confidence

• Misappropriation Theory
• A person commits fraud when he misappropriates
  confidential information for securities trading
  purposes, in breach of a duty owed to the source
  of information.
• U.S. v. OHagen, 117 S.Ct. 2199, 2207 (1997)
• According to the SEC duty of trust or confidence
  arises when
• Person agrees to maintain information in
  confidence.
• Person communicating material non-public
  information and person receiving it have a
  pattern or practice of sharing confidences and
  there is an expectation of confidence.
• Person receives material nonpublic information
  from spouse, parent, child, or sibling.
• 65 FR 51716, 51737

4
Material Information

• Material information is information which a
  reasonable investor would view as important
  in making an investment decision.
• Basic Inc. v. Levinson, 485 U.S. 224 (1988)
• But arent research findings speculative?
• Perhaps, but information can be material even
  though it concerns a speculative event. Court
  will consider two factors
• 1. Likelihood that event will occur
• 2. Magnitude of benefit to the company
• Basic v. Levinson

5
Nonpublic Information

• Generally defined as information that has not
  been disclosed to the public.
• Other definitions conclude that information
  becomes public once it has been publicly
  disclosed and adequate time has passed for the
  securities markets to absorb the information.

6
Enforcement

• Because insider trading undermines investor
  confidence in the fairness and integrity of the
  securities markets, the SEC has treated the
  detection and prosecution of insider trading
  violations as one of its enforcement priorities.
  -U.S. Securities and Exchange Commission
• Civil Penalties of 3x the profit realized or loss
  averted by virtue of trade. 15 USC 78u-1
• Criminal Penalties of up to 20 years imprisonment
  and 5,000,000 in fines.
• Controlling Person Liability
• Civil greater of 1 million and 3x profit or
  loss
• Criminal- Up to 25 million
• Controlling person knew or recklessly disregarded
  the fact that the controlled person was likely to
  engage in the act or acts of violating the law
  and failed to take appropriate steps to prevent
  the act or acts before they occurred.

7
Bounty Hunters

• SEC is authorized to award a bounty to a person
  who provides information leading the recovery of
  a civil penalty from an inside trader. 15 USC
  78u-I(e)
• Award of up to 10 of civil penalty assessed
  against inside trader.

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SEC v. Milton Mutchnick et al.97 CV 00709 (1997)

• Mutchnick was head of gastroenterology department
  at Wayne State University.
• Lead investigator for hepatitis drug Thymosin.
• His research indicated the drug was ineffective.
• Prior to information becoming public, Mutchnick
  warned friends and family of results of research.
• Mutchnick and those warned sold stock in the
  sponsoring company avoiding 300,000 in losses.
• Mutchnick and company were charged with insider
  trading.
• Mutchnick settled the charges by paying a
  163,494 civil penalty. His wife and the six
  people they had tipped paid 105,000 in
  forfeitures and penalties.

9
SEC v. Sanjiv S. Agarwala06 CV 0352J (S.D. Cal.,
2006)

• Associate Professor of medicine and associate
  medical director of melanoma program at the
  University of Pittsburgh.
• Consulted for Maxim Pharmaceuticals on clinical
  trials for cancer drug Cepelene.
• SEC complaint alleged that Agarwala learned of
  material nonpublic information regarding the
  drug.
• Knew of FDA approval before it was made public.
• Knew test results for clinical trials.
• SEC alleged that Agarwala used this information
  to purchase and sell Maxim stock.
• Agarwala settled the case by agreeing to pay
  14,784 for illegal trading profits and losses
  avoided and a civil penalty of 29,568.

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Conclusion

• Insider trading is not limited to Wall Street
• Information obtained in performing medical
  research is likely confidential.
• Duty of confidentiality owed to sponsor.
• Using information obtained during the course of
  medical research to buy or sell publicly traded
  stocks may constitute insider trading.
• The researcher may be subject to civil and
  criminal penalties.
• The Marshfield Clinic may be subject to civil and
  criminal penalties as the controlling person.