BOSTON (TheStreet) — Gossiping around the coffee machine. Commiserating with a bartender. Idle chit-chat with a barber or hairdresser.
It is hard not to talk about work in these settings. But will saying the wrong thing at the wrong time to the wrong person spell big trouble? Can loose lips put even a lowly, rank-and-file employee at risk of having committed the same sort of insider trading violations that have brought down such hedge fund giants as the Galleon Group?
“Even lower-level employees who learn of information by virtue of their employment with the company are ‘insiders’ for purposes of [SEC Rule]10b-5 and can be liable for insider trading if they trade or tip while in possession of material nonpublic information,” says Matthew Breitman, a partner at Blank Rome LLP, an international law and government affairs firm. “The secretary who learns of an upcoming nonpublic merger by looking at a document in the boss’ printer and then goes and trades on that material nonpublic information would be liable for insider trading. This is why a company’s insider trading policies should, and most do, cover all employees.”
Often, there may not be a clear-cut connection to draw between seeking personal benefit or monetary gain by leaking — or acting upon — confidential information. It can merely be a case of someone who couldn’t keep a secret.
Big Lots(BIG) recently filed suit against a Tampa-based research firm, Retail Intelligence Group. The gist of the suit is that the firm was able to get individual store managers to share confidential information about sales and inventory with its researchers, leading the employees to breach their fiduciary duty.
No claim, thus far, has been made that the research firm’s “channel checks” entailed payments of any sort. In the eyes of the litigant, however, the sharing of alleged trade secrets crossed an ethical and legal line.
So what of those store managers? Are they guilty of insider trading? Should they have known better? At what point does answering a question posed by a reporter or analyst — setting aside specific company policy — enter the realm of illegality?
The answer isn’t always clear cut, says Steve Lee, a self-described “financial detective” whose firm, Steve Lee & Associates, specialises in forensic accounting.
“Chances are, if you’re not a C-level employee or somebody who is ordinarily under scrutiny, you are going to get away with tipper/tippee behaviour,” he says.
“The problem is if, for any reason, you are under scrutiny, the law as it’s practiced and applied by courts is so unclear that anything can happen. Because insider trading is so much of a common-law issue, what we now have is a book of decisions, many of which are conflicting, at all level of courts, including the Supremes — who have done a strange job, really, of unofficially reversing themselves multiple times on this,” he says. “That’s the bad news, because that introduces tremendous amounts of risk, or potential risk.”
Most low-level slip-ups probably will never bubble to the surface, Lee says, but all companies need to assume they will, and set a zero-tolerance policy for confidentiality matters.
Even sparse details can lead to a connect-the-dots moment that puts an employee at risk.
He offers a fictitious example of an assistant vice president at an aerospace company kibitzing with co-workers and an outside vendor by the water cooler.
“Hey Charlie, how’s it going?”
“I’m so buried. What a horrible couple of weeks it has been.”
“What’s the problem?”
“I’m working on the acquisition of this lousy company in Palmdale, Calif. It has been a nightmare. The stakes are huge and my boss is breathing down my neck.”
That vendor, with minimal detective work, has more than enough to Google his way to the aerospace supplier hinted at and set a position.
“We’ve seen a lot of those types of cases,” Lee says. “It can be two guys talking on an aeroplane. It can be in the elevator, walking down the street, sitting in the restaurant or a couple of guys hoisting beers after work.”
Even if the leak escapes legal scrutiny, the employee can very likely “face some censure from inside the company,” Lee says.
“If you are sitting there thinking, ‘Should I say something, should I not say something,’ you should probably shut up and be careful about what you are saying,” he adds. “The thing you have to think about — even though most people aren’t actually going to contemplate anything before they say something — is that you are going to be judged in hindsight. Even if it was not material at the time, but was material later, you are in trouble.”
In a recent article published in the New York Law Journal, Michael Schachter, a partner in Willkie Farr & Gallagher’s litigation department and co-head of the firm’s white-collar criminal defence practice group, approached the topic from the angle of “personal benefit” and cites the overlapping Galleon Group/New Castle Partners insider trading cases.
In that case, Robert Moffat, an executive at IBM(IBM) was accused of leaking company information to Danielle Chiesi of the New Castle Partners hedge fund who, in turn, allegedly traded on it. Moffat eventually pleaded guilty and got a six-month jail sentence. Before that plea, however, attorneys suggested that because he never saw personal benefit, monetary or otherwise, holding him liable would be difficult.
That gambit didn’t play out, but such a strategy could benefit some, Schachter wrote.
“While courts have diluted the personal benefit requirement over the years, limiting the ability to distinguish malevolence from carelessness in the eyes of the law, the negligent, or ‘accidental,’ tipper should still be able to avoid liability for insider trading,” he wrote
That is because two legal yardsticks are commonly used: One, the so-called “classical” theory, holds that insiders violate Rule 10b-5 by using material, nonpublic information for personal gain and breach of their fiduciary duties. Second is the “misappropriation” theory, which goes the added measure of including corporate outsiders who lack such a fiduciary duty to shareholders.
Schachter cites the Supreme Court’s decision in Dirks v. SEC as one ruling that holds that the mere disclosure of material, nonpublic information, by itself, does not necessarily constitute a breach of an insider’s fiduciary duties.
He also cites the case SEC v. Switzer. Barry Switzer, the former University of Oklahoma’s football coach, had trading on information he overheard from George Platt, the onetime CEO of Texas International, while at a high school track meet. The court ruled that because Platt had no intention of being overheard as he discussed the nonpublic information with his wife, he did not breach his fiduciary duties and Switzer, in turn, was also not liable.
“A casual conversation between friends, during which material, nonpublic information is divulged for a purpose unrelated to securities trading, and without the tipper’s expectation of personal benefit, seems a poor case for the imposition of liability under Rule 10b-5,” Schachter wrote.
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