Friday, April 18, 2014

What if anything is civil insider trading?

The SEC today laid civil insider trading charges against a BP executive who (they allege) had information about the magnitude of the Deepwater Horizon oil spill before that information was public.

They allege that:

On April 29 and 30, 2010, while in possession of this material, nonpublic information, and in breach of duties owed to BP and its shareholders, Seilhan caused to be sold his and his family’s entire $1 million portfolio of BP securities. Specifically, Defendant caused to be sold his and his family’s holdings in the BP Stock Fund, a fund consisting almost entirely of BP American Depository Shares (“ADSs”), held in Defendant’s and his family’s retirement accounts at BP. In addition, Defendant exercised three different sets of options to purchase BP ADSs and immediately sold the underlying shares. 

This was nine to ten days after the explosion and Deepwater Horizon was already on the front page.

The main argument for the story was that when he sold the "official" leakage rate was about 5,000 barrels of oil per day. This was adjusted upwards eventually to over 50,000 barrels per day and the defendant knew that the real flow rate was higher than the publicly stated flow rate.

Here is what the WSJ story said a day before the share sales:
Vast swaths of reddish brown were visible Monday afternoon from a Coast Guard helicopter hovering 400 feet above the drilling site, where the small armada of ships hired by BP worked to collect the oil. A few miles away, a C-130 airplane released chemicals to disperse the long column of oil. A lighter sheen seemed to stretch to the horizon. 
Wildlife is already starting to be affected, and three sperm whales have been spotted in the area that is covered by an oily sheen. 
Cleanup crews from Louisiana to Florida are setting up booms intended to block as much oil as possible from coming ashore, said Steve Benz, chief executive of Marine Spill Response Corp., an industry-funded nonprofit company that cleans up spills. The crews are also preparing to clean up any oil that does come ashore.
Investors are growing worried about the rising costs associated with shutting off the well and cleaning up the spill. BP's American depository shares fell 3.3% to $57.91 in 4 p.m. Monday New York Stock Exchange composite trading, as other large oil companies rose in value.
The public information seemed at the time more-than-a-bit dire. Here is a picture from the WSJ of the size of the oil spill the day before the BP executive sold his shares:

The spill stretched about 100 miles and I suspect simple maths might have told you the spill was fairly large.

The share sales happened nine and ten days after the oil spill - and when - and I remember it at the time - BP completely dominated the financial blogosphere.

I am struggling here to see what the case might be. This is a civil case. If it were a criminal case I would have a very hard time convicting. The executive was - like many executives - overweight his company's shares and saw his career and financial wealth dissolving. He waited until the WSJ had a fairly accurate picture of the problem and then sold his shares.

As far as I can see civil insider trading is when the case is too weak for Preet Bharara and the SEC doesn't want to seem useless. In other words it is when the government ruins someones life without enough evidence for a criminal conviction.

This is - or at least should be - a criminal case. Or it should be dropped. I would go for dropped but the SEC might have better information than me. But in that case they should be convincing Mr Bharara and I would be all-in-favour of the Attorney trying the case.


It should be noted the case was settled. I was not the only person who viewed the case as weak and the government as heavy-handed.

That said - its probably a good policy if you are an employee of Goldman Sachs to sell ONLY on the day after earnings are announced. There is a strong case for being purer than the driven snow. After all, the government employee who is going to prosecute you makes MUCH less money than any mid-level Goldman Sachs employee.



Amos said...

Civil insider trading cases are how regulators establish new law. (Criminal cases are unlikely to lead to written opinions addressing substantive law.) Indeed, the concept of "insider trading" arose in private civil disputes, was then adopted by the SEC in civil actions, and it was two more decades before criminal prosecutions began. The federal criminal insider trading statute was enacted later because trying to criminally prosecute under other law... Oh it gets all complicated and theoretical and boring.

Anyway, in this case I doubt a prosecutor could establish the element of materiality beyond a reasonable doubt. I think the SEC is trying to make law on what materiality means.

There's also a more subtle problem that would arise in a criminal case, which is whether certain federal fraud statutes have extraterritorial application, considering that the victim is located abroad. It gets complicated and messy and boring...

Anyway I read the complaint and it looks like a fine case by the SEC.

Amos said...

Another example of the difference, compare with the text of Regulation FD. It seems (and while I debated this with folks years ago, I haven't followed it closely enough recently to be an authority) that post-Reg FD, to prove a *criminal* insider trading case one has to show that the tippee breached a duty of confidentiality in order to obtain a *personal* benefit, whereas to prove a *civil* insider trading case it may be sufficient to show that the tippee's conduct created a violation of Reg FD.

Anonymous said...

The strangest accusation of insider trading I have seen lately stems from the bankruptcy of Forge Group Limited (a smallish Australian EPC company).

The background is that Forge had done well for a number of years, riding the wave of mining construction in Western Australia. There were some concerns that the flow of mining related orders was peaking, so Forge tried to diversify by buying EPC companies with non-mining contracts.

After a few false starts, in 2012, Forge acquired CTEC, a small EPC company which had recently secured some contracts to construct power stations.

At that time, Clough owned 35% of the issued shares in Forge and Clough representatives sat on Forge board. It seems that Clough had some concerns about CTEC and they got their own engineers to evaluate the preliminary work done by CTEC on the new power station contracts. Clough didn't like what they saw and they promptly sold out of Forge at near record prices.

Fast forward to late 2013 ... Forge makes a shock announcement as to large and unexpected losses on the CTEC contracts, Forge's financiers are up in arms, Forge's share price plummets, etc, etc. In early 2014, the receivers move in and Forge is put into administration.

The adminstrator's report released on 11 March 2014 notes that a liquidator would be required to consider the above and do additional work so as to form a view as to whether there may be a viable insider trading case against Clough.

I don't know where this will end up. However, I do know that liquidators are always itching to get involved in legal action because it's a great way to prolong a liquidation and maximise their fees.

Note also Clough is no longer listed - it was acquired by Murray & Roberts, a JSE listed South African company.

The possibly interesting slant on all this is, if there is some kind of insider trading problem for Clough (and therefore Murray & Roberts), does that raise a short opportunity?

It's a ill wind that blows nobody any good.

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