Hedge Funds Join 'The CEO's Brother-In-Law' As The Target Of Insider Trading Cases

Author:Ms Michele Adelman and Catherine N. Karuga
Profession:Foley Hoag LLP

Insider trading cases often have focused on "the CEO's brother-in-law" or similarly situated individuals who used a tidbit passed along at Thanksgiving dinner to make a quick and easy personal profit. Today, hedge funds have joined "the CEO's brother-in-law" as the target of insider trading cases. In the hedge fund context, charges are being based on a hedge fund employee's collection of information as part of the employee's job in trading the hedge fund's assets, unlike the classic cases based upon receipt of an isolated "tip" outside of the work setting that will be used to generate profit for an individual.

The definition of insider trading has not changed since the days of the "evil brother-in-law." Illegal insider trading occurs when a person in possession of material nonpublic information about a company trades in that company's securities in violation of a duty of trust, and makes a profit or avoids a loss. That fiduciary duty or other duty of trust may be imputed. For example, in cases where a corporate insider "tips" a person about non-public information likely to have an effect on the company's share price, the duty the corporate insider owes the company is now imputed to the "tippee," and the tippee violates a duty to the company if the tippee trades on the basis of that information.

Most recently, the SEC has demonstrated its scrutiny of the trading activities of hedge funds by filing civil insider trading charges against four hedge funds, Galleon Management LP, New Castle Funds LLC, Spherix Capital LLC and S2 Capital Management LP. According to the Complaints, these hedge funds obtained material nonpublic information concerning market moving events such as earnings announcements, earnings and revenue forecasts, takeovers, and material contracts. The hedge funds then traded on the basis of that information, in violation of a fiduciary or other duty of trust, making purportedly over $33 million in illegal profits.

In addition to the four hedge funds, two other companies and fifteen individuals have been named as defendants. The individuals' job titles and affiliations are wide-ranging – a managing director at Intel Capital (a subsidiary of Intel Corp.), a director at McKinsey & Co., a Senior Vice President and Group Executive of IBM's Systems and Technology Group, and a former industry analyst at Moody's. Many of these defendants also face criminal charges.

The SEC's investigation into the Galleon matter is continuing as...

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