Building on the groundbreaking and sprawling Galleon case filed in 2009, insider trading cases sat at or near the top of the Department of Justice's and the SEC's securities enforcement priorities for the past year. In this paper, we summarize the key new cases in this area and offer our thoughts on their import for the securities industry. Our comments are strictly our own, and do not necessarily reflect the views of our firm or its clients.
Primary Global and Benhamou: Expert Networks/Industry Consultants
After Galleon, the government's most significant new insider trading initiative is its focus on expert networks and industry consultants. Generally speaking, expert network firms offer traders and investment managers access to the insights and opinions of experts on industries throughout the world. The government has alleged that one such firm, Primary Global Research LLC—despite assurances on its website that its consultants are forbidden to divulge inside information—paid employees of various public companies to reveal material nonpublic information, including corporate revenues and sales forecasts, to Primary Global's clients.
To date, the Justice Department and the SEC have brought criminal and civil insider trading and related charges against twelve individuals: three Primary Global employees; five consultants associated with Primary Global; the founder and an employee of hedge fund Barai Capital Management; and two former employees of SAC Capital Advisors.1 The Barai employee, who allegedly heard one of the tips, and one of the former SAC employees have pled guilty and are reportedly cooperating with the government. In one made-for-the-movies incident, one of the cooperators allegedly caught a defendant on tape saying that he used pliers to rip apart a USB drive with incriminating evidence and threw the pieces into four different garbage trucks.
In another expert consultant case, the DOJ and the SEC brought tipping charges against a French doctor, Yves Benhamou, who served on the steering committee of a clinical trial for a drug under development by Human Genome Sciences, Inc. (HGSI), while also acting as a paid consultant for an expert network firm.2 The government alleges that Dr. Benhamou revealed some adverse developments in the clinical trial to a hedge fund client (identified in the press as Front Point Partners) of the expert network firm that employed him. Front Point's portfolio manager allegedly avoided $30 million in losses by selling the fund's entire position in HGSI before the information became public. Notably, neither Front Point nor the portfolio manager has been charged.
For trading firms, the most significant issue raised by the expert network cases is under what circumstances, if any, a trader can safely trade on information from an expert network firm or an independent industry consultant. Legally, a tippee cannot be liable for insider trading unless (among other required elements) the tippee "knew or should have known" that the information was obtained in breach of a duty of trust or confidence.3 The SEC has not provided guidance as to when, absent explicit knowledge of a breach, a trader "should know" that the source obtained and/or disclosed the information improperly. Understandably, portfolio managers and traders are concerned about being second-guessed by the SEC or a court, in hindsight, about whether they should have known that a consultant gave them information that the consultant was duty-bound to keep confidential. As a result, some firms have gone so far as to prohibit any use of expert network firms; some require a compliance officer to listen in to any conversation with a paid consultant; and many conduct extensive due diligence on the firms and the relevant experts before using them. Although a firm's specific approach to expert networks will depend on a variety of factors, including its trading strategy, the extent and nature of its use of expert consultants, and its appetite for regulatory risk, every firm should think carefully about these issues, adopt and enforce clear written policies and procedures on the subject, and train its trading personnel on them.
Galleon Update: SEC Charges Prominent Corporate Director With Tipping
In the past year, the Galleon case mushroomed into the biggest alleged insider trading ring in history. To date, federal prosecutors have charged 46 people in the...