I’m astounded and almost (but not quite!) speechless after reading the SEC’s complaint from last week against a former Nixon Peabody associate for insider trading.  The SEC alleges that a client, Teleplus Consumer Services Inc., called the lawyer and asked her to draft a letter of intent about a possible merger between Teleplus and a company called Rooms.com. 15 minutes later, the lawyer allegedly called her broker and told him to buy 10,000 shares of Teleplus at 12 cents per share.  The stock price jumped when the deal was announced two days later, giving the associate a quick $5,800 profit.

People, please!! Are you kidding?! Would you rob a bank by walking in the front door with no mask on (and wearing a shirt with your name, address and phone number written on it), and then make a “getaway” walk home along a busy road (past the police station) carrying two big burlap sacks with green dollar signs on the side with bills pouring out of the top?

The chance of this lawyer getting away with the insider trading alleged by the SEC was Z-E-R-O, and that is only because we cannot go below zero, otherwise it would have been lower.  I’ve tried to explain this before. It remains a mystery to me why people with a zero percent chance of success will take that chance, even when they have so much to lose.

We’ve already seen SEC insider trading cases alleging husband betraying wife, wife betraying husband, boyfriend betraying girlfriend, brother-in-law betraying brother-in-law, and even divorcee betraying divorcee, but here’s a new one: brother betraying sister.

Yesterday, the SEC filed a settled insider trading action against Sarath B. Gangavarapu alleging that he misappropriated inside information from his sister, whose husband was an executive officer at Covansys Corporation. The SEC claims that Gangavarapu purchased over 54,000 shares of Covansys stock at a cost of over $1.4 million based on that information during the nine days leading up to Covansys’ public announcement that it would be acquired by Computer Sciences Corporation. The concept of “sibling betrayal” is a new one in SEC cases to my knowledge, but due to the typical love-hate relationship between siblings in general, I’m going to slot this case as Betrayal Level: Low (”Someday We’ll Laugh About It”) on the “Familial Betrayal Advisory System.”

The SEC alleges that in April 2007, Covansys was in discussions with CSC and another company about their interest in acquiring it. Gangavarapu allegedly spoke frequently with his sister during April 2007 and asked her questions about her husband’s work activities. His sister allegedly told Gangavarapu that her husband was in meetings behind closed doors and working extra hours, and after learning from her husband that Covansys’ board of directors would vote the next day on which acquisition offer to accept, told her brother that “by tomorrow, it’s a relief, it will be over.” The SEC says that Gangavarapu proceeded to trade based on this information, ultimately profiting more than $361,761.

Read the SEC’s Litigation Release

Today, Wayne State University law professor Peter Henning and I hashed through the various issues raised in “Hot Tips, Twitter and Insider Trading” in an online discussion. We also explored the recent Mark Cuban decision, the 2nd Circuit’s opinion yesterday in the Dorozhko case, and the bill now before Congress that would prohibit Congressional insider trading. Check it all out below.

A few weeks ago I offered the following hypothetical and questions:

An executive at publicly-traded ABC Corp. learns that his company is about to be acquired at a significant premium to its current stock price.  He goes on Twitter and posts the following:

“I’m about to become a rich man.  My company, ABC Corp., will be acquired next week at a 50% premium to current stock price. Shhh!!”

Here are the scenarios for discussion.  Assume in each scenario that many of the followers act on the tip by buying the stock of ABC Corp. that day:

(a) Executive has 5 followers, all family members.

(b) Executive has 5 followers, all strangers.

(c) Executive has 2,000 followers.

In fact, ABC Corp. is acquired the following week and the stock jumps from $20 to $30 on the public announcement, at which time the followers who traded sell their ABC Corp. stock for a big profit.  My questions for you are:

1. Is Executive liable for insider trading “tipping” in any of these scenarios?
2. Are the followers who profited on the tip liable for insider trading in any of these scenarios?

I then foolishly added that I would weigh in later with my own take, but quickly realized that the questions were, well, really hard.  I procrastinated and tried to lay low but eventually had to face the music when a couple of readers properly held my feet to the fire on this.  So I’m taking a shot at this below with the following caveats up front.

First, I do not pretend to know the correct answer to the insanely novel issues below and have not researched this.  For all of you executives at ABC Corp. and those similarly situated, please keep in mind the immortal words of Mike O’Sullivan’s now-defunct Corp Law Blog: “If you need legal advice, consult with a lawyer instead of a blog.”

Second, let me reiterate that this is way tougher than I thought it was going to be, as the “relationships” between the people are novel and uncertain, and there are variables I didn’t consider.  For instance, I assumed only followers would learn of the Executive’s “tweet” but I was reminded here that tweets go out to a public timeline that, at least in theory, is available to the world.  I’m sticking with my original assumption here, however.

I also didn’t really consider the fact that the “strangers” who follow Executive actually have no idea if he is, in fact, who he claims to be.  He could just as easily be a 16-year-old girl in high school making up stories for all they know.  Anyway, here are my thoughts:

1. Is Executive liable for insider trading “tipping” in any of these scenarios?

I’ll go with yes in (a), yes in (b) and no in (c):

In (a), you have what appears to me to be a classic insider trading case.  It seems no different than if he told the family this around the dinner table or via email, so I say Executive is liable.

I find (b) much tougher.  Here you have followers who are total strangers.  This dynamic does not really exist in the off-line world, does it?  Why would Executive walk up to a stranger on the street and deliver that message?  Executive has no idea if these Twitter followers even pay attention to what he tweets, and has no idea if they believe he is, in fact, an executive with ABC Corp. as he claims and believe his statement about an imminent acquisition.  I think it is analagous to Executive writing the message on 5 pieces of paper and dropping the papers at the bus stop.  Maybe people will see it, maybe people will believe it, maybe people will act on it.

Having said all that, however, since the hypothetical is that someone did trade based on Executive’s tweet, I would say that Executive should have reasonably known that this could happen and is liable.  It is the opposite fact pattern in some ways to the Barry Switzer insider trading case.  Switzer attracted the attention of the SEC when, after overhearing a corporate executive discuss the imminent “liquidation” of a public company merger, he profitably traded on that information in advance of the liquidation. The SEC brought an enforcement action against Switzer alleging insider trading, but the court ruled that the necessary “duty” had not been breached because the executive was unaware that Switzer had overheard his discussion of the liquidation.  Here, by contrast, our Executive is aware that he has Twitter followers who presumably read what he writes.

Bottom line: I’m going with “yes” in (b).

In (c), I think the fact that Executive has 2,000 followers changes things a bit.  It strikes me that at some level of followers, Executive’s tweet becomes the functional equivalent of a press release, and analagous to the company making the acquisition public by posting the information on its website.  Couldn’t a follower who is questioned by the SEC after his profitable trades say that he reasonably thought the acquisition information was public because he saw it on Executive’s public Twitter feed that is followed by 2,000 people?  I think this brings up a host of other issues, unfortunately.  For instance, as I understand it, the SEC is still hashing out what type of online disclosure is adequate under Reg FD, and I’m willing to bet the Twitter feed of a random company Executive is not on the approved list.  For the sake of argument, however, I’m going with “no” on (c) on the admittedly shaky ground that Executive’s disclosure to 2,000 people makes the information public.

2. Are the followers who profited on the tip liable for insider trading in any of these scenarios?

Same answers as in Question 1, for the same reasons.

In short, I’m grasping here, as the issues are novel and seem to multiply at every turn.  I’m going to seek out some better-researched answers to these questions from law professors or private attorneys, and will let you know if I have any luck.

This morning, U.S. District Judge Sidney A. Fitzwater dismissed the SEC’s insider trading case against Dallas Mavericks owner Mark Cuban. A copy of the Court’s Order is available here.

In his ruling, Judge Fitzwater focused heavily on the issue of whether the SEC had adequately alleged that Cuban entered into an agreement sufficient to create the duty necessary to establish misappropriation theory liability. The court found that the SEC needed to allege that Cuban entered into an express or implied agreement with Mamma.com (a) not to disclose material, nonpublic information about the PIPE offering, and (b) not to trade on or otherwise use the information.

The court ultimately concluded that the SEC failed to adequately allege the second part of this requirement, i.e., that Cuban agreed not to trade on or otherwise use the information. Judge Fitzwater wrote that

Although at one point Cuban allegedly stated that he was “screwed” because he “[could not] sell,” this appears to express his belief, at least at that time, that it would be illegal for him to sell his Mamma.com shares based on the information the CEO had provided. This statement, however, cannot reasonably be understood as an agreement to sell based on the information. Further, the complaint asserts no facts that reasonably suggest that the CEO intended to obtain from Cuban an agreement to refrain from trading on the information as opposed to an agreement merely to keep it confidential.

The court added that it also was not sufficient that the SEC’s complaint indicated that the executive chairman of Mamma.com may have expected that Cuban would not sell until the PIPE was publicly announced.  “Outside a fiduciary or fiduciary-like relationship, a mere unilateral expectation on the part of the information source–one that is not based on the other party’s agreement to refrain from trading on the information–cannot create the predicate duty for misappropriation theory liability,” the court stated.

As more people learn daily, Twitter is a way to get a message out to the entire world. The twist, of course, is that your message will only be seen by people who have chosen to follow your updates. A “tweet” by a person who has no followers is the proverbial tree falling in the forest with no one around to hear it.

I am interested in how Twitter may intersect with the insider trading laws, and would like to throw this hypothetical question out for your thoughts:

An executive at publicly-traded ABC Corp. learns that his company is about to be acquired at a significant premium to its current stock price.  He goes on Twitter and posts the following:

“I’m about to become a rich man.  My company, ABC Corp., will be acquired next week at a 50% premium to current stock price. Shhh!!”

Here are the scenarios for discussion.  Assume in each scenario that many of the followers act on the tip by buying the stock of ABC Corp. that day:

(a) Executive has 5 followers, all family members.

(b) Executive has 5 followers, all strangers.

(c) Executive has 2,000 followers.

In fact, ABC Corp. is acquired the following week and the stock jumps from $20 to $30 on the public announcement, at which time the followers who traded sell their ABC Corp. stock for a big profit.  My questions for you are:

1. Is Executive liable for insider trading “tipping” in any of these scenarios?
2. Are the followers who profited on the tip liable for insider trading in any of these scenarios?

I will weigh in with my take on this next week.

In a letter addressed to SEC Chairman Mary Schapiro on Monday, Senator Chuck Grassley says he is tired of waiting for an unredacted copy of the recent Inspector General report (discussed here) about the activities of SEC attorneys who may have engaged in insider trading and violations of the SEC’s own trading policies.  According to a press release on Grassley’s website, he has twice asked for information that the SEC has apparently already released in response to requests made through the Freedom of Information Act.  To date, however, the SEC has not sent it to him.

“The contents of the Inspector General report about the activities of SEC attorneys deserve congressional scrutiny. The public needs to know that the SEC is doing something to deter misconduct and that this sort of thing isn’t more widespread,” he said.

Grassley says he is just trying to get what was provided to the Washington Post over a month ago, and he would like to know “why the SEC’s responses to media requests pursuant to FOIA should be more complete and informative than responses to Members of Congress.”  On May 17, Grassley says, the Washington Post reported information that had been redacted in the version of the Report he received, citing a copy of the Report it obtained from the SEC through the Freedom of Information Act (FOIA).

If it makes you feel any better, Senator, the SEC still has not sent me anything in response to my May 15 FOIA request for a copy of the report!

An article Saturday in the AmLaw Daily about a case pending in federal court down in Tampa brings to the fore one of my favorite types of public companies: the treasure hunters.

Odyssey Marine Exploration is a public company that makes its money (or tries to) by going out on the open seas and trying to find shipwrecked treasure.  Odyssey believed it had uncovered one of the most lucrative shipwreck discoveries in history in May 2007, when it announced it had recovered 17 tons of gold and silver artifacts worth nearly $500 million from a secret Atlantic Ocean site codenamed the Black Swan (see the July 2007 video below about the haul).

As discussed in the AmLaw Daily article, the government of Spain contested Odyssey’s right to the treasure.  Spain claimed Odyssey had actually discovered a 19th-century Spanish frigate called the Nuestra Señora de las Mercedes that had been sunk by a British warship, sued Odyssey for violating Spanish heritage laws, and later seized the company’s Gibraltar-based flagship.

Odyssey had filed a salvage claim to the Black Swan site in U.S. district court in Tampa, but on Wednesday, U.S. magistrate judge Mark Pizzo recommended that the case be dismissed for lack of jurisdiction and that property recovered from the Black Swan site be returned to Spain under the principle of sovereign immunity.

Odyssey’s discovery of the treasure back in May 2007 also spawned an unusual and interesting insider trading case. On January 17, 2008, the SEC announced that it had filed a complaint against Ernesto Tapanes, one of Odyssey’s oceanographic surveying consultants.  The SEC alleged that Tapanes engaged in insider trading shortly before Odyssey made its May 18, 2007 announcement of its discovery of the Black Swan shipwreck. The complaint alleges that on March 30, 2007, Tapanes

discovered an anomaly on the ocean floor, while surveying off the coast of Gibraltar. Within days of the discovery, Odyssey Marine confirmed that the anomaly was an 18th century shipwreck, code-named the Black Swan, containing tons of silver and gold coins. Shortly thereafter, Tapanes and others signed a confidentiality agreement agreeing to keep the find confidential and not to trade in Odyssey Marine stock.

The SEC alleged that despite signing the confidentiality/no-trade agreement, Tapanes purchased Odyssey stock prior to the public announcement of the discovery, and then sold it all for a profit of more than $107,000.  Tapanes settled the case, agreeing to pay disgorgement of $107,101.92, plus a civil penalty of $107,101.92.

Down under, Merrill Lynch and one of its subsidiaries face allegations from a Sydney businessman that they engaged in what would reportedly be “the biggest case of insider trading in [Australia's] corporate history.”

The allegations against Merrill Lynch by David Waterhouse relate to certain short-selling by Merrill Lynch of $55 million of Australian stocks in January 2008. Waterhouse claims that on January 14, 2008, Merrill’s Berndale Securities subsidiary seized control of an account Waterhouse held called “How Trading” because it had breached its agreed margin call levels.  According to the Sydney Morning Herald, Waterhouse claims that Berndale then used the proceeds of the account through January 17th to short-sell over $55 million of blue-chip Australian shares in major banks and BHP Billiton.

On January 18, Merrill Lynch announced a $US9.83 billion fourth-quarter loss, which led bank stocks around the world to tumble as much as 10%.

A witness statement provided by Waterhouse alleges that Merrill Lynch and Berndale employees were aware that Merrill was about to release the “awful” news when it took the huge short position in bank stocks.  He claims that a Merrill Lynch employee specifically told him

“We wanted you done and dusted before our head office reported their results this week. That time has come and gone. Now we have to do some heavy things straight away today. We will short the hell out of stocks in the market that you have option positions on, maybe up to $100 million, which will more than match your option positions, it’s a great opportunity for you, that we know what is coming this week. With this huge short sale, we will then close the option positions and at the same time buy back the short sale stock, which will support the price on the options.”

The UK’s newly-aggressive Financial Services Authority (FSA) is pursuing another high-profile insider trading case, as reports emerged today that a partner at the London office of Dorsey & Whitney and a former partner of McDermott Will & Emery will be charged criminally next month with insider trading.  Bloomberg reports that Andrew Rimmington, a corporate partner at Dorsey & Whitney LLP, and Michael Gerard McFall, an ex-corporate partner at McDermott Will & Emery LLP, are the lawyers in question, along with Peter Andrew William King, the former financial director of Neutec Pharma Ltd.  The  prosecution relates to Novartis AG’s 2006 takeover of Neutec, according to court documents.

According to Bloomberg, King and McFall face charges of insider dealing and disclosing non-public information, while Rimmington will only be charged with insider trading.

As discussed here, the FSA has in recent months begun to gain traction in its effort to gain respect as an aggressive regulator.  This effort seemed to kick off in March, when the FSA’s chief executive, Hector Sants,  stated that “there is a view that people are not frightened of the FSA.  I can assure you this is a view I am determined to correct. People should be very frightened of the FSA.”  The initial reaction in the UK appeared a lot of eye-rolling, but a series of high-profile insider trading cases, enforcement “swoops,” and the FSA’s first-ever criminal prosecution on March 27 for insider dealing seem to have begun to change the FSA’s reputation.