The coronavirus-related market volatility has created investment opportunities for many market participants, including investment advisors and their clients and, apparently, members of Congress.
Recent reports of Sen. Richard Burr, R-N.C., selling certain stocks after receiving information in a closed-door government briefing highlight an issue important for anyone contemplating securities transactions while in possession of material non-public information: You don’t have to actually use the MNPI to face insider trading charges.
Burr tweeted that his trading was based on publicly available information about the coronavirus rather than anything he learned at the briefing, but that may make no difference to the SEC.
Before we turn to Burr’s plight, consider the case of hedge fund manager Doug Whitman, who was convicted in 2012 of criminal insider trading based on information obtained from an independent research consultant who in turn received the information from insiders at several publicly traded companies.
Earlier Insider Trading Case, MNPI
Whitman testified at trial that he never thought his sources of information possessed MNPI about the stocks he traded. Nevertheless, he was criminally convicted of insider trading, and his case found its way to the United States Supreme Court, which declined to hear his appeal.
A long unsettled issue in insider trading law presented by Whitman’s case is whether the government must prove that a trader used MNPI or whether it is sufficient merely to prove that the trader possessed MNPI at the time of the trade.
As one federal appellate court observed, if the government were not required to prove that the trader used the MNPI, that would “go a long way toward making insider trading a strict liability crime.”
In other words, a trader could be guilty of insider trading when in possession of MNPI even if the trade were based on some reason completely unrelated to the MNPI.
In 2000, the SEC attempted to clear up the use/possession muddle by adopting Rule10b5-1, which codifies the SEC’s position that trades are made “on the basis” of material, nonpublic information when the person making the purchase or sale was aware of MNPI when the trade was made.
Thus, the SEC takes the position that it need not prove a trader “used” the material, nonpublic information to trade. As part of the rule, the SEC also included an affirmative defense to shield those with knowledge of MNPI from liability for conducting certain trades “if the person making the purchase or sale demonstrates that [b]efore becoming aware of the information, the person had . . . adopted a written plan for trading securities.”
But when the Supreme Court denied hedge fund manager Whitman’s request for an appeal, the late Justice Antonin Scalia observed that an agency’s interpretation of the law, even in the form of a rule such as Rule 10b5-1, is not necessarily the law because “legislatures, not executive officers, define crimes.”
While Justice Scalia did not think Whitman’s appeal was an appropriate case to consider the issue, he invited other defendants to request Supreme Court review of the SEC’s Rule 10b5-1.
Burr may be in a position to take Justice Scalia up on his invitation. It will clearly be the government’s view that if Burr traded while in possession of information obtained as a result of government briefings, he will face insider trading liability — whether or not he used that information to trade or based the trades on what he read in a newspaper.
While not explicitly mentioning Burr, just days after the news broke about his trading the SEC’s Enforcement Division put out a public statement related to insider trading and the coronavirus:
[I]n these dynamic circumstances, corporate insiders are regularly learning new material nonpublic information that may hold an even greater value than under normal circumstances. This may particularly be the case if earnings reports or required SEC disclosure filings are delayed due to COVID-19. Given these unique circumstances, a greater number of people may have access to material nonpublic information than in less challenging times. Those with such access —including, for example, directors, officers, employees, and consultants and other outside professionals — should be mindful of their obligations to keep this information confidential and to comply with the prohibitions on illegal securities trading.
The SEC Enforcement Division’s warning is particularly important for hedge fund managers and other investment advisors who may come into possession of MNPI relating to coronavirus.
Even if the basis for trading results from public information or a thesis developed well before the coronavirus pandemic, the SEC will consider trades made by an advisor while in possession of the MNPI as illegal insider trading, assuming other factors are met. Trader beware.