By Jonny Lupsha, Wondrium Staff Writer
Insider trading laws in the United States are complex and widely varied. While other countries have made sweeping regulations against trading stocks of a company you know information about, the United States has more selective rules on the matter. A two-year sentence surrounding Amazon stock adds a new footnote.
A man, whose wife had access to insider knowledge about Amazon, was sentenced to 26 months in prison, last week. His wife had used that information to make a profit of $1.4 million between 2016 and 2018. He pleaded guilty last year to securities fraud after breaking trade blackout restrictions.
Insider trading laws in the United States are more of a patchwork than they are in many other countries. In the United States, some incidents are allowed while others aren’t. In his video series Law School for Everyone: Corporate Law, Professor George S. Geis, the William S. Potter Professor of Law at the University of Virginia School of Law, gave examples to help explain.
SEC v. Texas Gulf Sulphur
The first case Professor Geis mentioned was when the Securities and Exchange Commission sued the mining firm Texas Gulf Sulphur (TGS).
“In the early 1960s, TGS was exploring some land in eastern Canada; the firm’s stock was trading at about $19 per share,” he said. “By late 1963, TGS came across a very promising location; exploratory drilling revealed massive deposits of copper. But TGS wanted to keep this news secret, so it could buy up the surrounding land at a good price.”
Professor Geis said that over the next few months, TGS bought up all the land—and its higher-ups acquired plenty of stock for $20 a share. Rumors flew, TGS downplayed the value of the land and the company, and when the dam broke, their stock soared to about $58 per share.
The SEC and the Supreme Court said that it was acceptable for the company to buy the land for cheap, much like purchasing a valuable item inexpensively from an unaware seller at a garage sale. However, the company leadership should have either abstained from trading during this period of time or they should have disclosed the information.
“SEC v. TGS is a foundational decision on insider trading, and it sets out the traditional rule of abstain or disclose,” Professor Geis said. “But the case’s noble rhetoric about establishing a level playing field for all investors sweeps further than the U.S. Supreme Court has ultimately been willing to go.”
Dirks v. SEC
What if another opportunity like that of TGS happened, but employees knew they couldn’t buy stock in their own company because of the illegalities? Instead, they may decide to tell a friend to help the friend get rich. Or they may sell the knowledge to a money manager for a finders fee. According to Professor Geis, this is known as “tipper-tippee insider trading.”
“The foundations of tipper-tippee criminality were created in a 1983 opinion named Dirks v. SEC,” he said. “It established the general framework for determining whether a tip would count as insider trading.”
In this case, Dirks worked for a brokerage firm that provided investment analysis to its clients, most of whom were big-time investors. Dirks received a call from an employee of a Los Angeles insurance company called Equity Funding, who told Dirks that Equity was lying about its financial performance. The employee had already told several regulatory agencies about this but they’d refused to act on it.
“[Dirks] flew out to L.A. to interview some of the employees at Equity Funding,” Professor Geis said. “The senior leaders denied any wrongdoing at the firm, but several other lower-level employees corroborated [the] story of fraud. Neither Dirks nor his firm owned any Equity Funding stock, but they advised several large clients, and some of these clients did own stock.”
On Dirks’s advice, his clients dumped more than $16 million in stock, plummeting share prices from $26 to $15. California insurance authorities investigated and found widespread evidence of fraud at the company. The SEC pressed charges against Dirks for insider trading, arguing that as soon as he got the tip about Equity Funding, he became as liable as an insider as the employee who called him.
However, the Supreme Court ruled that two factors would have to be present to qualify as insider trading. First, that the tipper must have breached a duty to the firm when giving Dirks information, and that the breach of duty only arose if he or she gained something from it. Second, Dirks would have had to know about the breach of duty.