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How the Feds Catch and Successfully Prosecute Insider Trading
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How the Feds Catch and Successfully Prosecute Ins...

Insider trading can be a difficult criminal charge to prove because of the requirement of showing the mental intent.  The cases boil down to jury determinations of "why" the defendant traded stock at the time he did.  Several high-profile cases from 2018 illustrate that insider trading is alive and well but that the federal government is getting better at proving the charges. Peter J. Henning, "If You Think Insider Trading Flies Under the Radar, Think Again," New York Times,...

 

William T. Walters ("Billy"), a well known high-roller gambler, is serving a five-year prison sentence for for trading shares in Dean Foods, based on information that he obtained from the company's former chairman. The Walters case achieved notoriety because golfer Phil Mickelson was named as a "relief defendant" in the case. Mr. Mickelson was not charged despite having traded on information from Walters and did not testify in the case.  However, the federal government was able to pull the case together because of the patterns of Mr. Walters' trades.  He always managed to engage in sale or purchase activity of Dean Foods stock just prior to public announcements of Dean earnings, the spinoff of WhiteWave, a Dean subsidiary, and Dean's plans to buy Darden stock. With such advance information, the government calculated that Walters was able to make $32 million in profit and avoid $11 million in losses in his Dean Foods stock holdings. Mr. Walters made very large and very successful trades and caught the Securities Exchange Commission's (SEC) eye.

 

Once the government found the patterns, it realized that the information must have been from a high level source.  In some of the situations, only the chairman of Dean Foods, Thomas Davis, would have known of the pending events. The SEC then found photos of the two men being seen together quite often. The SEC charged Mr. Davis with 12 counts of insider trading, and he entered guilty pleas to all of them, and then agreed to cooperate in the prosecution of Mr. Walters in exchange for lenient sentencing (he is serving only 2 years). The two used code language such as "the Dallas Cowboys" as the name for Dean Foods, and "Let's go get a cup of coffee" as the signal that relevant information needed to be passed along. You never trust the people you cheat with.  They will throw you under the bus. 

 

A second high-profile case involved the chief information officer of Equifax, Jun Ying.  Mr. Ying exercised all of his vested stock options in Equifax and sold more than $1 million in share just one week before Equifax announced that there had been a hack of Equifax's data base. Mr. Ying's defense was that the government did not prove that he had used the information that he possessed as the basis for his transactions in Equifax stock.  However, by obtaining his computer, the government was able to show that Mr. Ying had performed a number of internet searches on the effect of a hacking on other credit reporting companies. His advance sale also saved him a loss of $480,000 that resulted from the drop in value of Equifax shares following the hacking disclosure. 

 

In other cases, the SEC starts small and tracks small successful trades and then follows the individuals' subsequent activities. As the SEC notes, they begin to get greedy and the trades become larger and larger as they continue to believe that they have escaped detection.  They really have not escaped -- the SEC is simply letting the insider traders develop the case against themselves. 

 

While the state of mind is a difficult thing to prove (and the defendants always have the ability to deny what the government says is their intent), the federal government has been successful through patient evolution of trading patterns and by tracking the activities and associations of defendants as they engage in the trading.  From internet searches to the company we keep, the SEC is watching market traders. 

 

DISCUSSION STARTERS

 

Explain when insider trading occurs and how.

Discuss how the SEC proves intent.