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Here’s a sort of touching monologue from David Einhorn’s call with Punch:
If you’ve done the analysis, and come to the conclusion that on it’s own, the company is not going to make it, it makes all of the sense in the world to raise equity at whatever the price is, so that you can know that the company, you know, is – is going to make it. Now, what that brings to my mind though is, you know, obviously we haven’t done your analysis, we haven’t done — signed an NDA; I don’t know that we’re going to sign an NDA, because we prefer to just remain investors, but from my perspective, and I’ll be just straight up with you, is that gives a lot of signalling value. And the signalling value that comes from figuring out the company has figured out that it’s not going to make it on it’s own is that we’ve just grossly misassessed the — you know what’s going on here. And — and that, that will cause us to have to just reconsider what we’re doing, which is not the end of the world to you. You will continue on even if we don’t continue on with you.
You could sort of see why the FSA read that to mean that he was insider trading. Like …
(1) You have told me something with signalling value. Sorry – “a lot of signalling value.”
(2) I will now act on that signal.
(3) Don’t be mad.
“Signalling value” sure sounds like it means “material nonpublic information,” doesn’t it?
Now as we’ve discussed before, trading on that information would not be enough to make Einhorn guilty of insider trading in the US, though maybe it wouldn’t be exactly a great idea here either. Why? Because in our weird but sort of sensible insider trading laws, it’s just not illegal to trade on material nonpublic information. It’s only illegal to trade based on material nonpublic information that was obtained in violation of some sort of duty of confidence. Since Einhorn didn’t sign an NDA, he had no duty of confidence. And since the Punch CEO and bankers weren’t tipping him for nefarious purposes, but were instead sounding him out on the company’s behalf as a shareholder and potential investor in a new capital raise, they weren’t breaching their duty of confidence. You could quibble with the details of that but it’s basically the law here. In England not so much.
That also seems to be the law for our friends in Congress, who recently passed a law making it illegal for them to insider trade, which is worrying some people who make their living from trading on Congressional inside information:
The new concern of the political-intelligence industry stems from the legislation giving lawmakers an explicit “duty” not to act on nonpublic, material information. Prior to the legislation, many securities lawyers thought it was unclear if such a duty—a key tenet of insider-trading law—existed on Capitol Hill.
In establishing that legal duty, however, the legislation also could put lawmakers and aides in legal jeopardy if they divulge that same information to individuals who then trade on the information. “Now that Congress is covered by the insider-trading law, if a member of Congress gives a tip to a hedge fund manager, that is going to be illegal,” says Stephen Bainbridge, a securities-law professor at the University of California, Los Angeles School of Law. … Some legal experts disagree with that interpretation of the legislation. They say Congress has the right and perhaps the obligation to speak with industries and other concerned citizens about pending legislation.
That is a puzzler. One tip-off as to the right answer is that the legal experts who disagree with Stephen Bainbridge’s interpretation (as quoted) include … Stephen Bainbridge:
Of course, [for it to be illegal] it also would have to be shown that the Member got a personal benefit from making the tip, such as a political contribution, log-rolling support for legislation, or enhanced repuation.
So, yeah, it seems pretty safe to say that:
(1) Congresspeople will still have “the right and perhaps the obligation” to talk to people about things, but
(2) if they’re talking to people about things to help those people make money – in exchange for some sort of nefarious back-scratching – then it’s jail for them. If they get caught.
That, by the way, is kind of the right result. You want Congress to talk to people about things. You want them to tell constituents their thought processes, and get advice and input from those constituents. You might even want that to happen in private and off the record, because you might think that would get you better advice. You might even want them to talk to banks about banking regulation. But if you care about the integrity of the capital markets, or of Congress for that matter, then you also don’t want them feeding inside information to hedge funds and political intelligence firms for more or less disguised kickbacks.
But it can be hard to tell the difference. A Congressional aide may actually want advice from a hedge fund on capital markets legislation, in his Congressional capacity – but if the act of asking for that advice provides “a lot of signalling value,” allowing it to make a profit, and if that aide is hired by that hedge fund in a few years, well, who’s to say if it’s a conflict of interest?
This is of course the exact same issue as the one faced by companies, like, say, Punch, that want advice and input from their shareholders – or who just want to keep shareholders happy by meeting with them – and the US has addressed it with Regulation FD. You can have nonpublic but non-material chats with shareholders – or you can have material chats with them after they sign an NDA and agree not to trade. If a company gives an investor material nonpublic information without an NDA, and the investor trades – well, then you have to decide if it was tipping in breach of a duty (in which case the investor and the tipper get in trouble for insider trading), or not (in which case the company gets in trouble for violating Reg FD).
It’s not always easy to tell. Nor is it always easy to tell what’s material – witness the Punch case, or Charlie Gasparino’s pretty alarming story yesterday about an SEC enforcement official who told a roomful of amazed securities lawyers that private post-earnings discussions with analysts, one-on-one meetings during analysts days, and other routine contact between companies and investors is illegal under Regulation FD:
“David [Rosenfeld of SEC enforement] was frankly shocked that some of this stuff was going on, which in turn shocked me,” said another attendee who is a partner at a major law firm. “You talk to your institutional investors as a regular course of business, and I can tell you from talking to people at the SEC, David is not alone at the commission holding these views.”
But, y’know. People try. And one thing that makes it easier – not easy, but easier – is that if you give someone material nonpublic information without a confidentiality agreement, and he trades on it, you’re in trouble. You may be violating Reg FD, or you may be an insider trader – and the recipient may or may not be in trouble – but you’re definitely in trouble.
The STOCK Act is new and … not the law yet … and there are various versions … so it’s hard to know what exactly it prohibits, but basically it makes it clear that Congress has a duty of confidentiality not to go around tipping people off for private profit. What it doesn’t seem to do is have a Regulation FD equivalent requiring a confidentiality agreement. Just like public companies, Congress can still go around talking about potential plans with interested parties – as long as they’re doing it as part of their job rather than for private profit. Unlike public companies, though, Congress doesn’t need to get an NDA before disclosing nonpublic information. And investors who don’t sign an NDA don’t have a duty not to trade.
Of course, England doesn’t have a Reg FD either, and both Einhorn and Andrew Osborne at Merrill seem to have thought that their no-NDA conversation was just fine. And look where that got them.
* I think. Remember how nothing you read on the internet is legal advice? Good. Keep remembering that.