It May Surprise You To Learn That Reasons For Greenlight's "Punch" Fine Are Not Entirely Clear To Me Either

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Remember how insider trading is trading on material nonpublic information? Only how it's not? Apparently it is in England! Someone found that out today.

I know, I'm soft on insider trading but hear me out. This is actually kind of screwed up.

First, a story. I used to work in a business that raised money for companies. Often when companies needed to raise money it was to do things like stave off rapidly impending doom, and the company would come to its bankers and ask "so, um, how's that story going to play in the market?" And you'd answer something like "I don't know but probably shitty?" And a way to make everyone feel better was a wall-crossed deal, in which the bank calls a few big potential buyers and says "would you buy this thing? at what price?" with the goal being to get the deal mostly done without freaking out the market - or, if that failed, to cancel the deal and move on to plan B also without freaking out the market.

Now in order to do this you needed to "wall cross" the potential investors by getting them to agree not to talk about the offering, or trade in the company's stock, until the offering became public or was abandoned. Why? Two reasons:
(1) A thing called Regulation FD makes it illegal for companies to tell some investors material things unless they either disclose it to everyone or get the investors to agree to keep it confidential and not trade on it.
(2) Also important! You did this whole wall-cross to avoid announcing your deal and freaking everybody out so they sell your stock. If you don't get investors to agree not to trade, then they'll probably sell your stock, so you've accomplished nothing except breaking the law a bit.

Now getting them to agree not to trade has a certain chicken-and-egg quality because getting a call from a bank saying "we need to lock you up on company X" is never a good sign (maybe rare exceptions). So the call would go like this:

Bank: Hello, investor. We would like to speak to you about a company but you have to agree not to trade in that company.
Investor: What company?
Bank: Well, before I tell you that, you have to agree not to trade in the company.
Investor: Umm.

There are various ways of dealing with that through compliance officers etc., but ultimately for an investor with a big position in Company X, at some point a portfolio manager has to say "okay, I'm fine with not trading that position for the next couple of days after you tell me some possibly life-altering news about Company X." Or he could, y'know, say "no, take your possibly life-altering news elsewhere, I'm going to keep my freedom to trade Company X." And with that freedom comes ... whatever signal your phone call constituted. Rarely good.

Now a thing about insider trading in the U.S. is that it's illegal to trade on material nonpublic information “in breach of a fiduciary duty or other relationship of trust and confidence.” It's not just illegal to trade on material nonpublic information. What that means in this context is:
- If the PM agrees to the wall-cross, i.e. that he'll keep the name confidential and not trade in it: if he then trades it's probably illegal. Because he went and took on that duty of trust and confidence.
- If the PM tells the bank to buzz off and doesn't take wall-cross: if he then trades, it's probably fine. Probably no duty.
- If the bank just forgets to ask the PM to keep things confidential: if he trades, again, it's probably fine.*

So in June 2009, when wall-crossed offerings for troubled companies were in vogue, a broker for a troubled company called one of its biggest shareholders and said "hey we were thinking about raising money, how would you feel about that?" And he said something to the effect of "first, I 'feel bad, and second, don't tell me anything nonpublic because as soon as we get off the phone I am going to remedy this being-one-of-your-biggest-shareholders situation." And that troubled company was Punch Taverns, and that troubled shareholder was David Einhorn, and you know the rest. [UPDATE: In fact, they asked him to take a wall-cross, he said no, and they had a non-wall-crossed conversation. This seems like a silly idea for all sides! But, yeah, in that context you'd really expect everyone to not say anything material and nonpublic.]

Which is not very much, so far. Einhorn dumped about a third of his Punch stake between that phone call and the public launch of Punch's equity offering six days later, which caused Punch's stock price to drop by 30%, so Greenlight saved some £6mm by not waiting. The FSA concluded that this was sort of shitty, but not intentionally shitty, and so fined Greenlight and Einhorn £7.2mm. Greenlight and Einhorn thought in turn that that was sort of shitty, but not worth fighting arduously over, so case closed. Call at 4pm.

A thing to notice here is that what Greenlight did is almost certainly fine under US securities laws. If a broker called him and said "hey, we're planning to raise capital, you in?" and he said no, hung up and traded - no problem. Probably. It's only a problem (probably!) if he first agreed to keep the information under his hat - which is something that the company should insist on, for their own protection, but if they don't it's not his problem.

Under UK law that distinction doesn't seem to apply: if you trade on inside information, you've committed "market abuse," and are in trouble. It doesn't matter if you agreed, or didn't agree, or were or were not asked to agree, to keep it confidential or not trade on it: if it came from inside, and isn't public, you can't trade. [UPDATE: As Einhorn pointed out on his call about the matter, UK precedents are not so clear - in previous insider trading cases there always was a breach of a wall-cross. But the US "breach of a duty" standard does not seem to explicitly apply so, y'know, first time for everything.]

Now, if you're me, you can sympathize with Greenlight here, and nod along as you read their statement:

The fine is for trading in advance of a decision that had not been made, and the FSA concedes we did not believe we had any inside information. We did not enter into any confidentiality agreement, we explicitly requested that we not be given confidential information, and we do not believe we were given any such information.

Or, if you want, you can not sympathize. You can go with the FSA and say:

On 9 June 2009, Einhorn was a party to a telephone conference in which it was disclosed to him by a corporate broker acting on behalf of Punch Taverns Plc that Punch was at an advanced stage of the process towards a significant equity fundraising. This was inside information and Einhorn should have appreciated this. ... The FSA accepted that Einhorn’s trading was not deliberate because he did not believe that it was inside information. However, this was not a reasonable belief. Investment professionals are expected to handle inside information carefully regardless of whether they have been formally wall-crossed.

Fine, whatever, you would believe that wouldn't you? But the US system is actually there for a reason. Imagine you're Punch and you want to raise capital. You have good reason to think that your US shareholders would not be down with that, and would dump their shares if you announced a new capital raise. What can you do? Under US law, you can call them and ask them not to - but they can say no. Punch can't unilaterally lock up Greenlight from trading: Greenlight has to agree to be locked up.

Under UK law, as it appears from this decision, Punch can call Greenlight, shout "hey we're raising capital and now you know about it suckers!" into the phone, and hang up. Now Greenlight, through no fault of their own, have inside information and can't legally trade. That would be kind of diabolical, no?

FSA fines Einhorn [FTAV]

* Hey remember how nothing you read on the internet is legal advice? That's a good thing to remember here. Also some people run into regret around these issues.

Also, I mean, to be clear, you shouldn't do it, and both from a compliance officer's and, like, good citizen of the markets perspective, it's a sketchy idea to go around trading once you've ambiguously received ambiguously inside information in an ambiguous context from the company or its brokers. But that doesn't mean it's illegal.

Related

David Einhorn Said No To A Capital Raise, Kept The Door Open For A Pub Crawl

Remember how David Einhorn got in trouble in England for insider trading on Punch Taverns stock and he was all "what?" and we were all "what?"? Well, you can judge it for yourself because now the entire disputed call with Punch is available online (at the back of this). So go read it, or read the highlights here. The FSA still thinks it's insider trading, but the count of people confused by the whole thing is rising, and now includes the Merrill banker on the call. There's lots of insider traderiness on this side of the pond today too so we should talk about that in a bit. For now, though, two other things. One is quick - no one can resist one part of the call and I can't either so here it is: DAVID EINHORN: Hi, I’m sorry I didn’t get to see you when you were in New York. PUNCH CEO: No, no, we -- well, we’ve -- we’ve only had the chance to speak once, although we have seen [reference to Greenlight Analyst] a few times since then. DAVID EINHORN: Oh, you’re -- you’re -- you’re getting more than -- than I could help with anyway. So, this is good. PUNCH CEO: Okay. That’s fair enough. Well, one day we’ll get you around on a pub crawl around some English pubs. DAVID EINHORN: Oh, that sounds fun. PUNCH CEO: It is. You’re right. English readers: Is it? I just assumed that Punch Taverns are rather grim places, like TGI Friday's but with more ... punching? ... but maybe I'm totally off base here. Also, here is a hypothesis: vice investments do well because, for the same level of profitability, they get more analyst/investor coverage and enthusiasm. Wouldn't you rather go on a pub crawl instead of like a tour of an auto parts factory in Queens? Would that influence your stock recommendations / money allocations? Someone should do a study.

After The STOCK Act It Will Still Be Legal To Trade On Congressional Inside Information*

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: