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Episode 7: Fact vs. Fiction – Breaking Down Insider Trading

June 5, 2023 The Investment Fraud Lawyer Speaks Podcast

Fact vs. Fiction – Investment Fraud Attorney, Jake Zamansky Breaks Down Insider Trading

Hello everyone. Welcome to the next episode of The Investment Fraud Lawyer Speaks a podcast produced by the Zamansky Law Firm. I’m Nancy Rapp from PaperStreet and I’m speaking with the Founder of the law firm Jake Zamansky. Jake is one of the preeminent lawyers in the country for security fraud matters and FINRA arbitration. The law firm represents individuals and institutional clients and cases against Wall Street firms for investment fraud losses. Today, we’ll discuss an investment broad topic that even non investors are familiar with insider trading, whether it’s an events in the news, or referenced in popular culture, Americans are largely familiar with the concept of insider trading. That said, media representations aren’t always informative, nor our movie or TV references accurate. Jake will provide us with some true insight needed that understand what insider trading is from a legal perspective, both on the security side of things and the criminal law side of things. Thank you for joining us today. Jake, insider trading is an example of stockbroker fraud, we actually discussed stockbroker fraud in your last show, but for listeners that may not have heard it, could we discuss what these class of securities fraud claims entail?



Sure, securities fraud claims means making a misrepresentation of a material fact about a stock to an investor. You know, and that happens quite often, either a company will say something false, or stockbroker will say something false to get someone to buy a stock. And we can then talk about insider trading and explain what that is.



Great. Okay, so let’s talk about what about what actions by that stockbroker would consider insider trading and how does this situation arise?



Okay, trading the stock by individuals with access to material nonpublic information about a company is insider trading, what’s happening is you’re taking advantage of privileged access, which is a breach of an individual’s fiduciary duty. Give you an example, where a CEO of a company learns of upcoming positive earnings release or let’s say a pending merger, and he buys the stock on that nonpublic information. The stock pops in the CEO makes a big profit. That’s insider trading. It’s unfair to others who do not have access to the same information.



Now, who typically is an insider, because I’ve heard that it could be different categories of people. How does this usually work for who would be considered an insider.



Insiders can be corporate officers, employees of a company or what they call tippers, people that give a tip to someone about a stock or “tipees” people that receive a stock a tip. The key here is that it’s inside information, and it’s not public. There are civil and criminal penalties. If you’re caught doing this, it’s a very serious thing. It can ruin your reputation as well. Give you an example… the famous case of Martha Stewart. I was attending in the courthouse doing commentary for new services, at the time. Martha Stewart, her broker told her to tell her that a stock called Imclone was going to stop start trading down. The insider at the company was a doctor named Sam Waksal also traded and he let other people know. So when Martha Stewart found out the information for her stockbroker, she immediately sold that the FDA was going to reject approval of a cancer drug. And as soon as that happened, the rejection, the stock went down. Martha avoided substantial losses as did Waksal and a number of other people. They all sold stock within minutes of hearing the news and avoided huge losses. Waksal was convicted of insider trading, he went to jail for seven years. Martha Stewart also was convicted she went to jail for six months. Someone is famous as that could be involved in insider trading and suffer penalties. It’s a real warning shot to everybody else.



Why do you think insider trading has some of the more harsher jail time and other penalties and other acts of security fraud?



Well, what happens is the Department of Justice and then the SEC on the civil side are trying to send message, they can’t go after everybody. But when they bring a high-profile case against someone, it sends a message of deterrence out to the public, the investing public. If you hear something that’s inside information coming from someone that on the inside of a company, you have a duty to refrain from trading, you’re not supposed to trade. Because you know, that’s not your information. It’s kind of stealing information from a company. It’s really something that you should refrain from doing. Now, I’ll give you another important case that shows what insider trading is all about. A gentleman named Rajiv Gupta was a prominent corporate executive on the board of Goldman Sachs. During the 2008 financial crisis, all the banks were getting hit hard, and stock was falling across the board, Gupta learned that Warren Buffett was going to invest $5 billion to help Goldman Sachs survive, he called a guy named Raj at a hedge fund. And within 16 seconds of hearing the news, they bought 175,000 shares of Goldman Sachs. After the news went public, Goldman stock surged, and Gupta and Raj made millions. This is one of the most high profile cases – big hedge fund manager, board of directors of Goldman Sachs, the Feds caught both of them, they were convicted, and they both went to prison. The careers in finance were ruined as a result of just one big trade. So, it’s something that people need to be aware of Gupta was the tipper here, Raj was the tippie, they both went down.



Now in these cases, it’s a little more obvious when you have an a victim for securities for transaction if they received bad advice, or, you know if their money was mismanaged or managed without their permission. What makes someone a victim of insider trading?



Well, insider trading, some people say it’s somewhat of a victimless crime. It’s not like you’re taking money out of one person’s pocket. But what it really does is it undermines the integrity of the public markets, you have, you know, people have to have confidence that there’s a level playing field when they go to buy or sell a stock, that the game is not rigged in favor of insiders. So the victim is really the public at large. If if every time there’s a story on insider trading, a lot of people feel wow, I don’t really have a chance. I’m not on the inside. You know, this, this is rigged against me. So that’s really the big problem is public confidence in the integrity of securities markets.



So really, it’s a goal to keep people investing largely, because if they people feel like they’re outsiders, they’re not investing. So the US government probably feels as a whole that it’s better to get people to invest. Is that correct?



Yeah, we want people to believe in the markets, you know, to invest. And this, this undermines that tremendously. Let me just go over what the key is to see whether something is insider trading. First of all, we’ve talked about an insider someone’s who’s inside the company, or has access to the information. The information has to be nonpublic. It could be an earnings report, news about a merger, or other important financial events. That’s private company information, which is very valuable. Let’s say Apple is going to report, you know, strong earnings. If you know about that in advance you can trade. And that’s an example of nonpublic information. Materiality is another issue. Is it important news? Is it information that’s expected to move the markets? So those are the three keys, insider status, nonpublic information, materiality.



That’s a good point, because not all insider trading is considered illegal. In fact, there are some cases where it’s not considered illegal. So what would really break down the difference of something it was an illegal act of insider trading or something that was permissible in court, right?



The key is, how did you find out the information? And did you know it came from an insider source? There’s some famous stories about people overhearing some news at a cocktail party, you’re at a cocktail party, you hear two people talking about stock, and somebody goes out and trades the stock. If you don’t know who those people are. And you trade it, maybe you just thought they were interesting people that they had some, you know, interesting idea about what was going to happen in the market. Well, that that wouldn’t be illegal. If you knew that somebody was an insider president of a company or some big executive, then you know, you shouldn’t trade because you know that it’s material nonpublic information, even if it inadvertently got in your hands. So a lot of it is, do you know who the people are that are that are talking about it? And how did you get the information? So it’s not likely that, that you’ll have a problem. If that’s the case. There’s also the issue of people doing superior research. One of the also prominent cases involves a company called SAC Capital, Steve Cohen, large hedge fund, they would have outside research firms, looking at stocks, you know, regularly, let’s say it’s a pharmaceutical company, they’d have an outside research firm with doctors and medical people, you know, looking at at the FDA docket, seeing what’s going on, doing research. If you do research, you know, through an outside firm, if it’s an internet stock, and you have people doing research, there’s nothing wrong with that. However, there’s this company had been accused, SAC Capital, of trying to get what they call “black edge,” trying to get those research people to get inside information, calling the company trying to figure things out. So there’s a gray area, when you’re doing, you know, careful research, due diligence versus trying to get inside information. You’re allowed to, you know, be crafty, and, and, and follow companies and, and have outside research firms, you’re not allowed to try and steal inside information.



It’s interesting, because you know, what this as this has more criminal penalties than some of the other things we’ve talked about. What if you’re at said cocktail party and you feel the people talking and you think other people might be trying to plan some incentive trading actions? Are you under any sort of duty to report this? Or are professionals required to report it? You know, how does that work?



Well, there’s no duty to report it. The duty is to refrain from trading. If you know or believe that you’ve gotten access to inside information, you’re not supposed to trade you got to refrain from trading. So that’s the standard. You don’t there’s no duty to report. And rarely does that happen. What the SEC does is, after there’s been an earnings announcement, a lot of times they’ll go back into look at the trades, what kind of trades were done, how soon after the inside information was there, so they can easily piece it together by subpoenaing brokerage firms. You know, Morgan, Stanley, UBS, if you put your trade so a firm, they can get access to that information. So, you know, there’s always a paper trail, which is another reason people should be really careful in doing this.



Now, Jake, what are some of the cases that I know we’ve talked about a few of the famous cases? What are some insider trading cases that you’ve worked on directly? That may have been unusual or just interesting to our listeners?



We’ve worked on cases involving stocks where, you know, this stock has fallen, and there’s allegations that companies have executives have traded on inside information. A lot of these cases are confidential, but we see it, you know, frequently, insider sales are reported, like two weeks after they they’re made. So a lot of times, you can take a look at it and see, wow, the timing here is pretty suspect. The Insiders sold, you know, the day before some announcement was made. So you can go back and look at insider sales. We’re also looking at some of these bank stocks, banks that have gotten hit, for example, the Securities Exchange Commission, the SEC is looking at first republic bank, whether insiders they’re traded, either they knew that a bank run was coming and they bailed out before the bank run, or in this case, they were acquired by JP Morgan. Insiders would have known about that. And something like that would have had a significant effect on the price of the stock. Other banks that have collapsed recently. There are allegations that insiders, you know, sold stock before the banks collapse. So there’s another example of something that’s taking place, you know, as we speak. So again, people can do their research, they can follow the stocks, they can contact investor relations, who gives out public information, but you got to be careful if you’re trading on nonpublic information.



Now, let’s say someone suspects that insider trading did occur is that when they contact a securities fraud lawyer, at what point do they reach out to you and what are your role? What is your role specifically?



Oh, lot of times, you know, I’ll get a call about something like that, you know, there are a lot of pump and dump schemes. And, you know, sometimes we’ll, we’ll pass that information along to regulators. It’s also important if you’re bringing a case against the company, to show that there was insider trading. So we get those calls. When people have lost a lot of money, particularly in smaller companies, and they think that, you know, a pump and dump has occurred, where they move the stock up, the insiders bail out, and then the investors are left holding the bag. So we see that somewhat frequently.



Just for our listeners, could you clarify what a pump and dump is in case they may have missed your other show?



Yeah, if a stock is it comes out as an initial public offering an IPO at say, $5 a share. And it goes up to $10 a share for $15 a share, the company is trying to move the stock up. Either having, you know brokers around the country, sell the stock, maybe they’ll give out, you know, some false positive information, knowing that eventually the news is going to come out that the company has got problems. So it’s kind of market manipulation, by insiders who move a stock up, you know, and then they profit because they sell their own shares. And everybody else, again, is on the outside. And it doesn’t have that benefit. And a lot of times the public will lose money on these stocks.



But is there any sort of, you know, damages or anything that a victim of insider trading can receive at these more like the securities class actions, lawsuits, where everyone just kind of gets a small amount, and it’s more about making a slap on the wrist to the participant?



Well, it’s more about deterrence, deterring people from committing what could be a crime or a civil violation, that that’s really where the action is, with the SEC and the Justice Department sending a message primarily to insiders and people that, you know, receive information from those folks. It’s, it’s, it’s the law is changing, you know, as new cases come up, but the principle is still the same. You can’t trade on nonpublic information.



I think some of like I said, I think the media and popular culture has made instant insider trading something that people are like, Oh, I know about it, because I’ve seen it on TV. But how do these criminal proceedings take place? Is it more like FINRA arbitration? Or is it more like the full throttles of a criminal case? Because I think our listeners are picturing more of law and order than they are possibly FINRA arbitration.



It’s primarily, you know, the Department of Justice, the criminal division, and the SEC, going after a particular individual or group of people. We, you know, we do see this a lot. And, you know, if you remember the show “Billions” with Bobby Axelrod. There, he’s always trying to get ahead. He’s trying to trade on inside information. A lot of people see that. And that was a big part of the theme of that show. So it’s something that the public is very interested in. As I said, it doesn’t have a direct effect on you. But it has the effect of undermining the integrity of the markets.



Now, on the flip side, there may be individuals who are completely unaware that their investments were part of insider trading, you know, whether somebody was their manager telling them it was okay to do this or something like that. What happens to these individuals and their funds, if they can show that they didn’t know it was insider trading?



Well, that’s yeah, that’s a defense if you can, but you know, it’s pretty hard to say that if, you know, the information is coming from a corporate executive. So a defense insider trading is, you know, I didn’t know, the source of the information. I wasn’t aware that it was nonpublic. You know, I was just doing my homework, right? Just overheard something. So anyway, those are examples of, of, you know, cases where the government wouldn’t succeed. But the average individual is not really involved in this type of thing, or, or has a direct, you know, negative impact from it.



Would a person be able to keep their funds and or is the only repercussions is that they get to escape jail time?



No, there’s this there’s disgorgement penalties, they have to give back everything they made, and, and also, you know, pay penalties. So yeah, there’s a severe price to pay for this.



Yeah, we’ve seen that there are tax protections in place for people who unintentionally benefited from Ponzi schemes. There’s nothing like that for insider trading.



No, no, there really isn’t. You know, we’re talking about people that are acting in violation. Under the law, so those folks will be held to account. There’s no tax benefits, you know, for people who may have benefited from this, or it’s just, you know, a penalty that’s imposed by the regulators. If you’re caught doing this.



We’ve talked about in other examples of security fraud, how some industries may be tied into others particular security fraud claims, like startups may have their risks of investing in them and thinking like that, with insider trading, can it happen anywhere? Or is it more likely to occur with major corporations?



No, we see it on thinly traded stocks, you know, where there aren’t that many shares traded? We see it, you know, in large cap stocks. You just mentioned the bank stocks. So it’s really across the board. And it’s something that, you know, the SEC is very vigilant and looking out for when a stock moves quickly, or some announcement, particularly when it’s a surprise announcement. You can rest assured that the SEC is looking at insiders to see what they’re doing. They look at the insider sales, they require them to be reported.



All right, Jake, thank you for providing us with some better understanding of insider trading, I think will pay more attention to what you have to say than what we see on TV. So thank you once again for all of your insights. Thanks so much. I appreciate it. Have a wonderful day everyone.



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