At a glance:
• For investor relations teams, ensuring that inside information stays “inside” is a critical part of their role.
• The case study of the US hedge fund Diamondback Capital shows how weak (or nonexistent) compliance policies can result in civil and criminal liability.
• Read our advice on mitigating risk.
Investor Relations teams interface with myriad individuals – from shareholders and analysts, to funds, journalists, and company employees. Information is exchanged daily, and in high volume. However, not all information is created equal – particularly when dealing with information that is material and non-public. For investor relations teams, ensuring that inside information stays “inside” is a critical part of their role. But, without proper controls, seemingly harmless exchanges can lead to serious consequences, as was demonstrated by the case study of Diamondback Capital, a hedge fund that shuttered its doors in 2012 after an extensive insider trading investigation.
Diamondback Capital: When a “Tip” Turns into an Investigation
In March 2018, NIRI Boston held an event to shed light on insider trading and the potential risks for both fund managers and investor relations professionals. Moderated by Walt Pavlo, a white collar crime consultant and lecturer, the event focused in part on the story of fellow speaker Todd Newman, a former Diamondback Capital portfolio manager who was tried and convicted of insider trading before his conviction was overturned and vacated on appeal. Pavlo and Newman were joined by Michael Fee, a partner with the law firm of Latham & Watkins, who discussed how insider trading cases are investigated, prosecuted, and defended.
In November 2010, Newman’s office was raided by government agencies following suspicions of potential insider trading. Spurred by a tip from a younger analyst in his team, two small trades executed by Newman led to five years of litigation, 4.5 million subpoenaed documents, hefty legal fees, and ultimately, an overturned conviction. As Fee recounted, the extensive litigation triggered by this type of white collar offense frequently destroys careers and can irreparably damage company reputations.
The story of Diamondback Capital highlights the need for institutional safeguards in hedge fund/IR relationships. What may seem like an innocent conversation between two parties can result in serious legal implications and violate Regulation Fair Disclosure. The panel discussion recounted how the piece of information that triggered Newman’s trading in this case came to him “fourth-hand” during off-hour conversations between an analyst at another fund and the IRO of a listed company. Newman’s analyst casually shared his tip on a company messaging platform, and Newman performed a trade without questioning (or knowing) the initial source of information. Where it may be unrealistic to thoroughly dissect every single exchange that occurs between employees at a firm, implementing proper controls for information flows and communications can create a critical safety net.
Weak (Or Nonexistent) Compliance Policies Can Result in Civil and Criminal Liability
The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) both have market surveillance mechanisms and whistleblower hotlines in place to detect potential insider trading. These organizations frequently contact public companies and investors as part of their initial investigations. If the case merits further investigation, the SEC Enforcement Division staff will proceed with interviews and testimony, sometimes in cooperation with a local U.S. Attorney’s Office and/or the U.S. Federal Bureau of Investigation. As of November 15, 2016, the SEC adopted Rule 613 under Regulation NMS (the Consolidated Audit Trail). With CAT, regulators can easily track securities and options trades throughout the U.S. using one consolidated database. This has increased the market surveillance capabilities of the SEC, but also stresses the general trend towards greater transparency and heightened regulation and data collection regarding broker-dealers and Issuers.
Creating compliance policies to mitigate potential risks regarding material non-public information, communications, and relationships is imperative – whether to address the potential conflicts of interests that arise between issuers and investors, or internally for issuers themselves. In recent years, investor relations professionals have also come under fire for insider trading. The panel touched upon a few recent cases where an investor relations officer played a pivotal role in insider trading incidents. In 2012, a former Vice President of IR at Carter’s was indicted for insider trading after working as a consultant for numerous hedge funds. He was sentenced to two years in prison. In 2014, the SEC brought a case against a partner and account executive of Cameron Associates, another investor relations firm. The defendant was charged with insider trading after executing trades on public companies after assisting with drafting earnings press releases. While Regulation Fair Disclosure is generally well understood among hedge funds, the panel urged IR teams to take extra precaution to ensure that material non-public information remains non-public.
Given the serious nature of these cases, Fee stressed the importance of policies, trainings, and controls within public companies. In the case of a regulatory inquest, being able to demonstrate that compliance and ethics policies exist can be a valuable first line of defense. Weak (or non-existent) compliance policies can result in civil and criminal liability. They can also negatively impact a company’s “culpability score”, subsequently increasing the willingness of the DOJ or SEC to prosecute. As a public company, lacking a policy in regard to insider trading can be considered “reckless disregard” by regulatory bodies.
To mitigate risk, follow this advice:
- Create a free-standing insider trading compliance policy (e.g. implement trade pre-clearance procedures, black-out periods, track access to certain company information).
- Make sure that employees are informed of and trained on policies, and that mechanisms exist to flag and resolve potential issues.
- Clearly define “material non-public information” and who is considered an “insider”.
- Be aware of risks involved with the misuse of political intelligence.
Interested in learning more about tools that can help you with your internal compliance and workflow processes? Manage your insider lists with EQS Insider Manager and learn more about EQS Integrity Line, the GDPR-compliant whistleblower and case management solution.
See the full featured article above in the July 2018 IR Update Magazine.Back to home