This post was written by Amy J. Greer, Terence Healy, and Lisa G. Blackburn.
A recent insider trading prosecution has shown once again that, when you are an officer of a public company with material nonpublic information, you can never be too careful about what you say, even in what should be a secure environment. On November 15, 2012, a Pennsylvania jury convicted Timothy McGee of criminal insider trading and perjury, in connection with his trading in the stock of Philadelphia Consolidated Holding Company, Inc. (ticker: PHLY). McGee had purchased more than 10,000 shares of PHLY in advance of the public announcement that the company was being acquired. McGee learned of the impending acquisition from a friend at an Alcoholics Anonymous (“AA”) meeting.
The sheer audacity of trying to profit from information learned in such a confidential environment shocked the jurors – and McGee may spend some time in federal custody as a result (sentencing is set for February 13; United States v. McGee, Criminal No. 12-236 (E.D. Pa.)). He also faces pending SEC charges. Among other things, the McGee case shows that, in the American legal system, facts control outcomes in the courtroom. In the eyes of a jury, trying to profit from private information at an AA meeting just ain’t right …
The law of insider trading is quite nuanced, and requires proof of some deception. A violation of section 10(b) of the Securities Exchange Act, and Rule 10b-5, occurs when one trades (a) based upon material nonpublic information, (b) when that information is obtained through a breach of a duty of trust and confidence owed to the issuer of the securities or to the source of the information, and (c) where the trader is aware of the breach.
Most people are familiar with what is known as the Classical Theory of insider trading, under which a company insider is liable if he trades based upon material nonpublic information learned through his position with the company. Such trading is seen as a breach of the duty the insider owes to his employer and its shareholders, and acts as a deception upon market participants trading without the inside knowledge. McGee is a misappropriator. Under the Misappropriation Theory, the trader does not need to be a company insider. Instead, the trader comes into possession of nonpublic information through a relationship of trust and confidence, and then violates the duty owed to the source by trading based on that information. The trader uses the information for a purpose other than for which it was conveyed, misappropriating the information from its source.
The McGee case falls squarely within the Misappropriation Theory. The executive who discussed the acquisition at AA meetings was simply describing a source of stress in his life, in an environment where he thought the information would remain confidential. He did not breach any duty. Although McGee argued that no relationship of trust or confidence existed between himself and the executive, the court, in deciding pre-trial motions, and the jury, in convicting McGee, plainly disagreed.
In a related pending SEC case, McGee is also facing charges that he “tipped” a friend about the inside information, who then proceeded to share that tip with his friends and family members, leading to further illicit trading. McGee’s criminal conviction is likely to commence a domino effect of settlements with the SEC.