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October 4, 2012
Insider Trading
Navigating the Patchwork of Global Insider Trading Regulations: An Interview with
Adam Wasserman of Dechert
By Jennifer Banzaca
As the investments and operations of hedge fund managers become increasingly global, managers must contend with a growing number and complexity of regulatory regimes. One of the most complicated and important areas in which regulation varies from jurisdiction to jurisdiction is insider trading. Insider trading regulation is complex enough domestically. When you factor in the asymmetry among global regimes; different treatment of the same conduct; the often counterintuitive aspects of insider trading doctrine; and the ease of tripping jurisdictional wires, global insider trading regulation becomes a minefield for the unwary hedge fund manager. Moreover, non-U.S. regulators – in the United Kingdom, Hong Kong and Japan, among other places – are growing more vigorous in their insider trading enforcement.
To help hedge fund managers identify and address some of the most important issues in global insider trading regulation, The Hedge Fund Law Report recently
interviewed Adam Wasserman, a Partner at Dechert LLP. The interview covered, among other topics: the biggest differences between the insider trading laws of the U.S. and non-U.S. jurisdictions; the unexpected aspects of insider trading doctrine from various jurisdictions; a discussion of the Greenlight Capital U.K. insider trading settlement; the
relevance of the scienter element in insider trading claims in non-U.S. jurisdictions; the applicability of U.S. insider trading laws to conduct outside of the United States; the applicability of various jurisdictions’ insider trading laws in complex situations; whether the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ) are focusing insider trading efforts domestically or globally; identification of jurisdictions becoming more forceful in insider trading enforcement; the views of hedge fund managers with respect to domestic versus global insider trading issues; and policies and procedures hedge fund managers should implement to understand insider trading regulations where they do business and to prevent violations. This article provides the complete transcript of our interview with Wasserman. This interview was conducted in conjunction with the Regulatory Compliance Association’s upcoming Symposium entitled Compliance, Risk & Enforcement 2012.
Wasserman will be one of various asset management industry thought leaders participating at that Symposium, which will take place on October 30, 2012 at the Pierre Hotel in Manhattan. For more information about the Symposium, click here. To register for the Symposium, click here. Subscribers to The Hedge Fund Law Report are eligible for discounted registration.
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HFLR: What are the biggest differences between the in-sider trading laws of the U.S. and non-U.S. jurisdictions?
Wasserman: I think the biggest difference between insider trading laws in the U.S. and the insider trading laws globally is that in the United States, insider trading is primarily prohibited by the general antifraud provisions of the securities laws – i.e., Section 10(b) and Rule 10b-5 under the Securities Exchange Act of 1934. What this means is that most of the details of what constitutes insider trading in the U.S. have been enumerated by the courts, as opposed to being specifically set out by statute. So, in the United States, many key elements of insider trading, such as who is an insider, what constitutes material non-public information and what constitutes a duty are not statutorily defined. Rather the details and contours of these elements may be seen as more subject to interpretation and can evolve over time as the courts come out with new rulings on these issues.
Most other countries, by contrast, have more specific insider trading statutes that define in greater detail the contours of what constitutes insider trading. Instead of having a couple of sentences that generally say you cannot engage in securities fraud, statutes outside the U.S. often set forth the specific elements of insider trading and provide definitions of the key terms that constitute these elements (e.g., who is an insider or what information is material).
Countries with more defined insider dealing statutes include, among others, the United Kingdom, Canada, China, Hong Kong, India and numerous members of the European Union. So, the United States is in a very small minority as to how it goes about legislating against insider trading.
HFLR: Can you identify, based on your experience, one or two non-intuitive or unexpected aspects of insider trad-ing doctrine from one or more of the followtrad-ing notable jurisdictions: the UK, China, Hong Kong, Canada, Brazil and India? In particular, we are interested in identifying conduct that would be legal under U.S. law but illegal un-der the laws of the identified jurisdictions. The purpose of this exercise is to enable readers of this interview to avoid unintended or accidental violations.
Wasserman: It is important to understand that the specifics of insider trading laws can vary greatly jurisdiction by jurisdiction. The rules governing what constitutes insider trading here in the U.S. may not be applicable outside of the United States. What is okay in the U.S. might be different than what is acceptable in Hong Kong, which might be different than what is permissible in the UK. So, insofar as an investment adviser has a global business, it is extremely important to have a good understanding of the insider trading laws in all the countries where the adviser may be operating. As for conduct that might be legal in the United States and illegal abroad, one prime example is that the United States is relatively unique in that it often focuses on the importance of there being some sort of fiduciary or other duty in order for there to be a violation of the insider trading laws. Many other jurisdictions, such as the UK, France, Germany, Canada and Mexico, have rejected the duty model in favor of an “access” doctrine, which, instead of focusing on a duty or special relationship, generally focuses on prohibiting trading by those people who have unequal access to the material non-public information.
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What this means, practically speaking, is that there can be situations where a person would not be liable for insider trading in the U.S. because she did not violate a duty, but could be liable for insider trading abroad because she had unequal access. It is also worth pointing out that just like there are situations where what is legal in the United States may not be legal abroad, there are other ways the U.S. insider trading laws may be seen as being stricter than those in other jurisdictions. For example, other jurisdictions, such as the U.K., may take a more liberal view of when information may be deemed “public.”
HFLR: The recent Greenlight Capital case in the UK has garnered considerable attention in the hedge fund commu-nity. [See “FSA Imposes £7.2 Million Penalty on Hedge Fund Manager David Einhorn and Greenlight Capital for Unintentional Insider Dealing in Shares of British Pub Owner Punch Taverns Plc,” The Hedge Fund Law Report, Vol. 5, No. 5 (Feb. 2, 2012).] Briefly, what were the relevant facts in that matter, and would those facts be sufficient for finding Greenlight or Einhorn liable for civil or criminal insider trading under U.S. law?
Wasserman: The Financial Services Authority (FSA) charged Greenlight with market abuse, which is a civil charge. This was based on a call between Einhorn and Punch Taverns. The FSA claimed that, during the call, Einhorn learned that Punch would be selling shares to raise capital. As a result of this, Einhorn sold stock and allegedly avoided more than $9M in losses.
Prior to the call, it was alleged that Punch asked Einhorn to accept a non-disclosure agreement, but he refused to do so.
In the U.S., this would have given Greenlight and Einhorn a very good argument against insider trading liability because since there was no signed non-disclosure agreement, there was no duty not to trade.
In the UK however, the FSA found Einhorn could still be liable for market abuse because in the UK it can be a violation for an insider to trade on the basis of inside information relating to the investment in question. The definition of an insider is broad and could include someone who learns information by a means where he or she should know that the information is confidential. This is a perfect example of a difference between the U.S. regime, which relies on duty, and the UK and other regimes that focus instead on access.
HFLR: Is scienter or an element of willfulness a common thread in the insider trading laws of global jurisdictions, or are there jurisdictions in which a hedge fund manager can violate insider trading law negligently?
Wasserman: There are certainly jurisdictions that may be viewed as having a lower scienter threshold for insider trading than in the United States. In the U.S., one typically would need to have acted willfully or at least recklessly for there to be regulatory liability. Under the UK market abuse regime, however, it appears that negligence may be sufficient to support at least civil liability.
Indeed, in the Greenlight case the FSA accepted that Einhorn did not deliberately or recklessly engage in market abuse, but they found that given Einhorn’s position and experience he should have known that the information he received could have been inside information and thus he should have sought compliance and/or legal advice before trading.
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HFLR: Can U.S. insider trading law apply to conduct outside of the United States? For example, if a U.S. hedge fund manager has a UK affiliate with investment decision-making authority over a Cayman Islands hedge fund, and that UK affiliate causes the Cayman Islands hedge fund to sell equity in a UK satellite broadcaster after a portfolio manager at the UK affiliate talks privately to the CFO of the broadcaster in London about as yet unreleased disappointing financial results, would the SEC or the DOJ have jurisdiction over the investigation and potential enforcement action?
Wasserman: That sounds like a pretty difficult law school exam question. That said, one thing that is clear is that the extraterritoriality of U.S. securities laws has gotten more complicated since the Supreme Court’s decision in
Morrison. You could probably devote an entire interview to that topic alone.
Before Morrison, many courts used a conducts or effects test, finding that U.S. laws could apply extraterritorially either if substantial acts were conducted in the United States or if the fraud had a direct and foreseeable impact in the U.S. What happened in Morrison is that the Supreme Court substituted a transaction test, which instead asks whether the purchase or sale is made in the U.S. or involved a security listed on a domestic exchange.
However, there is confusion as to which of these tests should apply to insider trading cases. First, it is not crystal clear whether Morrison applies only to private actions or to government actions as well. For example, Justice Stevens stated in his concurring opinion in Morrison that “the Court’s opinion does not, however, foreclose the Commission from bringing enforcement actions in additional circumstances, as no issue concerning the SEC’s authority is presented in
this case.” However, despite this concurrence, there have been several commentators who have opined that Morrison’s reasoning applies equally well to SEC and DOJ actions. If that were not complicated enough, even if Morrison did apply to government actions, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) has attempted to codify the conducts/effects test for cases brought by the SEC and DOJ. (Dodd-Frank also directed the SEC to conduct a study, which was published this April, concerning whether Morrison should be reversed as to private actions). Despite Dodd-Frank, commentators have been split as to whether or not that legislation has successfully reversed
Morrison for cases brought by the SEC or DOJ.
So, to try and answer your hypothetical, I would look at it from both the standpoint of the transactional test and the conducts and effects test (since there is still uncertainty as to which tests should apply). If the transactional test applies, then assuming the trades were made abroad and the issuer is not listed in the U.S., the DOJ and SEC would be hard pressed to have authority over this case. And, there is at least some case law suggesting that, even under the transactional test, the case could not be brought by the SEC even if the trade were placed domestically.
On the other hand, even if the conduct/effects test applied, one could argue under this scenario that there was no substantial conduct or effect in the United States that would justify giving the SEC or DOJ jurisdiction. That said, it’s always possible the SEC might disagree with my assessment about the effect on the U.S. And, even if you did not have to worry about the DOJ and SEC, under this hypothetical a hedge fund might have to be concerned about the UK’s FSA taking a closer look.
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HFLR: If a U.S. hedge fund manager obtains and trades on the basis of material nonpublic information about the supply chain of a technology company and that supply chain originates in China, runs through Germany and culminates at U.S. retail outlets, who would have jurisdic-tion over the resulting insider trading investigajurisdic-tion and enforcement action?
Wasserman: I think who technically would have jurisdiction to investigate this would depend on the specifics of each country’s insider trading laws and their jurisdictional scope. If under a country’s own insider trading laws the conduct would not be considered improper, then it is doubtful that country would be inclined to lead an investigation. If, on the other hand, a country believes that its own insider trading laws were implicated, then it might take a closer look at whether or not it would have jurisdiction under the specific circumstances. That said, those countries who would most likely have the most interest in investigating the conduct would be those countries on whose exchanges the issuer’s securities are listed. However, those countries where the trades took place and those countries where the confidential information originated might potentially decide to look at the conduct as well. So, while I can’t necessarily say which specific country or countries would assert jurisdiction in your above hypothetical, I could tell you that under the circumstances, at least one, if not more countries, might be interested in investigating.
HFLR: Since the arrest of Raj Rajaratnam and the start of operation perfect hedge, the U.S. has been very vigorous in its enforcement of insider trading laws. Are the SEC and the DOJ focused primarily on domestic conduct, or are they taking a more global approach?
Wasserman: I think that it is clear that in recent years, U.S. enforcement initiatives have taken on an increasingly
global flavor. For example, this July, the SEC obtained a court order to freeze the assets of traders using accounts in Hong Kong and Singapore to reap more than $13 million in allegedly illegal profits by trading in advance of the public announcement that China-based CNOOC Ltd. agreed to acquire Canada-based Nexen Inc.
That same month, the SEC filed a settled complaint against Guerilla Capital and several individuals that focused on, among other things, alleged insider trading in reverse merger companies. The SEC accused the fund of selling stock of a Chinese company based on information regarding the company’s CEO’s purported illicit activity, shortly before that illicit activity was made public. The SEC also alleged that the fund engaged in insider trading, after agreeing to go “over-the-wall” in connection with ten confidentially marketed offerings for Chinese companies.
In addition to these cases, many of the recent expert network convictions involved individuals with strong ties overseas. For example, you have Don Chu of Primary Global research who regularly travelled to Asia and was caught on tape saying that getting “involved in the United States is dangerous,” and that the SEC is too strong. He allegedly said, “In Asia, the SEC can’t do too much.” [See “Lessons for Hedge Fund Managers and Expert Network Firms from the Government’s Criminal Complaint against Don Chu, Formerly of Primary Global Research LLC,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).]
Additionally, you have Winifred Jiau, a consultant who was convicted of insider trading. She was originally from Taiwan and had many contacts there. [See “Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).]
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There is also the case of Dr. Benhamou, who was arrested for tipping off a hedge fund manager about setbacks in a clinical drug trial at Human Genome Sciences. He was from France. [See “Recent Decision Holds That Hedge Fund Managers Have Some Recourse Against Firm Employees That Engage in Insider Trading and Deceive Their Employers Pursuant to the Mandatory Victims Restitution Act,” The Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).]
It’s very is clear that U.S. regulators are focusing on conduct both domestically and globally.
HFLR: As a matter of enforcement trends, are there juris-dictions that are notably becoming more vigorous in their enforcement of insider trading law?
Wasserman: Certainly. Three prime examples of countries with an increased focus on insider trading enforcement are the UK, Hong Kong and Japan.
In the UK, not only do you have the Greenlight Capital case, but in July, the FSA convicted six people who were involved in an insider trading ring that profited from information stolen from print rooms of two of London’s largest investment banks. This case, which has been described as the longest and most complex UK criminal insider trading prosecution to date, resulted in a half dozen prison sentences ranging from 1.5 to 3.5 years. Also recently, the FSA and the Serious Organized Crime Agency announced charges against an investment banker and three others in connection with an alleged insider dealing scheme whereby the defendants earned nearly $5 million. Indeed, since the FSA obtained the power to criminally prosecute insider trading cases in 2000, they have obtained 20 criminal convictions.
In Hong Kong, the Securities & Futures Commission (SFC) has taken numerous steps to prove that it is one of the most stringent securities regulators in Asia. This includes focusing
on insider trading. While insider trading was not even a criminal offense in Hong Kong until 2003, since the second half of 2008, the SFC has cracked down hard on insider dealing. Indeed, in the first year of that crackdown alone, the SFC obtained 10 different convictions for insider trading. Just recently, in February 2012, a former outside director of HK Aircraft Engineering Company was convicted of buying HAECO shares after learning of the possibility that Swire Pacific Limited would make a general offer for HAECO’s shares. In April 2012, a former portfolio manager was found civilly liable for selling shares of Chaoda Modern Agriculture Holdings when he learned about a share placement from company management.
Just this past week, Hong Kong’s Court of Appeal upheld the insider trading conviction of an investment banker who was convicted of insider trading in CITIC Resources Holdings while he was part of a deal team that was advising the company on acquiring oil fields in China. While the Court of Appeal reduced the defendant’s sentence from seven years to six years, this remains one of the longest criminal sentences for insider trading globally.
In Japan, there have been a number of prominent insider trading investigations in 2012 involving Japanese and global investment banks. This past year, regulators have identified at least five cases where stockbrokers are alleged to have leaked information to favored clients in advance of share offerings. The government’s investigation now includes at least a dozen major brokers, including some of the most prominent U.S. and European investment banks. Indeed, a Japanese governing party committee has asked regulators to scrutinize suspicious trading activity that took place before at least 12 public offerings over the course of the last three years. These investigations ultimately led to the resignation of Nomura’s CEO and COO.
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In addition to these investigations, Japan is also considering new legislation and rules to stiffen the penalties on insider trading and to also make persons who tip subject to
regulatory sanctions, as opposed to current law which focuses primarily on persons who trade. Japan is exploring expanding the law to give its regulators far more power over tippers, in addition to traders.
HFLR: As a practical matter, do you think that hedge fund investors are less concerned about non-US insider-trading investigations, or do investors look through the jurisdiction to the substance of the underlying claims? For example, Einhorn and Greenlight seem no worse for the wear following the Punch Taverns matter (see the recent Wall Street Journal article saying that investors hang on Einhorn’s every word), and Soros did not suffer much from the long-standing French insider trading investigation. On the other hand, a number of hedge funds have col-lapsed following a mere visit from the U.S. Federal Bureau of Investigations (FBI).
Wasserman: That’s a very interesting observation. I believe that investors are focusing on the potential impact that an investigation might have on the funds.
Taking the Greenlight and Soros examples, at the end of the day, the Greenlight case resulted in a civil penalty that the adviser could easily handle. In the case of Soros, you are looking at alleged conduct that was nearly 25 years old. On the other hand, if the FBI is raiding a hedge fund today, investors may be concerned that the fund and its principals may be subject to criminal and/or regulatory charges that could have an enormous impact on the funds. And, it’s certainly possible that going forward you could have investigations outside the United States that could have
similarly serious implications. Still, one of the scariest aspects of today’s regulatory environment is that even the mere allegation or hint of potential impropriety can prove fatal to a fund’s future, even before the fund has had a chance to defend itself. With U.S. and international regulators becoming increasingly focused on global insider trading issues, it reinforces the importance for funds and their advisers to have a good understanding of the securities laws wherever in the world they are doing business.
HFLR: Considering regulators’ increased focus on insider trading and your advice to hedge fund managers to have a good understanding of relevant securities laws in the jurisdictions in which they do business, what policies and procedures would you suggest that hedge fund managers have in place to better acquaint themselves with applicable global securities laws and to try and prevent insider trad-ing violations?
Wasserman: I think the first thing an adviser needs to do is figure out where it is they are doing business and analyze where they have the greatest potential regulatory risk. That could differ from adviser to adviser. Some advisers may be purely focused on the United States while other advisers may have traders in the UK and research analysts in Asia. The important thing is to examine where in the world you have the most risk. Then you need to get a good understanding of the laws in those countries and make sure your employees have an understanding of those laws. You want to make certain your employees understand that what may be acceptable in the U.S. may not be okay in the UK or France or Japan – and that the reverse can also be true. It is important for funds to focus on these issues globally and to be able spot these issues where they can potentially arise so legal and compliance can render assistance when necessary.
