The Legal Infrastructure of Business

In Response to Banker’s Ex-Girlfriends Found Innocent on Insider Trading Accusations

Insider trading has been a controversial issue in the U.S. and other countries. Generally, it is not a recent matter in the business, but insider trading legislation and enforcement are relatively recent phenomena since the 1980s. In fact, insider trading had been legal in almost all the countries until the 1970s.

As Marcelo wrote in his blog post, insider trading seems “simply unfair.” Insider trading may undermine public confidence in the stock market since the two parties in a transaction do not have equal information and an outsider is put in a less competitive position, but there are no clear and simple answers to whether insider trading should be prohibited or not. Economics professors and other researchers in law and economics have applied economic principles to the legal issues about insider trading regulations. Those for insider trading regulations claim that the regulations are based on fairness or equity and may increase social welfare by preventing insiders’ undesirable behavior, but those against insider trading argue that the ban rather reduces market efficiency. 

Some studies have found that insider trading may have economic benefits for the capital market and a company under certain conditions. For opponents of insider trading prohibitions, there are two main arguments: an effect on the pricing of securities and an efficient compensation scheme.

1. The benefit for the capital market: insider trading promotes market efficiency by disseminating information

Insider trading has a positive effect on the market price of securities to move toward the accurate price by giving insiders incentives to make relevant information on the securities publicly available in the market. Through trade on the secondary market, insiders contribute to the efficient market. The regulations prevent the market from quickly adjusting to changes in the demand for and supply of corporate stocks, thus misleading market participants. Henry Manne, dean emeritus at George Mason University School of Law and an author of a seminal law and economics book “Insider Trading and the Stock Market,” explained in a WSJ article, “Corporate scandals such as Enron and Global Crossing would occur much less frequently and impose fewer costs if the government didn’t prohibit insider trading.”

2. The benefit for a company: assigning the property right to inside information to managers is an efficient compensation scheme

Insider trading is an efficient form of compensation to provide incentives for managers. It gives managers a right to alter their compensation given new knowledge on the company to avoid continual renegotiation. Insider trading reduces the uncertainty and costs of renegotiation, and increases the incentives of managers to produce valuable information. Moreover, compensation in the form of insider trading is cheap for long-term shareholders because it does not come from corporate profits.

I am not contesting the legitimacy of the current regulations here. These claims are not sufficiently backed by the empirical research, and insider trading might have some negative consequences on the capital market. Those who have found guilty of insider trading might have acted unlawfully under the current regulations, but there are still no simple and clear justifications that insider trading should be prohibited. I think that much research is required to fully justify—or to improve—insider trading regulations.

 

References:

The Law and Economics of Insider Trading: A Comprehensive Primer by Stephen M. Bainbridge (2002)

Insider Trading: An Economic and Legal Problem - How would O'Hagan Come Out Under the New German Securities Trading Act? by Joerg Hartmann

THE POLITICAL ECONOMY OF INSIDER TRADING LEGISLATION AND ENFORCEMENT: INTERNATIONAL EVIDENCE by Laura Nyantung Beny (2002)

5650 INSIDER TRADING by Stephen M. Bainbridge (1999)

Do Insider Trading Laws Matter? Some Preliminary Comparative Evidence by Laura Nyantung Beny (2005)

The Issue of Insider Trading in Law and Economics: Lessons for Emerging Financial Markets in the World by E. Mine Cinar (1999)

A Survey of Securities Laws and Enforcement by Lopez-de-Silanes, Florencio (2004)

Insider trading in financial markets: legality, ethics, efficiency by Phillip Anthony O’Hara (2012)

An Economic Defense of Insider Trading by Jeffrey A. Miron (2012), The Atlas Society

Learning to Love Insider Trading by Donald J. Boudreaux (2009), WSJ

Banker’s Ex-Girlfriends Found Innocent on Insider Trading Accusations

A couple of weeks ago Jessica Mang (30-year-old British chiropractor) and Christina Weckwerth, two girlfriends of former Mizuho investment Banker, Thomas Ammann, were found not guilty (by a court in London) of illegally trading on guidelines from him about Canon’s acquisition of OCE NV.

Background

In 2009, Thomas Ammann found out in his investment banking job that Canon Inc would acquire OCE. In an effort to avoid being caught (and an eventual prison time) while generating some cash, Ammann employed a couple of middlemen: his two girlfriends, who not only traded on the material non-public information, but also put up the cash for the investment. Once the M&A transaction became public, Weckwerth and Mang sold their shares making 1M euros and 29K pounds, respectively (both shared half of their profits with Ammann).

The Financial Services Authority (“FSA”) said: “Ammann passed information to Weckwerth and Mang and encouraged them to trade in the shares of OCE prior to the acquisition being announced. Both considered Ammann to be their boyfriend and had no idea of the existence of the other.”

According to court information “Mang bought OCE shares and then sold them five days later for almost twice what she invested. Mang wrote in her personal diary that Ammann advised her to invest, according to the prosecutor. Mang had been living in central London with a friend who worked in hedge-fund sales for Goldman Sachs. When told about Mang’s plans to invest in OCE, her friend “expressed her disapproval and kept calling it insider dealing.” In her diary, Mang wrote of her annoyance that her roommate insisted the trades were insider dealing. “Really?” Mang wrote, according to court documents. “Is that necessary? Increasingly prissy”.

Ammann pleaded guilty early this year to insider trading and encouraging Mang and Weckwerth to commit insider trading. Both girls pleaded not-guilty to similar serious charges.

In defense, both Mang and Weckwerth argued that they were used by Ammann who abused their trust. Mang basically said that “…to show him that I trust him – I needed to invest the money – once that’s done, we’ll go on holiday in Seychelles….and if she didn’t do it, he didn’t want to be with her anymore… Ammann suggested that she should invest so they could build a future together”. Additionally, she mentioned that she bought the shares of OCE only after she researched Ammann’s recommendation. Her own calculations showed her that the shares, which were trading at ~2.50 euros (beginning 2009), had a fundamental value of over 7 euros. Later, lawyers for Mang indicated that she was "clueless" as to what insider dealing really meant.

Thoughts

For me this case calls into question why insider trading is considered illegal, if it is possible to trade while in possession of confidential information, yet not engage in securities fraud.

I believe there is no discussion that the information Mang and Weckwerth received was material (evidenced also by the huge price increase upon public announcement) and that they acted on insider (non-public) information for their own benefit (they were actually allowed to keep the cash they gained). Moreover, it is clear that the inside information was intentionally shared with them.

The court might have resolved its decision on the ground that there was no understanding with Ammann about confidentiality or not trading on the information. Also that they both traded anonymously in the stock market and made no explicit face-to-face misrepresentations to investors from whom they bought the stock. Additionally, both Mang and Weckwerth are outsiders, not insiders or constructive insiders (i.e. like Ammann). In the United States, a violation of the insider trading SEC Rule 10b-5 occurs when a corporate insider trades in his corporation’s securities on the basis of material, confidential information he has obtained by reason of his position. If the UK has a similar 10b-5 SEC Rule, maybe both Mang and Weckwerth are not subject to it.

At the end of the day, I am still surprised by the court’s verdict. This decision puts into question the theory of the market as a “level playing field”. Maybe this theory is just over-reaching, but I believe that insider trading is simply unfair when an individual (either a corporate insider, outside adviser or just an outsider) takes advantage of access to information to earn substantial personal gains that are unavailable to other investors, regardless of who is the primary source of the information or who actually executed the trades. Both Mang and Weckwerth knew that they were trading on non-public information provided by their “boyfriend” and, as such, should have been found guilty as they engaged in securities fraud (even though they were not the primary source of the inside information).  

Sources:

http://dealbreaker.com/2012/11/women-who-insider-traded-on-shared-boyfriends-behalf-somehow-found-not-guilty/

http://www.bloomberg.com/news/2012-11-15/ex-mizuho-banker-s-girlfriends-not-guilty-of-inside-trade.html

http://dealbreaker.com/2012/10/girlfriend-insider-trading-on-two-timing-boyfriends-behalf-found-roommates-judgment-a-little-uncalled-for/

http://www.ft.com/intl/cms/s/0/51f2490e-2f38-11e2-b88b-00144feabdc0.html#axzz2DIvjgvA8

 

Legal Issues Of Hostess Bankruptcy

As I am sure everyone knows, Hostess Brands, maker of such iconic American products as Twinkie and Wonder Bread has filed for bankruptcy and asked a court to begin liquidating its assets. Although it is believed the brands will live on after some other CPG company buys them in the liquidation process, almost all of the 18,500 people who work at Hostess will be laid off. Granted, some might get re-hired by the new brand owners, but it is not guaranteed. It will be interesting to see if there are any class-action suits that arise out of this development.

But first, let us understand what happened at Hostess and how we got to this end game. It can be said that is it not a simple Wall Street vs. Main Street, Union vs. Business battle that ended badly for everyone. Rather, it was a series of many bad decisions over many years. To get to this understanding we have to look at Hostess’ history, starting with its last bankruptcy in 2004…

In 2004, Hostess filed for bankruptcy protection due to (predictably) declining sales, bloated union contracts, and a general lack of competitiveness. However, unlike other companies that have used bankruptcy to make big changes, Hostess did not address its root and core issues. Instead, a PE company called Ripplewood Holdings bought the company for $130M and took it private, loading up the company with debt, and again, not making any radical (but needed) changes to labor, to products, to management, etc.

As expected, the company didn’t turn itself around, and with mounting interest payments on its debt, it went bankrupt again in 2012. It tried again to cut costs by squeezing unions out of their packages, but one union stood firm and decided that it would not give in, deciding the jobs weren’t worth saving at that point (or trying to call the PE firms bluff). Either way, the company is now done, and its assets being liquidated (with the PE firm taking a loss on its investment).

Therein lies some legal questions:

There is plenty of blame to go around, and blame can often get translated into lawsuits. At first glance the easiest blame to place is the bakers union not accepting revised contracts (which is understandable). However, I think the company’s management actually has more of the blame. Its overall strategic incompetence as a leadership team and its inability to turn the company around should have raised some eyebrows. Many companies have faced powerful unions and still survived and thrived (think Detroit automakers). So, could there be a class action lawsuit by laid off workers against the management team for their incompetence which ultimately cost them their jobs?

Secondly, the PE firm invested in a business and clearly itself did not know or have a plan to turn around the Hostess business. They loaded up the company with debt as PE firms do with seemingly nothing behind it except for lack of a better word “greed”. Will there be an internal audit or investigation? What stakeholders does Ripplewood have that might be able to go after (legally speaking) a decision maker or two in this horrendously botched investment?

Lastly, is there an opportunity here for a different kind of class action lawsuit against the bakers union by the other employees who will now get laid off? Since the bakers union was only a minority of the overall workforce, is it liable in any way for the business going under by rejecting a “fair” deal? I am not sure.

In the end – a sad story, and I will watch the news in the weeks to come to see what lawsuits spring up as a result.

Sources:

http://online.wsj.com/article/SB10001424127887324556304578122632560842670.html?mod=WSJ_business_LeadStoryCollection

http://www.washingtonpost.com/business/as-hostess-seeking-bankruptcy-court-approval-to-sell-assets-twinkies-are-likely-to-live-on/2012/11/18/059a5d26-31cc-11e2-92f0-496af208bf23_story.html

http://www.theatlantic.com/business/archive/2012/11/whos-to-blame-for-the-hostess-bankruptcy-wall-street-unions-or-carbs/265357/

http://www.prnewswire.com/news-releases/hostess-brands-to-wind-down-company-after-bctgm-union-strike-cripples-operations-179640671.html 

http://en.wikipedia.org/wiki/Class_action

 

 

 

 

 

 

 

 

@TheSlammer: The Perils Of Sending False Tweets

Background:

 There have been several instances where pieces of communication relayed via twitter have caused either embarrassing episodes or have actually resulted in serious miscommunications that had tangible effects. Some of the most notorious cases include fake bomb threats, false kidnappings, and the most recent, incorrect information about destruction from the Sandy storm.  All of these produced frenetic transmissions (“retweeting”) of information that created panic and at times, mobilization of state and federal resources (Police, FBI, etc.).   In the latest example where a twitter user exaggerated and outright fabricated  false information regarding what was occurring as the storm traveled through the Northeast, has prompted officials to push a tighter enforcement by the company itself (Twitter) and also harsh penalties for information transmitted with obvious malicious intent.  This creates an interesting problem regarding the responsibility that a company bares when its sole mission is to provide a forum where freedom of speech applies.

 

Opinion:

We have seen several cases where a company decides to take a proactive stand to avoid finding itself in a legal limbo where it is not clear what its role should be outside of its core offerings.  We have seen that most companies, such as ISPs would rather act to inform and ultimate deter users from taking actions that would constitute a violation of the law.   That said, in this particular case, we are entering the very complex subject of freedom of speech. Is a company directly or indirectly responsible for miscommunications that happen either because of an incorrect source or due to the reliability of retweets that can best resemble a game of “broken telephone”?  The WSJ article provides commentary from Law School professors across the country and they all seem to agree that it would be hard to prosecute someone for lying given the U.S. Supreme Court decision in the U.S. v. Alvarez case, where they established that lying is technically protected under freedom of speech. That said, the article does state that falsehoods “such as perjury and lying to the government” are punishable under the law.

It will be interesting to see what actions Twitter will take to either monitor outright lies or deter this behavior (known and repeat offenders).  I believe that the company will try to inform its users but ultimately, it does not have the resources or appetite to enforce (maybe punish) the users that continue to use the service for malicious intent.

 A bit off topic but relevant --  If anyone has some interest to dig deeper in the ethics of journalism (not directly related to the above), I would encourage to read about the Judy Miller controversy.  

 

Sources:

http://online.wsj.com/article/SB10001424052970204755404578098983739717360.html?mod=WSJ_hps_MIDDLENexttoWhatsNewsThird

http://www.bbc.co.uk/news/magazine-17530450

http://www.digitaltrends.com/social-media/watch-what-you-tweet-how-online-troll-crackdowns-threaten-freedom-of-speech/

Judy Miller:

http://en.wikipedia.org/wiki/Judith_Miller

Authors

Joan De la Paz Hellmer

Amadeo Ibarra Flores

Felipe Silva Mendez