FRIDAY AFTERNOON SMACKDOWN – THE SEC v. THE HOUSE OF REPRESENTATIVES

On Friday, June 20, 2014, the Securities and Exchange Commission filed an action against the Committee on Ways and Means of the U.S. House of Representatives and congressional staffer Brian Sutter seeking enforcement of subpoenas the SEC issued. The SEC is investigating whether laws against insider trading, specifically applicable to members and employees of Congress via the Stop Trading on Congressional Knowledge Act of 2012 (the “STOCK Act”), were violated by the disclosure of non-public information about Medicare reimbursement rates. This is pretty exciting stuff for securities lawyers. It isn’t everyday that one branch of the federal government sues another. (Generally, the facts set forth below are derived from the SEC’s court filing and have not yet been established as true in court.)

About a year after the STOCK Act became law, the SEC launched an investigation into whether information regarding the April 1, 2013 announcement by the U.S. Centers for Medicare and Medicaid Services (“CMS”) on the 2014 reimbursement rates for the Medicare Advantage program was leaked improperly prior to the official public announcement. In its brief filed with the United States District Court for the Southern District of New York, the SEC details the opening of a formal investigation to determine, among other things, the source(s) of information in an email sent from a lobbyist to a broker-dealer that issued a “flash report” indicating that certain Medicare reimbursement rates would actually increase, rather than decrease as had been expected. The flash report was issued approximately 40 minutes before the official CMS announcement regarding the reimbursement rates and was followed promptly by a dramatic increase in the price and trading volume of certain health care stocks.

On May 6, 2014 the SEC staff issued subpoenas to the House Committee on Ways and Means and Brian Sutter. Mr. Sutter is the Staff Director of the House Ways and Means Committee’s Healthcare Committee. Before becoming Staff Director, Mr. Sutter was a staff member to the Subcommittee. Both the Committee and Mr. Sutter have refused to comply with the subpoenas, citing a number of legal objections, including that the documents demanded are protected by the Constitution’s Speech or Debate Clause. The SEC is having none of that and, on June 20, 2014, the SEC filed an action to enforce subpoenas it issued in connection with its investigation, potentially setting up a Constitutional showdown.    

From my perspective, there are at least two interesting points here. First, the SEC appears to be aggressively enforcing the STOCK Act. Hopefully, the courts will find a way to support the SEC in its efforts to conduct the investigation. If the SEC cannot investigate, the STOCK Act may have little, if any, bite. (If you would like to read more about the STOCK Act, please see our summary in the April 2012 issue of Up to Date.) Second, it will be very interesting to watch the matter unfold from a Constitutional perspective.

10b5-1 Trading Plans Continue to Draw Attention

As we previously discussed, executives’ trading under Rule 10b5-1 plans has been the focus of SEC scrutiny.  The Wall Street Journal continues to publish articles casting 10b5-1 trading plans in a harsh light, and the SEC is continuing its aggressive pursuit of those illegal insider trading.  Recently, the Council of Institutional Investors wrote to the SEC to reiterate the requests made in its December 28, 2012 letter asking the SEC to consider various changes to Rule 10b5-1 or the issuance of interpretive guidance “to address the variety and number of abuses that have been identified” with respect to 10b5-1 trading plans. 

The SEC has a lot on its plate at the moment and the SEC may not address the perceived abuses or misuses of 10b5-1 trading plans any time soon.  Nonetheless, public company boards should consider reviewing their policies regarding 10b5-1 trading plans to be sure the policies are up to date and adequately address the needs of the company’s officers and directors as well as investors’ concerns.  For more on what to consider when reviewing your 10b5-1 trading plans, please see our December 2012/January 2013 issue of Up to Date.

Beware Inside Traders: SEC has “57 Varieties” of Ways to Get You!

The SEC announced last Friday that it had obtained an emergency court order to freeze assets in a Zurich, Switzerland-based trading account that allegedly was used to reap more than $1.7 million in insider trading profits in advance of the February 14th announcement of the acquisition of the H.J. Heinz Company by Berkshire Hathaway and 3G Capital Partners. The case is noteworthy because of the speed of the SEC’s action and the fact that there is only the suspicion of insider trading.

According to the SEC complaint, “certain unknown traders engaged in highly suspicious and highly profitable trading in Heinz calls through an omnibus account located in Zurich, Switzerland.” The traders purchased 2,533 out-of-the-money June $65 call options, each of which would enable the holder to purchase 100 shares of Heinz stock for $65 per share before the calls expired on June 22, 2013. The SEC complaint termed this trade “highly suspicious” for several reasons, including:
• at the time preceding the June $65 call option purchase, Heinz stock had typically traded around $60 per share;
• the general historical lack of trading in the June $65 calls;
• the fact that the trading account had no prior trading history in Heinz stock or options; and
• the timing of the investment of nearly $90,000 in risky call options the day prior to the Heinz acquisition announcement.

The SEC alleged that the trades were effected while the traders were in possession of material, nonpublic information about the contemplated Heinz acquisition and, therefore, were in violation of Section 10(b) of the Securities Exchange Act and Rule 10b-5.

According to Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office, “Despite the obvious logistical challenges of investigating trades involving offshore accounts, we moved swiftly to locate and freeze the assets of these suspicious traders, who now have to make an appearance in court to explain their trading if they want their assets unfrozen.”

Guess that leaves the “suspicious traders” in a pickle!

SEC Intensifies Scrutiny on Stock Sales by Insiders and 10b5-1 Plans

On February 5, 2013, the Wall Street Journal published the third in a series of articles discussing trading by public company executives in their companies’ securities, including trading pursuant to Rule 10b5-1 trading plans.  A 10b5-1 trading plan is a plan for buying or selling securities meeting the requirements of Securities Exchange Act Rule 10b5-1(c).  A properly adopted and implemented Rule 10b5-1 trading plan provides an affirmative defense against accusations of insider trading and allows the purchases and sales of securities even when the person who adopted the plan is aware of material nonpublic information. 

This latest Wall Street Journal article, “SEC Expands Probe on Executive Trades,” reports that the Securities and Exchange Commission has expanded its investigation into trading by corporate executives beyond the seven companies named in the first article in the series.  This latest article also refers to “shortcomings of the regulations” and “loopholes in the rules . . . known as a 10b5-1 plans.”  Whether or not you agree with the characterization of 10b5-1 plans as “loopholes” (I don’t), the Wall Street Journal’s recent reporting makes clear that trading by executives pursuant to 10b5-1 trading plans is likely to be subject to intense scrutiny in the coming months.  If you have not done so recently, now may be a very good time to review your company’s policies with respect to 10b5-1 trading plans and other insider trading policies to be sure they are adequate for today’s environment.  For some tips on what you may wish to consider in such a review, please see our December 2012/January 2013 Up to Date newsletter.

Margin Call Sales May Violate Insider Trading Policies or Wake Up and Smell the Coffee (Burning)

            The chairman (and founder) and the lead independent director of Green Mountain Coffee Roaster (GMCR) both have been removed from their leadership positions as a result of margin call sales of company stock last Friday that were “inconsistent with” the company’s insider trading policy, GMCR announced yesterday.  According to the company’s press release, Mr. Robert P. Stiller no longer serves as Chairman of the Board and Mr. William D. Davis no longer serves as independent lead director because they had margin call-related stock sales totaling 5.548 million shares.  These forced sales were related to margin loans, which were secured by pledges of Mr. Stiller’s and Mr. Davis’ GMCR stock and triggered by recent GMCR stock price declines (the stock dropped almost 50% after the company released quarterly results and lowered its fiscal year forecast).  The sales occurred at a time when the trading window in GMCR stock was closed under the company’s internal trading policy.  Also, it was discovered that Mr. Davis pledged shares after the internal trading policy had been amended to prohibit pledges of company stock (other existing pledges were grandfathered).  

            These actions serve as a reminder that public companies should periodically review their insider trading policies to ensure that they are current and that management and others subject to the policies understand their operation.  We will address this topic further in the next issue of Up to Date.