Tuesday, October 26, 2010

Insider Trading Redux

Last week I wrote a post about potential difficulties in identifying insider trading.  The post and the comments are worth a read - if for nothing more than to illustrate how cloudy the topic can be.

Today, NYT Dealbook's Andrew Ross Sorkin visits the subject, with another interesting case:

"Have you heard about the railroad workers charged with insider trading?

Late last month, the Securities and Exchange Commission brought an unusual and colorful insider-trading case: It accused two employees who worked in the rail yard of Florida East Coast Industries and their relatives of making more than $1 million by trading on inside information about the takeover of the company.

How did these employees — a mechanical engineer and a trainman — know their company was on the block?

Well, they were very observant.

They noticed “there were an unusual number of daytime tours” of the rail yard, the S.E.C. said in its complaint, with “people dressed in business attire.”
The case is raising eyebrows — and some important questions — about what constitutes insider trading at a time when the government is taking a tougher line against Wall Street and white-collar crime."

"The S.E.C. claims that Mr. Griffiths and Mr. Steffes acted on more than a hunch. The commission says that “shortly after the tours began, a number of F.E.C.R.’s rail yard employees began expressing concerns that F.E.C.R. was being sold, and that their jobs could be affected by any such sale.”

The S.E.C. also claims that Mr. Griffiths was asked by the company’s chief financial officer for a “list of all of the locomotives, freight cars, trailers and containers owned by F.E.C.R., along with their corresponding valuations, which she had never requested before.” Florida East Coast Railway, or F.E.C.R., was a wholly owned subsidiary of Florida East Coast Industries.

Is all of that material information? Clearly, it is all nonpublic. But without being told directly that a deal was in the works, did the men actually have inside information?

Sorkin relates a good rule of thumb, pretty much the same as the one I proffered in the comments of my previous thread: "A safe maxim might be: “If you have to ask if it’s right or wrong, it’s probably wrong.”

EDIT: thanks to commenter UrbanAnalyst for pointing me toward the official SEC complaint.  It's a must read for anyone wanting to comment intelligently on the details of this case.  



Yangabanga said...

See the problem with a maxim like that is that in this day and age everything is or can be illegal! This is a whole other topic that laws are written so vaguely (and then reinterpreted again and again by judges) that yeah you pretty much need to ask "is this illegal" about anything you do.

In this case the answer is nobody knows! By its nature "inside information" can take many forms and there are many different participants with different levels of information.

It should be the responsibility of government to have common sense laws that are clear and have a clear goal. Since the subject is by its nature fuzzy, they should define insider trading very specifically and clearly, rather than being overly broad and thus ensnaring the people in this example.

Kid Dynamite said...

a friend of mine writes to me via email:

"Unfortunately for them, I think it is (insider trading). The key is the code of conduct prohibiting dissemination of material nonpublic info. They had a duty of confidentiality to the company, which was breached {KD NOTE: we discussed this in the previous blog post's comments}.

If it was just seeing guys in suits in the trainyard, probably ok even with the code.

But that + the CFO’s request + the code is a problem.

If they leaked all that to the local press, THEN bought options after it was published, they still would have violated the code, but probably would have been in a better legal situation re: insider trading since the info was public.

KD NOTE: I'm not sure leaking info to the press would have been good for them either... that's probably a violation of a different duty

Transor Z said...

Another issue is that the two trainyard employees don't have access to the same quality legal representation that the "Big Boys" do in defending against the SEC. Something about this SEC action seems really chickenshit to me in light of everything else they could be doing with their time and our money. But anyway...

Good post.

Anonymous said...

apologies for being off topic, but what scary halloween outfit do you have planned? fat finger trader? HF trader?

UrbanAnalyst said...


While on the surface this case may sound tenuous, it may also emerge in discovery that the employees had access to more specific evidence that a transaction was about to take place. Note that in the SEC complaint (page 8) it describes one of the defendants as having "daily interactions" with the president and COO of FECI. It is more likely that the SEC's case is based on the fact that the combination of evidence accumulated by the defendants resulted in material non-public information. I think the 'mosiac' analysis theory begins to dissolve its innocence when a majority of the information is non-public.

On the other hand, if their trading was based purely on the sighting of due diligence trips and initial deliverables most people would agree that they took on significant risk in their investments, and one might reasonably question the material nature of this information.

Whether or not one agrees that this is a violation of insider trading law, this can reasonably be viewed as a violation of their fiduciary duty (internal code of conduct).

For the reference of your readers, here is the direct link to the SEC release:

Kid Dynamite said...

thanks UA - i updated the main post to link to that.

I'm not a lawyer, so I don't see the use in speculating on this, but I think the SEC's claims on page 8 with respect to Cliff Steffes are pretty weak - gossip in the rail yard is NOT MNPI.

to me, the key part of the case is the list of assets and valuations that Gary Griffiths was asked to prepare

I also wonder how different it would be if these guys hadn't told their friends and family...

I also love how their broker made them sign a statement that he advised against it!


for me, in general, another standard to apply is "what would a reasonable person have done with this same information?"

UrbanAnalyst said...

I am curious as to whether the marked increase in trading risk and deviation from trading patterns is factored into grey-area decisions on materiality from an enforcement standpoint.

In this example, were the actions of the defendants in capital markets incorporated into the SEC's weighting of materiality? Granted there are many foolish individuals who might risk their net worth without evaluating the associated risks (and not that that may not be the case here), but the defendants did a) buy securities related to their company, which they did only once prior in shares, b) use options (that expired in 3 months) for leverage, and c) engage in transactions that deviated so far from their client objectives statements (presumably) that their brokers required specific waivers. Do these actions alone tip the scale towards materiality in the mind of the SEC?

As you mention Kid, we need an attorney's comment for more clarity.

StB said...

This is a good one. I agree with yor friend. The Code of Conduct is what will end up getting them. Observation in the railyard may be construed as non-public information, an item addressed in that Code. Plus as a VP, he had to know something was up when responding to the request for inventory.

On a different tangent, I think they showed some guilt by amassing so many calls. They were already on the SEC's radar before the deal was announced. One guy putting a year's worth of salary and his net worth into this? That is never going to look right.

Transor Z said...

One of the guys was VP and Chief Mechanical Officer and not just a "mechanical engineer" as in the Dealbook synopsis. Dealbook made it sound like they were two characters from "Conjunction Junction" just hookin' up words and phrases and clauses (i.e., mosaic theory).

p. 7: 33. . . . . "FECI’s Code of Conduct specifically provided that information regarding a merger or acquisition may constitute material information."

"Material" means info that would influence stock price, not what influenced these guys to bring the family in on a "sure thing." I can't really think of an instance when news of a pending M&A would not be material info.