After reading the NY Times account of David Sokol’s trading in Lubrizol just prior to pitching the stock to his boss, Warren Buffett , it seems crystal clear that Sokol engaged in insider trading.
But why should anyone be surprised by this? In my view Buffett and Berkshire have always been the ultimate insiders. Because of Warren’s status as a living investment legend he has access to all kinds of information average Joe investors only read about weeks later in the financial papers. I assume that having “insider” access is part of the culture at Berkshire, just as it is at big money hedge funds.
For example at the depths of the financial crisis, it was Buffett that got the call from Goldman Sachs offering him a sweet deal on 10% yielding $5 billion in preferred stock. Buffett also got a load of stock warrants.
Who get’s to buy $5 billion in Goldman Sach’s preferreds with a junk bond yield? No one but Berkshire Hathaway. Warren got a similarly sweet deal from General Electric at the depths of the financial crisis.
At the time of the Goldman purchase, in the Fall of 2008, Warren was being asked to lend a big vote of confidence to the American financial system by making a big investment in the world’s best known investment bank. Buffett’s profit on the whole Goldman rescue, including preferred dividends and stock warrant profits, will be north of $3.7 billion. Not a bad ROI for a $5 billion cash outlay. It’s the kind of profits you would expect “insiders” to make, not average Joe investors.
So as Raj Rajaratnam’s trial plays out in the media, investors should keep in mind that in the clubby moneyed world of giant hedge funds ( Berkshire is the probably biggest and most successful quasi-hedge fund ever), insider trading is pretty much commonplace. The smart money guys get information earlier than the rest of us, they act on it and make huge profits.
Don’t be surprised if people connected with some of the hottest new tech companies find themselves hauled into court on insider trading charges.
Many in Silicon Valley apparently believe that insider trading rules don’t apply to buying or selling stakes in non-public companies like Twitter and Facebook.
Recently, in an article about a Facebook employee who allegedly bought shares in his the company in advance of an investment by Goldman Sachs (NYSE: gs), Sarah Lacy and Michael Arrington of TechCrunch wrote: “In a public company this would almost certainly violate a number of federal laws. However, say sources, the fact that Facebook is not (technically) a publicly traded company means those laws don’t apply.”
Henry Blodget of Business Insider recently voiced a similar thought in an article about the venture capitalist John Doeer.
“Legendary venture capitalist John Doerr is said to have once described his investment philosophy as ‘no conflict, no interest.’
In other words, when Doerr and venture capital firm Kleiner Perkins aren’t privileged enough to enjoy a potential conflict of interest with respect to a potential investment, they have no interest in making the investment.
In the public markets, some investors might describe this as having ‘an edge.’ Others might describe it as investing with the benefit of influence and information that other investors don’t have. Others might say, at least in some cases, that it might be investing with inside information-a.k.a., insider trading.
But in private markets there are no clear rules about insider trading.”
Based on discussions I’ve had with other folks in the tech start-up scene, this interpretation is very common.
“It’s very widespread,” Silicon Alley Insider reporter Nick Carlson told me.
Wrong
It’s also wrong. Insider trading rules aren’t limited to stocks traded on public stock markets-they apply to every kind of security interest or option to buy shares.
But armed with this mistaken interpretation, it seems likely that people in the tech sector are probably buying or selling stakes in companies while in possession of material non-public information.
Companies like SecondMarket put investors together with shareholders of non-public companies. This allows people – mostly early stage venture capital investors or employees who were compensated in shares – to monetize their stakes without waiting for an IPO or a buyout.
It’s easy to see how insider trading can develop in such illiquid and non-transparent markets. If, for instance, you are a Facebook employee who has been privy to internal discussions about a possible acquisition of the social-media start-up Foursquare, you might decide to invest in Foursquare ahead of the acquisition.
Or maybe you’re a venture capitalist who has chatted with Foursquare founder Dennis Crowley about a not yet publicly announced new feature that you think will really improve user experiences. Based on the chat, you buy up some shares on Second Market.
In either case, you’d be engaging in illegal insider trading that could land you in court facing the Securities and Exchange Commission or even criminal charges.
Insider trading is barred under Section 10(b) of the Exchange Act of 1934 and Rule 10b-5, a regulation that the SEC made to implement that provision of the Exchange Act. They bar anyone from using “any deceptive device” in connection with the purchase or sale of securities.
The SEC long ago persuaded the courts that using “material non-public information” to make trades was a form of fraud that was barred under the act-giving birth to the rule against insider trading.
While it’s true that most insider trading cases involve the purchase or sale of stocks that are traded on public exchanges, there’s nothing in the rule or the case law that limits enforcement to public stocks. Buying or selling any security-including privately held shares of non-public companies – while possessing material non-public information is potentially insider trading punishable under the law, regardless of where the sales take place.
The SEC is now on notice that the tech sector seems to have adopted the mistaken belief that buying stakes in private companies while possessing inside information is not illegal.
Facebook fired a senior employee who bought Facebook shares through secondary markets in violation of the company’s policy on insider trading, according to people with direct knowledge of the matter.
The episode could bring further scrutiny to markets that deal in shares of private companies like Facebook, Twitter, LinkedIn and Zynga. The Securities and Exchange Commission began an inquiry into these markets last year.
The employee, Michael Brown, worked in corporate development. In a statement e-mailed by his lawyer, Edward Swanson, Mr. Brown said: “I did buy Facebook stock on the secondary market in early September 2010, and I did so with the absolute best of intentions and only because I believe in Facebook.”
Mr. Brown’s ouster was first reported by TechCrunch.
TechCrunch initially wrote that Mr. Brown had bought the shares ahead of a $1.5 billion financing round led by Goldman Sachs in January.
In an apparent reference to that report, Mr. Brown said: “False and damaging information has been published about my actions.” He added that he had no knowledge of the Goldman Sachs deal “until it appeared in the press in January 2011.”
TechCrunch updated its story Friday morning, saying that Mr. Brown may have bought the shares in September.
Facebook fired Mr. Brown a few weeks ago, according to the people with knowledge of the firing, who agreed to speak on the condition of anonymity because they were not authorized to discuss it.
Stephen Diamond, a professor at Santa Clara University who teaches securities law, said that many of the legal restrictions on insider trading applied equally to private and public company shares.
“If the employee had material information which he did not share with the seller, he could be charged with violating the law,” Professor Diamond said.
The episode could also bring further scrutiny from the S.E.C. to exchanges like SecondMarket and SharesPost, he said.
“This could be evidence that the control procedures in these markets are not sufficient,” Professor Diamond said.
According to Mr. Brown’s LinkedIn profile, he had been employed at Facebook since April 2009. Before that he worked at Foundation Capital, a Silicon Valley venture investing firm.
“I am saddened by the course of events that led to my departure and the incorrect reporting of it,” Mr. Brown said. “I am now focused on moving on past this unfortunate series of events.”
Two Victorian men have been charged with multiple counts of insider trading while acting as brokers for Citigroup Wealth Advisors in Perth, while a third man has also been charged following an investigation by the Australian Securities and Investments Commission (ASIC).
Roberto Gerald Catena, Colin Edward George Hebbard and Flemming Hood Nielsen appeared in the Perth Magistrate’s Court for allegedly possessing inside information regarding a possible takeover of Vision Systems in July and August, 2006.
Catena has been charged with 20 counts of insider trading while employed as a broker with Citigroup for advising five of his clients, including Nielson, to purchase Vision Systems shares.
Hebbard has been charged with four counts of insider trading while employed as a broker with Citigroup for advising three clients to purchase Vision Systems shares.
Nielson has been charged with 13 counts of insider trading for receiving inside information while a client of Catena and using it to purchase shares of Vision Systems through Citigroup and CommSec.
All three men were not required to enter a plea, with the matter being adjourned until 27 April.
NEW YORK (Reuters) – Two men have been charged with insider trading based on information stolen from three of the most prominent U.S. law firms specializing in mergers and acquisitions, federal prosecutors said.
Prosecutors said the information was stolen from the law firms Wilson Sonsini Goodrich Rosati; Cravath Swaine Moore LLP, and Skadden, Arps, Slate, Meagher Flom LLP, all of which had employed the defendant Matthew Kluger, a lawyer.
Kluger and co-defendant Garrett Bauer, a trader, reaped more than $32.2 million of profit from their 17-year conspiracy to invest in a variety of stocks, such as technology companies McAfee Inc, Sun Microsystems Inc and 3Com Inc, according to a complaint filed with the federal court in Newark, New Jersey.
Prosecutors said Kluger regularly stole information about anticipated corporate mergers and acquisitions from his law firms. They said he would then pass the information to an unnamed co-conspirator, who would then give it to Bauer with instructions on how many shares to buy for the three of them.
The pair invested more than $109 million in the scheme, which ran from 1994 through this March, the complaint said.
The news follows dozens of arrests since October 2009 relating to federal allegations of insider trading focused on hedge funds. One-time billionaire Raj Rajaratnam, who founded the hedge fund firm Galleon Group, is on trial in Manhattan in Wall Street’s biggest insider trading case in two decades.
Prosecutors said Bauer worked at a variety of trading firms, most recently at Lighthouse Financial Group from about June 2009 through roughly August 2010.
Lighthouse also once employed the broker Michael Kimelman, who was arrested in 2009 in connection with the hedge fund insider trading probe. Kimelman has been represented in that case by lawyers at Wilson Sonsini, court records show.
Kluger lives in Oakton, Virginia, and Bauer in New York. It is unclear whether they have lawyers for their defense.
Kluger did not immediately return a call to his home seeking comment. Bauer could not immediately be reached for comment. Wilson Sonsini did not immediately return a request for comment. Representatives of Cravath and Skadden had no immediate comment.
17 COUNTS
Prosecutors charged Kluger and Bauer with 17 counts, including 11 counts of insider trading, four counts of obstruction of justice, conspiracy to commit insider trading, and conspiracy to commit money laundering.
The case was built in part on phone wiretaps that prosecutors said show the defendants’ conspiracy.
Prosecutors said that in recent years, Kluger, Bauer and the co-conspirator would try to avoid detection by using pay phones and prepaid cellphones that they would later throw out.
They also said Bauer in late 2009 spent more than $7 million of proceeds from the scheme to buy two homes: a $6.65 million condominium on Manhattan’s Upper East Side, and an $875,000 home in Boca Raton, Florida.
According to the complaint, Kluger worked from December 2005 until this March 11 as a senior associate in Wilson Sonsini’s office in Washington, D.C., where his annual salary was about $290,000. Kluger worked at Cravath from 1994 to 1997, and at Skadden from 1998 to 2001, the complaint said.
U.S. Attorney Paul Fishman in New Jersey, and officials from the FBI and the U.S. Securities and Exchange Commission are expected to hold a press conference on the arrests later Wednesday.
The case is U.S. v. Bauer et al, U.S. District Court, District of New Jersey, No. 11-mag-03536.
(Reporting by Jonathan Stempel in New York; Additional reporting by Dena Aubin; editing by Dave Zimmerman)
