Would you consider it a violation of the federal insider trading laws if you had material non-public information, and you casually made a joke referring to that information?
The United States Court of Appeals Second Circuit says yes. There is a little more to the story (circumstantial evidence), but the bottom line is this: “I was just joking” turns out to be an ineffective defense to an insider trading charge.
As a reminder, federal law prohibits not just trading on material, non-public information yourself; it also prohibits the practice of tipping others so that they, the tippees, make the trade whether it be for you, themselves, or others. The government treats tipper-tippee liability as seriously as direct insider trading.
In January 2019, the Second Circuit found a patent attorney guilty of violating the federal laws against insider trading (United States of America v. Tibor Klein and Robert Schulman) related to a merger between Pfizer and King Pharmaceuticals in 2010.
Schulman was a patent attorney who represented King Pharmaceuticals. He learned from one of his law firm colleagues about the potential merger.
The defendant (Schulman) was not able to convince the jury that his casual pun – “Boy, it would be nice to be king for a day,” which he made over dinner and drinks with his financial advisor (Klein), was not conspiracy to commit securities fraud regarding the Pfizer-King merger.
The pun, he said, was “a boastful, imprudent” remark with no relation to King Pharmaceuticals and no intention of tipping his financial advisor to trade on the information.
In his deposition, Schulman said this (from the court decision found here):
[T]here was one evening when Mr. Klein was at my house where I did mention, and I kind of made a joke with him, “boy, it would be nice to be king for a day.” And I made some joke with him about that. And at that point I would have never told him anything about their meeting, there’s a potential merger, it would have been much more of the nature of “hey, wouldn’t it be great to be king for a day, ha, ha, ha,” kind of like telling him, like acting like I am a big shot and I know this thing. But that’s the extent of what I would have communicated to him.
According to Schulman, the evidence only suggested that he “made a misguided comment to a friend in an effort to show off that he knew something that the public did not.”
The court disagreed:
Although Schulman told the SEC that he had communicated “nothing” more than that he wished he could be king for a day … a comment that, by itself, is innocuous—the jury was entitled to disbelieve that he communicated nothing more. The district court instructed the jury to draw “reasonable inferences,” … and “us[e] common sense”…
The court stated that as a matter of common sense, for Schulman’s comment to even make sense as a joke or a boast, he had to have communicated additional information to Klein, and Schulman admitted to the SEC that he was, in fact, referring to King Pharmaceuticals when he made his king-for-a-day comment.
There was more circumstantial evidence that the jury considered as well, including the fact that Schulman’s financial advisor, Klein, not only bought shares in King Pharmaceuticals ahead of the merger for 48 clients, including Schulman, but he also shared the information with a friend who bought trades ahead of the merger as well.
That friend was a financial advisor for Ameriprise Financial, and he was subsequently investigated by Ameriprise a few weeks after the merger when he sold his King stock.
This set off a series of investigations leading back to Schulman. It’s worth noting that the friend admitted his guilt and cooperated with the government, including by testifying at Schulman’s trial.
As a reminder, in an insider trading case, proof must exist that the insider would personally benefit from the disclosure to the tippee – and “benefit” can be interpreted in different ways.
In this decision, the court pointed out that the “critical question regards the tipper’s purpose: did the tipper share the material non‐public information with the tippee intending that the tippee use the information to improperly trade in securities?”
Unfortunately for Schulman (and Klein), the jury answered yes.
This tale is a reminder about how cautious those who possess material non-public information need to be. As this article by Baker Botts put it: “… even an offhanded remark can unleash a chain of events culminating in a regulatory enforcement action and/or criminal prosecution.”
I’ve written in the past about important insider trading cases, and why you should never get careless about your corporate policies and personal practices when it comes to material non-public information.
Companies are well served by ensuring that their corporate policies against insider trading are up to date, and that they have provided their employees with good training—especially when it comes to tipper-tippee liability.
I particularly recommend doing live trainings from time to time. This keeps the subject fresh and allows folks to ask questions.
As a reminder, Woodruff Sawyer provides its D&O insurance clients access to live training on insider trading policy. These are customized for our clients and can be given to key executives, all employees, or a combination as warranted.
Finally and most importantly: If you happen to possess insider info, it’s important to stay tight-lipped. Refrain from your desire to create clever puns — the Securities and Exchange Commission will not share your sense of humor.