If your brother-in-law is a senior accounting executive at a public company, and that public company is secretly in negotiations to be acquired at a premium, and your brother-in-law is working on the deal, and you talk to him regularly while the deal is being negotiated, “including by phone, at your daughters’ basketball events, and at multiple family gatherings over the Christmas holidays,” and after each time you talk to him you buy some short-dated out-of-the-money call options on his company’s stock, and you call your son and tell him to buy call options on the company’s stock, and you take out a loan on your car to buy even more call options on the company’s stock, and you make up 100% of the volume in those call options on some of the days you trade, and then shortly after Christmas the company announces the merger and the stock shoots up and you (and your son) make a ton of money on your call options — is that illegal insider trading?
I don’t know! It has the main hallmarks of insider trading:
Short-dated out-of-the-money call options on a merger target, and
Brothers-in-law. (“The brother-in-law’s role” in American culture “is to insider trade on his brother-in-law’s information.”)
But notice that, in my litany of suspicious events, I did not actually say “and your brother-in-law told you about the merger negotiations.” Sure he was working on the merger, and sure he kept seeing you at basketball events etc., and sure each time you saw him you went out and bought call options. But maybe you just talked about basketball! Maybe seeing him reminded you that his company existed, and you went off and did fundamental research and traded without any inside information from him. Or maybe you saw him looking stressed, or happy, or he rushed in late to basketball practice, and you thought “hmm something might be cooking at his work” and bought options without a tip from him.
Still, given that list of suspicious signs, it’s a safe bet that the Securities and Exchange Commission will bring an insider trading case. And in fact it did: This is a real case, the person who traded is Christopher Clark (who made $243,000 of profits; his son made $53,000), and his brother-in-law is William Wright, an accounting officer at CEB Inc., which was acquired in 2017. The SEC sued last December. Last month, Wright settled without admitting or denying the charges, agreeing to pay a fine of about $240,000 and to be barred from serving as a director or officer of a public company for two years. But Clark went to trial, and this week he won:
A federal judge in northern Virginia on Monday dismissed the civil fraud case against Christopher J. Clark, whose bullish and risky trades just before a 2017 acquisition were spotted by regulators’ high-powered surveillance databases. The SEC alleged Mr. Clark’s brother-in-law, a former corporate accounting officer, told him days before the deal that Gartner Inc. would buy CEB Inc.
U.S. District Judge Claude Hilton dismissed the SEC’s claims after regulators presented their evidence and before the case was sent to the jury. “There’s just simply no circumstantial evidence here that gives rise to an inference that he received the insider information,” Judge Hilton said Monday, according to a transcript. …
Mark Cummings, a lawyer for Mr. Clark, said the outcome underscores that regulators can rely too much on statistical evidence, such as trades made just before an event that caused a company’s stock price to rise or fall. Data alone isn’t sufficient to support a civil or criminal case against a trader, he said.
Mr. Clark, 53 years old, refused to settle the SEC’s lawsuit because he had good reasons for believing CEB shares would rise, Mr. Cummings said. His research had nothing to do with his brother-in-law, William Wright, who had worked as CEB’s corporate controller.
“The lesson here is suspicious trading is not necessarily illegal trading,” Mr. Cummings said. “Just because the circumstances look bad, there can be an equally innocent reason for the activity.” …
“The government can speculate that he made a little too much money, he was a little too successful or more successful than he ought to be, so therefore he’s getting insider information,” Judge Hilton said, according to the hearing transcript. “But there’s no evidence of it.”
Notice that what happened here is not that the SEC presented all its suspicious evidence, Clark testified “no I did my own research and it’s all innocent,” and the jury went and deliberated and decided that they believed him. Instead, what happened here is that the SEC presented all of its suspicious evidence and the judge said “nope, there’s nothing here even worth bothering a jury with.” Believing Clark’s explanation has nothing to do with it; he didn’t even present his explanation. The judge just decided that the facts I laid out in my first paragraph — brothers-in-law, basketball games, mergers, short-dated out-of-the-money call options — couldn’t possibly be enough, on their own, to find someone liable for insider trading.
That will make life harder for the SEC! This is just one district judge’s decision in one case, and I would not exactly call it The Law, and in any case nothing in this column is ever legal advice, but I will say, if you find yourself in the fact pattern in that first paragraph — if you have been trading short-dated out-of-the-money call options on a merger target after seeing your brother-in-law who is working on the merger — and the SEC comes after you for insider trading, don’t give up hope. “What, all of this is nothing,” you can say to the SEC, and to a judge, and if nobody has any proof of what you talked about it might work.
Also I can’t believe Wright settled and had to pay the SEC $240,000. He didn’t make that money trading call options; Clark did, and Clark beat the charges. I know what Clark should give his brother-in-law for Christmas this year.
Well, another lesson for us retail investors, find a brother-in-law that has insider information!