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One Step Closer to Mandatory Jail Time for Securities Offenders?
This past summer Robert Ramnarine, an executive with the Bristol-Meyers Squibb Company, was arrested by the FBI and charged with insider trading for buying stock options in three companies targeted for acquisition. Ramnarine allegedly made $311,361 in illicit profits from the trades. Yet even if convicted, Ramnarine could conceivably serve less time in jail then someone making just $25,000 in profits. Why? Because of a push by the federal government to crack down on insider trading. Even those who do not make significant profits can receive stiff prison sentenceswitness the two-year hitch handed out in October to former McKinsey CEO and Goldman Sachs board member Rajat Gupta for his conviction stemming from the Galleon scandal, even though Gupta did not receive any monetary benefit from the insider tips he shared. The Federal Sentencing Commissions new amendment to the Sentencing Guidelines mirrors this evolving trend.
On May 1, 2012, the Sentencing Commission passed an extensive amendment to the Sentencing Guidelines, as directed by Section 1079A(a)(1)(A) of the Dodd-Frank Act. The new amendment, which became effective on November 1, 2012, has the potential to increase the sentences persons guilty of insider trading receive by creating a higher punishment for sophisticated acts of insider trading, even when the amounts at issue are relatively small.
The most recent amendment provides an alternate base penalty level for an offense termed sophisticated insider trading. The offense is designed to punish more harshly those individuals who systematically and continuously seek out non-public information to gain an advantage in the market, as opposed to those individuals who, by chance or good fortune, trade on non-public information but do not have mechanisms set up to obtain the information.
The original layout of the Sentencing Guidelines in relation to insider trading was a base numerical offense level, which would be added upon by factors laid out by the guidelines, such as total loss from the offense. The resulting number would represent the gravity of the offense, and would correlate to a sentencing chart that assigned prison time lengths according to the number. In essence, the more money at stake the greater the level of potential incarceration.
Under the old guidelines, the base offense level for insider trading was eight for a first-time offender. The level of eight under the Sentencing Guidelines equates to zero to six months imprisonment, which most often results in a probationary period with no actual time served in prison, even though this number is two levels higher than other forms of fraud recognized by the Sentencing Guidelines. Insider trading was given the especially high initial punishment in light of worries regarding its elusiveness to enforcement officials and the potentially large-scale fraud that could occur. Aside from the higher base offense level, increases in punishment derived from the monetary gravity of the offense are calculated according to the loss table found in § 2B1.1 of the Guidelines Manual.
The new guidelines keep the original base level of eight for insider trading offenses, but they also add an additional, distinct enhancement for sophisticated insider trading. Sophisticated insider trading has been defined by the Sentencing Guidelines as an organized scheme to engage in insider trading. The Sentencing Guidelines give a non-exhaustive list of factors for the courts to consider in deciding whether or not the offense falls within sophisticated or regular insider trading, including the duration of the offense, the efforts taken to obtain material, non-public information, and efforts to conceal the offense. The guidelines further clarify that they refer to a scheme to engage in insider trading that involves calculated, systematic, or repeated efforts.
The amendment becomes increasingly less powerful and less relevant as the offender reaps more reward. In fact, this enhancement only applies to organized schemes that generate loss, according to the loss table, of under $30,000. The punishment for a crime of over $30,000 would be calculated by the existing guidelines.
Under the new amendment, sophisticated insider trading with less than $30,000 in alleged loss has a base level of 14which the Sentencing Commission seems to have concluded warrants incarceration for a short but definite period of time. The Commission found it pertinent to make a distinction between those who devise and implement a program to obtain non-public information and trade upon it from those who trade upon non-public information obtained by chance. The new Sentencing Guidelines take into account that traders within a scheme are more likely to be educated and experienced, and should know the dangers of insider trading and how to avoid insider trading.
The increase in potential liability derives from the governments perception that these traders are more capable of using their skills to evade detection of fraudulent trading, which makes them more dangerous and worthy of special punishment. The director of the SECs Division of Enforcement, Robert Khuzami, has stated that sophisticated insider trading, [i]s very different fromand far more disturbing thancases where we see opportunistic trading by someone who happens to come into possession of valuable inside information, such as a once-in-a-lifetime takeover or other extraordinary corporate announcement, and succumbs to the temptation of illegal profits. In sum, according to the SEC, those who have developed a way of obtaining, transmitting, and selling based upon non-public information in a manner that is likely to evade detection deserve a higher punishment.
Examples of How the New Guidelines Apply
The new guidelines distinction between sophisticated insider trading and traditional insider trading has the potential for unusual and possibly unfair results. The sophisticated insider trader learns information from communicating with supply chains about inventory amounts, attending conferences, and meeting with management in order to obtain material non-public information. On the other hand, the institutional trader can engage in unsophisticated insider trading, where family, friends, or colleagues tip them off about an upcoming material event. Yet both of these types of traders can still gather the same material non-public information. If they do happen to make similar trades, and if neither of the trades in question yields above $30,000, the sophisticated trader will unquestionably face higher penalties.
This new standard in assigning punishment can be especially harmful to traders who have developed a formula or system for obtaining and trading on information, since the formula may be regarded as an organized scheme which will invoke liability for sophisticated insider trading.
Implications of the 2012 Amendments
Defendants may face automatic prison time of at least a year under the 2012 amendments for sophisticated insider trading. In order to avoid jail time, corporate lawyers and in-house counsel must increase their efforts to review, advise, and monitor the activities of directors and officers. They must go over their own work with more scrutiny, to avoid inadvertently facilitating the commission or concealment of insider trading by other employees with whom they affiliate and cooperate.
If a client is accused of insider trading and conviction seems likely, the representing lawyer must focus on convincing the court that the trading was not sophisticated and was merely a fortuitous, opportunistic chance discovery of tempting information that was acted upon. In this instance, it might actually be useful to highlight that the trade was done in a blatant manner, which tends to negate that there was a scheme present. Counsel may want to show that the information was acquired in one shot and not obtained through a more intricate method. Counsel should also work to show the insider trading as an isolated event(s), and negate any notions of patterns or systems in place to facilitate insider trading.
Still, despite the best efforts of counsel, one may be found to be a part of a sophisticated insider-trading scheme, and may likely face a prison term, even in the face of no significant gains made in the scheme.
John J. Carney is a partner in the New York office of Baker Hostetler and serves as co-leader of the firms national white collar defense and corporate investigations group. Robert J. Ciampaglio Jr., a 2014 J.D. candidate at Rutgers School of Law, was a 2012 summer writing assistant for Mr. Carney.