Insider trading seems like a quaint vestige of the 1980s. It’s been more than 30 years since Wall Street’s Gordon Gekko decreed “Greed is good,” and Ivan Boesky and Michael Milken went to jail for using insider information to bet on corporate takeovers. But even as hair scrunchies and oversized jean jackets are making their comebacks, so is insider trading, and we’re seeing it regularly in the investigative work K2 Integrity does.
At its simplest, insider trading involves people with nonpublic knowledge of a company buying or selling stock in advance of the release of news about the company, either good or bad. While these individuals are typically officers or a director of the company, they may also be friends, relatives, bankers, accountants, or just about anyone who has learned of an upcoming company event before it became public.
On 15 June 2021, the New York County State Supreme Court granted New York Attorney General Letitia James’s request and ordered Eastman Kodak Co.’s CEO and general counsel to testify regarding possible insider trading activity, allegations that have plagued the once-giant film manufacturer since the summer of 2020. Much of Kodak’s business disappeared in a flash with the introduction of digital and smartphone cameras. However, in July 2020, the Trump administration announced it would sign a letter of interest to provide a $765 million loan to launch a new arm of Kodak to produce crucial pharmaceutical components in response to COVID-19. Meanwhile, a month before the announcement—while negotiations were occurring—Kodak’s CEO bought approximately 47,000 shares of stock, and at least one independent director made a much smaller purchase in the same time period. Other senior executives received option grants just days before news of the loan was released. The company’s stock spiked, rising to a high of $60 per share, or more than 27 times what the CEO paid for it weeks earlier.
Although the loan evaporated, regulators still investigated the trades. A special committee of Kodak’s board issued a public report stating the CEO and others had received preclearance for their trades, but also acknowledging “gaps” in Kodak’s policies. In December 2020, The Wall Street Journal reported that the investigator general of the U.S. International Development Finance Corporation, the agency issuing the loan, did not find evidence of wrongdoing. Nonetheless, the New York Attorney General has threatened a lawsuit and C-suite executives have been ordered to testify regarding their trading. And Kodak isn’t the only company facing such issues. Recently, the U.S. Department of Justice has made headlines with other disclosures of insider trading.
While the shoulder pads and spandex popularized in the ‘80s were (thankfully) passing fads, insider trading never completely disappeared, as evidenced by these recent enforcement actions. Instead, it has remained in the background, often obscured by new and more dramatic frauds.
In the course of K2 Integrity’s work, our teams routinely review thousands of trades disclosed by senior executives and directors. We match insider filings with a company’s stock price and correlate this information with public disclosures, which usually culminates with a pro-forma statement about our review and lack of findings. But not always. Every year we uncover a dozen or so individuals who purchased or sold stock just before significant information was released to the public. These trades are often small and have not been flagged publicly by regulators. Unfortunately, the staggering number of stocks traded on the market hampers the ability of the SEC or other enforcement bodies to monitor all of these types of transactions.
In the last six months, our work for clients revealed evidence that:
- The CEO of a publicly traded company bought tens of thousands of dollars’ worth of stock a few weeks before the company’s acquisition was disclosed but months after discussions had begun. The CEO subsequently made more than $100 million on the sale of the company.
- The chairman of an audit committee sold stock outside of his routine trading plan, two months before the discovery of a multiyear fraud and the resulting restatement of the company’s financial statements were disclosed.
- A hedge fund sold stock in a company in advance of a poor earnings report soon after winning a proxy fight and placing a director on the company’s board.
Insider trading is an insidious and endemic fraud. Lack of regulatory action against an individual or company neither guarantees that the trades are clean, nor obviates the fraud. While most instances of inappropriate trading do not rise to the level of Enron fraud, they do call into question the actions of those making the trades and can point to oversight weaknesses on the part of a company. If discovered, businesses can use such findings to make decisions that protect their interests and maintain the integrity of their company. As a result, we recommend clients:
- Routinely review trading by their executives to ensure they are complying with the company’s policies regarding stock purchases and sales.
- Assess the adequacy of their policies and procedures regarding option grants and trades made by employees, officers, and directors to ensure the policies are being complied with and that there are no gaps in the policies that can be exploited.
- Make provisions to scrutinize available insider filings in the context of mergers and acquisitions, senior-level hires, board appointments, corporate contests, or other applicable situations, when the temptation to trade on inside information may be strong.
As history shows, knowledge is key to establishing an adequate defense should regulators come knocking. In the immortal words of Gordon Gekko, “The most valuable commodity [we] know of is information.”