With a headline like that, I am in hog heaven.Mr. Dirks, an analyst at NYSE member Delafield, Childs, Inc. was accused of trading on inside information in the case of Equity Funding when, after a tip from a disgruntled employee that the whole company was a fraud, Dirks did some digging, told his favored institutional clients of the scam and alerted the SEC.
Twas a time when I could spot an under-reserved P&C with one whisk of my slide rule, when the aftermath of Equity Funding, Raymond L. Dirks v. Securities and Exchange Commission, became a cautionary tale for any analyst or manager able to ferret out a scam* and when an actuary was more than just the punchline to a joke.**...
From DealBook:
Deductive Reasoning Can Be a Dangerous Thing
A recent case involving a Canadian investment banker raises an interesting question about whether a person’s own intuition about a merger constitutes illegal insider trading charge. The answer becomes even more difficult when two securities regulators reach different conclusions about whether there was any confidential information involved.In the case of Mr. Dirks he had to fight the S.E.C. all the way to the U.S. Supreme Court where he was vindicated.
The Securities and Exchange Commission in the United States and Canada’s Ontario Securities Commission filed separate cases against Richard Bruce Moore, who had worked at Canadian Imperial Bank of Commerce. He agreed to settlements with each, paying about $850,000 and accepting restrictions on any future work in the securities industry.
The trading involved Tomkins, a British maker of car parts, before it received a takeover offer in July 2010 that led its stock price to rise nearly 30 percent. The circumstances by which Mr. Moore gathered the information about the offer make it hard to find any clear line that separates good deductive reasoning from illegal trading.
At the time, one of Mr. Moore’s clients was the Canadian Pension Plan Investment Board, which was planning an offer for Tomkins along with a private equity firm. Mr. Moore regularly dealt with one of the pension plan’s senior representatives about providing investment banking services. He learned there was a significant transaction involving the pension board, but that C.I.B.C. would not be involved in it.
Over the course of the next few months, Mr. Moore gleaned additional tidbits about the transaction from his interactions with the pension board representative. In this case, no one tipped him off about the deal, at least not in the traditional sense. In essence, he put two and two together after he saw the pension board representative speaking with someone at a charity event, and the representative refused to introduce them or even identify who he was speaking with. A short time later, another person identified the unknown person as the chief executive of Tomkins.
Having figured out the likely target of the deal, the next day Mr. Moore started buying Tomkins stock through an offshore account, ultimately putting approximately one-third of his net worth into its shares. His trades included buying American depositary receipts in the company that were traded on the New York Stock Exchange, which gave the S.E.C. jurisdiction over the case.
Under United States law, the so-called misappropriation theory of insider trading requires proof that a defendant took information from a party to whom he owed a fiduciary duty and then converted it to his own use by trading. In its complaint, the S.E.C. claimed that by pulling together different strands of information about the impending deal from a client, Mr. Moore “misappropriated that information from his employer by purchasing Tomkins securities.”...MUCH MORE
From a brief filed by the Justice Department, in defense (!) of Dirks:
“Dirks is a securities analyst, ‘well-known for his investigative talents,’ who researched insurance company securities. In March 1973, Dirks applied those investigative talents to uncover a major fraud perpetrated by the officers of a publicly-owned insurance company. As the court of appeals observed, ‘in two weeks of concerted effort, at times resembling something from detective fiction, Dirks investigated and confirmed rumors of massive fraud by the Equity Funding Corporation of America, an insurance holding company whose stock traded on the New York Stock Exchange. Largely thanks to Dirks one of the most infamous frauds in recent memory was uncovered and exposed.
Despite his efforts to uncover and expose the criminal scheme at Equity Funding, the Securities and Exchange Commission charged Dirks with ‘tipping’ material inside information in violation of Section 10(b) of the Securities Exchange Act of 1934.
"Dirks first learned of the fraud at Equity Funding from a former officer of the company, Ronald Secrist, who met with him for several hours on March 7, 1973. ‘Secrist made a series of detailed but nearly incredible allegations about Equity Funding,’ including allegations that the company had produced large numbers of spurious insurance policies to inflate its sales revenues and that ‘its top officers had Mafia connections which they used to threaten the lives of employees who objected to the fabrications.’ Secrist urged Dirks to verify the existence of the fraud and then expose it. He expected Dirks to transmit evidence of the fraud to ‘his firm’s customers’ and ‘clients,’ thereby triggering large-volume securities sales that would lead to a full investigation: ‘by jarring the stock, he would jar the corporation - this was my plan – he would jar the corporate officers and would also rattle the Wall Street financial community to the extent that someone would take action very quickly.’ Secrist believed that selling pressure would cause the price of Equity Funding stock to ‘drop close to zero very quickly,’ and thus ‘reveal the fraud to the world’ and ‘prevent its continuation.’
“During their initial meeting, Dirks sought and obtained Secrist’s permission to convey evidence of the fraud to the Wall Street Journal. Secrist warned, however, that merely presenting the information to regulatory authorities, including the SEC, would be abortive. Secrist stated that employees who attempted to do this in the past had been ‘brushed aside with a comment that that’s a ridiculous story;'...MORE
