Insider Trading

1. Insider Trading “Today’s Insider Trading Suspect May Wear a Lab Coat” -New York Times, August 9, 2005

2. What is “Insider Trading?” • Buying or selling a security • In breach of a fiduciary duty (or other relationship of trust or confidence) • While in possession of material, nonpublic information about the security. • Includes “tipping” which is providing inside information to another who buys or sells stock based upon this information.

3. “Breach of Fiduciary Duty or Duty of Trust and Confidence” • “Misappropriation Theory” • A person commits fraud when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of information. • U.S. v. O’Hagen, 117 S.Ct. 2199, 2207 (1997) • According to the SEC duty of trust or confidence arises when: • Person agrees to maintain information in confidence. • Person communicating material non-public information and person receiving it have a pattern or practice of sharing confidences and there is an expectation of confidence. • Person receives material nonpublic information from spouse, parent, child, or sibling. • 65 FR 51716, 51737

4. Material Information • Material information is information which a “reasonable investor” would view as “important” in making an investment decision. • Basic Inc. v. Levinson, 485 U.S. 224 (1988) • But aren’t research findings speculative? • Perhaps, but information can be “material” even though it concerns a speculative event. Court will consider two factors: • 1. Likelihood that event will occur • 2. Magnitude of benefit to the company • Basic v. Levinson

5. Nonpublic Information • Generally defined as information that has not been disclosed to the public. • Other definitions conclude that information becomes public once it has been publicly disclosed and adequate time has passed for the securities markets to absorb the information.

6. Enforcement • “Because insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.” -U.S. Securities and Exchange Commission • Civil Penalties of 3x the profit realized or loss averted by virtue of trade. 15 USC § 78u-1 • Criminal Penalties of up to 20 years imprisonment and $5,000,000 in fines. • “Controlling Person” Liability • Civil – greater of $1 million and 3x profit or loss • Criminal- Up to $25 million • Controlling person knew or recklessly disregarded the fact that the controlled person was likely to engage in the act or acts [of violating the law] and failed to take appropriate steps to prevent the act or acts before they occurred.

7. Bounty Hunters • SEC is authorized to award a bounty to a person who provides information leading the recovery of a civil penalty from an inside trader. 15 USC 78u-I(e) • Award of up to 10% of civil penalty assessed against inside trader.

8. SEC v. Milton Mutchnick et al.97 CV 00709 (1997) • Mutchnick was head of gastroenterology department at Wayne State University. • Lead investigator for hepatitis drug Thymosin. • His research indicated the drug was ineffective. • Prior to information becoming public, Mutchnick warned friends and family of results of research. • Mutchnick and those warned sold stock in the sponsoring company avoiding $300,000 in losses. • Mutchnick and company were charged with insider trading. • Mutchnick settled the charges by paying a $163,494 civil penalty. His wife and the six people they had “tipped” paid $105,000 in forfeitures and penalties.

9. SEC v. Sanjiv S. Agarwala06 CV 0352J (S.D. Cal., 2006) • Associate Professor of medicine and associate medical director of melanoma program at the University of Pittsburgh. • Consulted for Maxim Pharmaceuticals on clinical trials for cancer drug Cepelene. • SEC complaint alleged that Agarwala learned of “material nonpublic information” regarding the drug. • Knew of FDA approval before it was made public. • Knew test results for clinical trials. • SEC alleged that Agarwala used this information to purchase and sell Maxim stock. • Agarwala settled the case by agreeing to pay $14,784 for illegal trading profits and losses avoided and a civil penalty of $29,568.

10. Conclusion • Insider trading is not limited to Wall Street • Information obtained in performing medical research is likely confidential. • Duty of confidentiality owed to sponsor. • Using information obtained during the course of medical research to buy or sell publicly traded stocks may constitute “insider trading”. • The researcher may be subject to civil and criminal penalties. • The Marshfield Clinic may be subject to civil and criminal penalties as the “controlling person.”