Material, Non-Public Information? Why JPMorgan Does Not Care; And Why If You Are A Corporate Insider Client, Neither Should You

Tyler Durden's picture

A recurring theme on Zero Hedge over the past few months has been the inordinate (and seemingly inexplicable if one takes at face value the arguments for an improving economy) amount of insider selling of corporate shares, which has reached a staggering ratio of 30-1 of sales to buys (if not much more). A back of the envelope calculation indicates that insiders may have sold well over $10 billion worth of their own company's shares in the last quarter alone. Aside from what implications this activity has for claims of the recession being over, as those best familiar with their businesses can not wait to offload their holdings, a larger question is one of propriety, and whether insiders are abusing inside information loopholes, particularly if they are aware of material, non-public information when selling their stock.

In this environment of unprecedented insider selling, it makes sense to refamiliarize readers with JP Morgan's confidential presentation, "Hedging and Monetization" from February 2007, first presented by Wikileaks, which focuses exclusively on providing company insiders with mechanisms to circumvent not just regulatory curbs on insider selling, but to obfuscate market signals typically associated (but definitely not in this market environment) with an insider dumping boatloads of his or her own stock. In particular, JP Morgan latches on to the biggest regulatory loophole, courtesy of the SEC, namely Rule 10b5-1, which is a tacit understanding by the SEC that insiders can do whatever the hell they want, including trading purely on inside information, while providing affirmative defense in the case lawsuit(s) are brought up against them.

As a reminder, from the SEC's own rulebook:

Examples of insider trading cases that have been brought by the SEC are cases against:

  • Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments;
  • Friends, business associates, family members, and other "tippees" of such officers, directors, and employees, who traded the securities after receiving such information;
  • Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;
  • Government employees who learned of such information because of their employment by the government; and
  • Other persons who misappropriated, and took advantage of, confidential information from their employers.

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.[ZH: this is where the Raucous Laughter cue card goes up for the live studio audience]

The SEC adopted new Rules 10b5-1 and 10b5-2 to resolve two insider trading issues where the courts have disagreed. Rule 10b5-1 provides that a person trades on the basis of material nonpublic information if a trader is "aware" of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. The rule permits persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.

In other words, insider trading is not really insider trading, if the person perpetrating the insider trading had full intention of committing this fraud, and in fact prepared for it, via apriori (paid) arrangements with specific counterparties.

Enter JP Morgan.

In a Strictly Confidential presentation, in which every page had the following "we may or may not be breaking the law by telling you this" disclaimer: "Assuming exempt to Section 16 and in compliance with company policy. For illustrative purposes only" JP Morgan was providing advice to corporate insiders on how to not only circumvent Rule 10b5-1, but to do so in a way that has the least possible stock price impact, or as JPM puts it "minimize negative market signal." And, of course, to take benefit of this, insiders would have to pay JPM for its PrISM product. After all, spending long hours finding out how best to breach the SEC's open loopholes and to facilitate insider transactions is expensive work. Invoices tend to come quite a few zeroes.

And here, in exquisite detail, is the guideline for why insider trading proceedings will not be initiated against a corporate person, if they have taken advantage of JPM's wonderful PrISM product.

[Rule 10b5-1] establishes “affirmative defense” – no liability if, before becoming aware of the material nonpublic information, insider:
– entered into a binding contract to buy or sell, or
– gave instructions to another person to buy or sell for the insider’s account, or
– adopted a written plan for selling securities

JP Morgan is happy to provide insiders with a peace of mind each and every time they decided to sell their stock, "for whatever reason," as long said insiders are paying their tithe to the SEC-Wall Street establishment.

And here are the broad guidelines for how insiders should be well on their way to shareholder funded, "information asymmetric" riches. After all, you have to love the "protection" provided by that bastion of integrity, JP Morgan, whose "dedicated team provides additional distance between insider and execution of trades, reducing appearance of impropriety."

Yet while the appearance may indeed be reduced, the impropriety sure as heck is still there.

So can anyone use this plan? Why yes, with the only caveat that at PrISM inception time, the insider has no material, non-public info. If subsequent to plan initiation, inside information is obtained and stock is sold (automatically, of course) nobody is the wiser.

  • Enter into a plan only when insider is not aware of material nonpublic information
  • Corporation must acknowledge the selling program by signing the sales plan

Lastly, just in case there is any confusion that JPM is merely the messenger here (for the SEC no less), the ultimate responsibility to prove lack of malfeasance lies with the insider, bringing numerous questions at to the ultimate legality of all such 10b5-1 plans.

The insider has the burden to prove compliance with the rule

We realize that the SEC is neck deep in enhancing its incompetence on so many different fronts, that to propose it should do something about evaluating its stance on 10b5-1 in a time of historic insider selling (and, as a corollary, the peddling of such products as PrISM by "reputable" investment banks who provide the benefit of "Protection" to insiders who nonetheless have the burden of proof in rule compliance) is simply presumptuous. After all, we are well aware that with its untrained and amateur staff and record budget, the SEC can only do one thing at a time, whether it is continuing its incompetence at catching the next Madoff, or rerequesting public opinion on such an issue as Flash, and, speaking of failed first attempts at public feedback on completely flawed initiatives, we do hope that in the not too distant future the SEC will also do a repeat public opinion survey on the much more relevant issue of the Supplemental Liquidity Provider NYSE initiative, where numerous disagreements seem to have slipped between the "cracks" of the SEC's highly trained professionals; don't worry SEC we are on top of this, and will shortly remind you much more vocally about the imminent need for SLP public opinion resolicitation.

In the meantime, corporate insiders should sleep soundly, knowing full well that the SEC and JP Morgan have their backs when they are selling billions worth of their own shares, whether it involved extensive knowledge of material, non-public information, or not. After all, the administration, the Wall Street complex, and the regulators are the first to smile upon such activities.

 

h/t Peter

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buzzsaw99's picture

Stocks are for asshats.

Anonymous's picture

True statement.

LoneStarHog's picture

The only true asset left to the common man that is not manipulated is the Green Tip!

cmazur's picture

True.  Don't forget 00.  Can't have enough of either.    

LoneStarHog's picture

Yup!  I use the Winchester Military-Grade 00 Buckshot in a Mossberg "Door Buster" Tactical Cruiser in 12 ga.

Sqworl's picture

Hello...operator, yes I would like to speak to Mary Shapiro...I'm sorry, she is on a conference call with her superior Mr. Dimon, may I take a message???? 

Anonymous's picture

Wow. God help us.

deadhead's picture

Thanks ZH....yet another nice piece exposing the underside of the dirty bellies slithering around cheat st.

how does that go again, Jamie Dimon?  Something like..."you're either in the club or out of it"?

 

 

Project Mayhem's picture

Jamie?  Hi it's Lloyd.  Oh, you're in the middle of a coke binge?  Ah, my apologies.  Yes yes, I know, you are the king.  King of the world!  I'm calling because I want to know when we are going to pull the plug on these middle class American idiots. . .

 

deadhead's picture

<insert deflation whale pic here>

Miles Kendig's picture

PM - I am sure you got this.  In case you missed it... Cheers.

http://www.medicalnewstoday.com/articles/166102.php

 

ilene's picture

Here's another one, by David Kirby who wrote Evidence of Harm.  I posted this at Phil's Stock World.   http://philsbackupsite.wordpress.com/2009/10/02/new-study-hepatitis-b-vaccine-triples-the-risk-of-autism-in-infant-

Eventually, I want to write more on the topic, there's a disconnect between what studies actually show and what the media claims - that it's proven that there's no association.  Many of the studies were done with MMR, which doesn't have thimerosal.  Also, studies finding no correlation are quite flawed in their design and methods. - Ilene

long-shorty's picture

As a doctor, it was frustrating at times that patients had such odd beliefs about their health on the basis of personal experience or poorly-done studies. It was also frustrating that physicians often failed to see the limits of studies--this is why docs had so many women on HRT before the big multicenter RCT, or some docs tried to treat all of their diabetics down to a HgbA1C of 6.5 but didn't realize the side effects they were causing.

These debates can rage for a long time and people can stick to their position even when it is has no merit.

The nice thing against markets is that one can have whatever ideas one wants, and you don't have to do that many hundreds of trades before it becomes very plain whose ideas are working and whose ideas are wrong, if the goal is to make money. I think it is safe to say, Ilene, that you don't manage a fund, at least not one that charges performance based compensation.

ilene's picture

long-shorty,

Here's another article which I moved up on my backup site for Phil's Favorites:  http://philsbackupsite.wordpress.com/2009/10/04/autism-vaccines-and-the-cdc/.   And no, I don't manage a fund.

 

Here's a few other articles for anyone curious:  http://www.rollingstone.com/politics/story/7395411/deadly_immunity,

http://www.boston.com/news/globe/editorial_opinion/oped/articles/2005/07/01/autism_mercury_and_politics/

 

 

Hephasteus's picture

Ya. They should stick to the best science. Have huge drug company develope a theory and then throw money at it till it get proved. I'll see you at the convention in Hawaii. We can discuss the merits of charging 100,000 dollars for procedures with .1 percent efficacy because expensive things are worth it while simultaneously berating intelligent people with 1 side of our hypocricy.

http://www.youtube.com/watch?v=sNT8SMlqLJA

Fish Gone Bad's picture

A friend of my family is a chiropractor.  She would go on and on and on about the evils of vaccines.  This is really hilarious considering chiropractors think they can cure disease by "cracking" people's backs.

Speaking of vaccinations, there appear to be two groups of swine flu people.  Those who do not want to get sick and those who think the vaccine will cause ______ (insert fear word). 

Anonymous's picture

amazing... actually unbelievable

lizzy36's picture

Tyler, you do have a way with words.

Like any good addict I am lying poolside (after about 2 hours of sleep) reading ZH

Good thing jamie dimon is the man who saved wall street! And also obama's go to guy!

Cistercian's picture

 Classic.Just when you thought the criminality could not be more obvious.

 

Anonymous's picture

The perfect legal defense against a charge of insider trading, "I follow Zero Hedge."

Anonymous's picture

http://www.stanford.edu/~alanj1/research.html

Stanford professor offers compelling evidence that 10b5-1 programs are actually a STRONGER signal than regular way sales because the insider has a plausible defense.

Exhibit A: CWTR. Chairman selling 250k/week. Gee, I wonder if he's going to allow anything bad to be said while that program is in effect. Sales/earnings miss as well as abrupt CEO resignation were quickly explained away. In 6 months, the stock will be $1. It's a borderline fraud and terrible business, but he's walking away with millions.

Assetman's picture

Yeah, my colleagues think that 10b5-1 plans don't mean a thing in terms of selling.

If you are selling 50% of your outstanding shares at a 10% clip every week for 5 weeks, you better keep your head on a swivel if you own the stock.

Tyler does a great job of highlighting that insider selling really doesn't have much of an impediment.  You might want to play accordingly.

sensate's picture

This is exactly what Mozillo, and countless others, used before the meltdown. When pressed about their stock sales, they all cited their previously-entered agreement to sell. And one by one, their firms went down.

Anonymous's picture

Just this morning I dropped off a rent check to my landlord. I dated it September 30.

AN0NYM0US's picture

From Nomi Prins

The Coming Bank Bust

http://www.thedailybeast.com/blogs-and-stories/2009-10-03/the-coming-big...

Nomi Prins is author of It Takes a Pillage: Behind the Bonuses, Bailouts, and Backroom Deals from Washington to Wall Street (Wiley, September 2009). Before becoming a journalist, she worked on Wall Street as a managing director at Goldman Sachs, and running the international analytics group at Bear Stearns in London.

Anonymous's picture

Holy cow she is hot.

Sqworl's picture

To Big to Fail was borrowed from our Government and extended to new financial order.

Lionhead's picture

Yes, this expose will definitely increase the demand for stocks and propel the market ever higher in the distribution campaign to novice investors. I can see thru the eyes of the Prism quite clearly. My "trust" in the system has been restored after reading this.

Anonymous's picture

The big loophole is that you can cancel your plan at any time, even based on insider information (since it means you didn't actually trade, so you didn't inside trade).

So plan to sell just before earnings, then cancel your plan once you see how things are going.

Miles Kendig's picture

How is that Blue Label and rail going down now Jamie?

geopol's picture

Sixteen tons, what da ya get, another day older and deeper in debt, st. peter don't you call me cause I can't go...... I owe my soul to the bankers in tow...

DA DA DA DA DA DA DA DA!!!

 

defender's picture

http://www.youtube.com/watch?v=Joo90ZWrUkU

That song has always been one of my favorites.  History doesn't repeat itself, but it sure does rhyme some times.

AN0NYM0US's picture

I am sure it is just me and my trusty old 80286 but I find that refreshing ZeroHedge.com is not as speedy as it used to be, the slowdown seems to correlate with bid.openex.net as it loads advertisements

Anonymous's picture

The rules should be changed so purchases/sales made by officers/majority shareholders of a company in any amount have to be reported electronically and IMMEDIATELY accessible to the public at the time the transaction takes place and not one day later.

Anonymous's picture

Great article. Pulitzer worthy, honestly.

To no one in particular I say:

Problem is, the ship is sinking and this is the Titanic, we all know it and there's no way to stop it. Everything being done is window dressing and attempts to buy time to prepare.

Should we all go down? Is that the inspired solution?

Put aside your self serving vindictiveness that can't see past how everything only affects the messiah that is yourself for a minute and try to see the big picture.

Trickle down is not a concept, it is a reality.

$1,000,000 split among a million people does nothing, goes nowhere, is the very definition of inflation.

$1,000,000 to a single person creates jobs, creates movement, creates opportunity.

$1,000 to a 1,000; $10,000 to 100, they only dilute the effect.

If you can't see that, I can't help you.

Is it fair? Hell no.

Does it help you? It's hard to see but it does, it really does. Let the rich have their fun, how does it affect your daily quality of life? Just be happy you have the porcelain pot to piss in that you do, the success of one has a lot to do with the lot of the rest.

If you don't think your life can get any worse, just wait till this hits in earnest and then maybe you'll see how much worse it could have been if the rich squirrels had not salted up their nuts in advance thus leaving you something to suck on a year or so from now when the grasshoppers are all left on the roadside.

Look at your job, your employer, their actions they are taking leading up to this catastrophe. If they are selling everything, you'll likely continue to have a job. If they are sitting on their hands and crying foul and dishonest you'll likely be standing in a soup line before this all over and done with.

Anonymous's picture

-9000 everyman points
over 9000 elitist points

Anonymous's picture

I mainly read ZH and find most commenters to have interesting and valuable comments. You are an absolute idiot!

Anonymous's picture

Your entire argument is contingent on the assumption that money is a directly transferable store of value, which by such definition is the discriminating metric by which all value is measured. It is not and it holds only the power that you give it, willingly.

Can my life get worse? Of course. By that same argument do I need to consume endless piles of worthless shit just 'cause some rich guy told me it keeps my neighbors in work?

Hell no.

1,000,000 to a single person serves the implicit interest of that specific individual, and no one else. Even Nelson Mandela is not exempt from the self-serving affliction known as the human condition.

Opportunity is neither created nor destroyed. It merely changes form, and is subjected to the interpretation of the opportunistic.

"Trickle down" is a load of bull.

If you can't see that, I can't help you.

Anonymous's picture

Tyler ....you are awesome....

Let´s clean it up already.....

...........................................

Where we need to go....

One day one wakes up to a true....first come....
first served exchange....

It is fully direct access electronic....

It is worldwide....all securities discover their
price on the new worldwide exchange....

No internal matching...

No dark pools....

No front running before public information....

All public information wiki based....

Margin is simplified....4:1...intraday or over night....

No account minimums....or maximums....

Size limitations per security....

All asset classes of all public securities are available....

There is no market fragmentation....

All transfers of name ownership pay the same nominal rate....no cost advantages regardless of size....

............................................

When one examines the current Worden software....and the BATS exchange....one knows that this possible today....

Just think of what is possible tomorrow....

...........................................

Let the current toxic assets go through public discovery....so that finally the problem can go through resolve....

All public products must go through public discovery....not the likes of BlackRock....GS or any of the majors....

Banks need to act like banks.....IB´s need to supply the exchanges with public names....

............................................

And finally the exchange traded securities should all trade universally tax free in the name of efficient capital....

............................................

TRUST is not going to happen....until the above happens....

.............................................

The alternative ...there is no other viable alternative....

If capitalism is going to be logical to the likes of a Chavez or other socialist mind....one has to provide good reason....

The fact is .....a truly nongameable exchange is one of the few ways wealth can be distributed....by merit....

Anonymous's picture

Time to form the ZH Militia..............

arnoldsimage's picture

i've imprinted zh on all my .556 and 7.62 rounds.

geopol's picture

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