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