TRADING BEFORE HEINZ BUYOUT TRIGGERS SEC INVESTIGATION

On Feb. 14, H.J. Heinz Co. announced that Brazilian company 3G Capital and Warren Buffett’s Berkshire Hathaway Inc. intended to buy out the company for $28 billion. The stock market responded swiftly to the announcement and shares of Heinz stock increased in value by 20 percent in one day to $72.50 per share.

But the Securities and Exchange Commission (SEC) was watching and it wasn’t happy with what it saw: indicators of federal white-collar crime. The day before the announcement, Heinz stock traded at double the average daily volume for the month prior. Close to 3.5 million shares in the ketchup company traded hands on Feb. 13, a number not seen by those watching Heinz stock since it had announced its quarterly earnings in November.

Leading up to the announcement, block trading of Heinz stock had also shown an uptick. Block trades are orders of 10,000 or more shares of a single company’s stock. Two block trades were made on Feb. 11, three on Feb. 12, and 15 on Feb. 13.

In response to what it considered suspicious trading activity, the SEC filed a complaint on Feb. 15 and requested that the court freeze the accounts of unknown traders who had purchased call options of Heinz stock the day before the buyout was announced. The unknown trader(s) purchased more than 250,000 options, which gave them the right to purchase Heinz stock at $65 per share through June; following the buyout announcement, the value of that $90,000 investment skyrocketed to $1.8 million.

What Is Insider Trading?

A highly suspicious trade is not necessarily an illegal trade. In fact, insider trade is not necessarily an illegal trade. According to the SEC, the phrase “insider trading” includes both legal and illegal trading activity. Insiders such as directors, officers, and employees can buy and sell their own company’s stock, despite technically being “insiders.” This is not illegal insider trading.

Using material insider information to make a trade before the information has been released to the public is illegal and is considered a type of securities fraud.

The Securities Act of 1933 and the Securities Exchange Act of 1934 are key pieces of federal legislation that dictate what is prohibited as insider trading. Both were passed in response to the stock market crash of 1929 and intended to stop practices that were believed to have contributed to the crash.

• Section 16(b) of the 1934 Act puts restrictions on short-swing profits by insiders. Directors, officers and those who own more than 10 percent of a company’s stock must return any profit realized on the purchase and sale of company stock if both transactions are completed within six months of each other.
• Section 10(b) of the 1934 Act prohibits the use of fraudulent or manipulative means in the purchase or sale of stock.

Rules 10b5-1 and 10b5-2 were later passed to further define what constitutes illegal insider trading under Section 10(b).

• Rule 10b5-1 clarifies that a person who is aware of an insider, nonpublic information when making a trade is trading on the basis of insider information for purposes of illegal insider trading rules. It also carves out exceptions to illegal insider trading that include trades made pursuant to a pre-existing contract or purchase plan or based on a good-faith instruction to purchase the stock.
• Rule 10b5-2 clarifies the misappropriation of insider information as a form of illegal insider trading. For example, if during the course of employment, an employee learns insider information from his or her employer that another company is being bought out and uses that information to trade stock, he or she could be found guilty of illegal insider trading.

When material, nonpublic information is intentionally given to an investor, all investors must be informed at the same time. This is called Regulation FD or Regulation Fair Disclosure.

Who Can Commit Illegal Insider Trading?

Directors and officers of publicly traded companies must be aware of insider trading prohibitions and be careful that nonpublic information gained as a member of the board or as an executive does not filter into their stock purchases or sales. But it is not just those in positions of authority within a company that may be held liable for insider trading; any of the following may commit illegal insider trading:

• A tipster. Someone who knows nonpublic, inside information then shares that with another person who uses that information to buy or sell stock. The tipster does not have to directly engage in trading to be found guilty of insider trading.
• A family member. A person who receives nonpublic, material information about a company through a personal relationship and then acts on that information by buying or selling stock may be guilty of illegal insider trading.
• A stockbroker. If a stockbroker is given material information about a company that is not available to the public and then uses that information to make stock trades, he or she may be guilty of insider trading.
• An employee. An employee of a company may learn of material, nonpublic information about his or her employer in the course of employment. Using that information to trade stocks is illegal insider trading.
• A government employee. Those who work for the government, particularly in the securities industry, may become aware of material, nonpublic information. If that information is used to buy or sell stocks, that may amount to illegal insider trading.

Trading by insiders is not illegal once material information is made available to the public. In the Heinz example, trading on Feb. 14, after the announcement of the buyout, by an insider at the three companies involved would not have amounted to illegal insider trading. Insider trading protections are meant to keep investors on an equal playing field.

SEC Enforcement Of Anti-Insider Trading Rules

The U.S. economy appears to become more and more entwined in the stock market and securities industry each day. Because of this reliance on the market, the SEC has made enforcing anti-insider trading rules a top priority. According to the SEC, the agency pursued enforcement actions against 131 individuals and entities in 2012. In total, that consisted of 58 enforcement actions.

Over the past few years, the SEC has been focusing greater resources on rooting out securities fraud in the form of insider trading. The federal agency filed more insider trading enforcement actions between 2010 and 2012 than in any other three-year period.

If you are being investigated for insider trading violations or other securities fraud, you should speak with an experienced white-collar crimes defense attorney about your rights as soon as possible. The government has substantial resources behind it to pursue a case against you and you will need a strong defense strategy to preserve your assets, your reputation, and your lifestyle once the feds begin investigating.