Risk & Compliance

Did Amazon’s CEO Pass the Smell Test?

Can CFOs stop their bosses from making suspicious insider trades?
Joseph RadiganMarch 13, 2001

The ferocity of the insider trading controversy picked up steam when The New York Times reported last week that Amazon.com CEO Jeff Bezos is being investigated by the Securities and Exchange Commission for his sale of up to 800,000 shares in February.

It’s far from certain that Bezos actually ran afoul of securities laws on insider trading. In fact, several securities lawyers told CFO.com that they believe the SEC would have a hard time proving its case, primarily because Amazon’s stock rose immediately following Bezos’s disputed trades. Although the stock has deteriorated since then, that may not be enough to support the SEC’s allegations.

An SEC spokesman would neither confirm nor deny the existence of an investigation, and an Amazon spokeswoman said, “We have no information, nor have we been contacted about any investigation.” An assistant to Warren Jenson, Amazon’s CFO, said he was unavailable for comment.

The Amazon spokeswoman says the company has a trading window every quarter that applies to all employees, and it normally opens following the release of the company’s quarterly results. This quarter, the window opened on Feb. 2 and closed on Feb. 28. Bezos’s trades were reviewed by Amazon’s legal department, like those for any employee.

Still, at the very least, the incident raises the question of what steps CFOs can take to ensure that no senior executives from their firms run afoul of insider-trading laws. Much of what they do may depend on how their firms apply a ruling the SEC issued as part of its Reg. FD statement last October. Called 10b5-1, the rule amends the original Exchange Act of 1934 and spells out the steps corporate officers need to take to avoid running afoul of insider trading rules.

Harry Weiss, a partner with the Washington law firm of Wilmer, Cutler & Pickering, says that under 10b5-1, corporate officers may trade, provided they’ve given advance notice of their plans. But there’s a fine line executives have to walk.

According to the SEC’s summary, 10b5-1 was issued to resolve the differing interpretations of insider trading rules among the agency and the federal courts. Regulators have maintained that if a trader is in “knowing possession” of non-public information, he or she may be liable, but the courts haven’t consistently backed that interpretation.

Under 10b5-1, the SEC says an executive must demonstrate that a stock trade was planned in advance of that executive’s receiving material, non-public information.

Click here to read the SEC’s final ruling on Reg. FD, including its explanation of 10b5-1.

But at this late date, after so many years when insider trading scandals have grabbed headlines, it’s nothing short of remarkable that the CEO of a company with such a high profile as Amazon could find himself in an insider trading jam.

“They all have something in their handbooks that says something like ‘Thou shalt not trade on insider information,’” says Ronald Marmer, a partner with the Chicago law firm of Jenner & Block, and a co- chair of the American Bar Association’s Securities Litigation committee.

Still, despite those rules, insider-trading guidelines are followed as much in the breach as they are in the observance.

“With any public company, we encourage them to adopt a process by which directors, officers, and employees with access to sensitive information are required to clear all trades,” says Karl Groskaufmanis, a securities lawyer in Washington. “That creates a screen for all trades.”

While most public companies do at least have some policy in place, unfortunately, not all of them follow their guidelines, says Groskaufmanis, a partner with the Washington law firm Fried, Frank, Harris, Shriver & Jacobson and the chairman of the ABA’s Ad Hoc Committee on Public Company Information.

All too often, the policies are as porous as a slice of Swiss cheese. Even at firms where the house counsel does not report to the CFO, securities lawyers say, the CFO ought to be apprised of any insider trade reviewed by the chief counsel.

Still, no matter what precautions are taken, any time a senior executive sells shares it can raise eyebrows. Last summer CFO Magazine advised readers to generally hold on to their own shares, particularly when the stock is caught in a downdraft.

Marmer says there are three general avenues companies take. Under the first, executives may set up a regular divestiture program, and sell a set amount of shares at a predetermined time on a regular basis. For example, Microsoft chairman Bill Gates, for many years, sold 1 million shares every quarter.

Paul Elliott, an analyst with Thomson Financial/First Call, says Gates’ trades are so regular, that no one follows them closely any more. But in general, executives are reluctant to lock themselves into regular trading schedules, because that doesn’t leave them any room for flexibility, particularly in a down market.

Still, as far as regulators are concerned, if an executive is committed to an autopilot form of selling, then that executive is unlikely to find herself or himself in hot water.

Companies can also, like Amazon did, establish finite trading windows that last for a short period each quarter following the release of the quarterly financial results. But, Marmer says, “The CFO has to be particularly cautious, because there’s the criticism that the financial information is stale. You don’t want the window period viewed as a sham.”

Under the third option, executives can submit their trading plans as they arise. But Marmer says this set-up can be exceptionally troublesome, particularly if an executive with knowledge of a merger or major customer contract hasn’t disclosed it to the counsel’s office.

Marmer says it’s possible to imagine a scenario where neither the corporate treasurer nor counsel have been informed about a pending merger. If the treasurer has already received the legal clearance to make a trade, and profits significantly once the merger has been announced, the SEC is certainly going to be skeptical about the trade.

Regulators may not be able to successfully prosecute either the treasurer or the counsel, particularly if they can make a convincing defense that they had no knowledge of the merger. But Marmer says the risk of such an example ought to be enough incentive to make sure that CEOs and CFOs keep their house counsels apprised of all material activity involving the company.

“The CFO has to be careful that if he has sensitive information, that he’s communicated it to the chief legal officer,” Marmer says. “There could be an instance where the CFO calls the chief counsel and says, ‘Don’t approve any trading, I can’t tell you why, but don’t approve anything.’”

A company might argue that if it took such a step, it would create rumors. But Marmer says no matter how tumultuous the rumors, they’re still preferable to an insider trading case.

“You have to tell them, ‘That’s how life works in a fishbowl, guys,’” he says.

Exactly where Amazon’s Bezos stands at this stage is far from clear. The basic facts are this: On Jan. 26, Amazon executives received an advance copy of a sharply critical report by Lehman Brothers convertible bond analyst Ravi Suria. The report raised the likelihood that Amazon’s working capital may run out before the end of the year, and that the company’s suppliers may cut it off as their concerns grew about the firm’s survival.

The company released its year-end results on Jan. 30, and the normal quarterly window for insider trades opened. On Feb. 2, CEO Bezos submitted a filing to the SEC that he planned to sell 375,000 shares, and on Feb. 5, he notified the agency that he planned to sale another 425,000 shares, netting approximately $6.1 million with each trade.

Finally, on Feb. 5, Suria’s report was published by Lehman Brothers.

Since the SEC will not publicly discuss the existence, or non-existence for that matter, of an investigation into Bezos’s sales, it’s by no means certain that the sales were illegal. According to the securities lawyers contacted for this story, as long as Bezos cleared his activity with Amazon’s counsel in advance, the SEC would have a hard time bringing a case against him.

A wild card in determining the strength of the SEC’s allegations is Bezos’s own opinion of Suria’s report. State of mind is virtually impossible to prove in a court of law. But some of the other events leading up to the release of the report at least create the impression that Amazon insiders believed that the report would materially harm their company.

The New York Observer reported in mid-February that John Doerr, an Amazon outside director lobbied Lehman Brothers management to kill the report. Doerr is a partner in Kleiner, Perkins, Caufield & Byers and one of the most influential venture capitalists in Silicon Valley. While it’s not unusual for companies to ask investment banks to delay, if not quash, unfavorable analyst reports, the sequence of events at least creates the appearance that something unusual was at work.

An assistant to Doerr said he was unavailable for comment, and the Amazon spokeswoman would not comment on “private conversations” involving the firm’s directors.

Groskaufmanis says Doerr’s lobbying of Lehman’s management could support the SEC if it decides to make a case against Bezos.

In the meantime, Suria’s report has only fueled doubts about the company’s health. For more than a year, The New York Society of Security Analysts has had a continuing forum on corporate governance devoted to Amazon.com. Last week, the forum’s chairman, New York investment banker Gary Lutin, wrote to Bezos and asked him to publicly disclose the basis for the company’s belief that its funding will remain adequate through the remainder of the current fiscal year. Click here to read the NYSSA letter to Amazon’s CEO.

The Amazon spokeswoman could not say when the company planned to respond to the NYSSA.

As for Bezos himself, perhaps there is only smoke and no fire to the allegations that have been raised. But over the weekend, he told the BBC, “I wouldn’t invest in Internet stocks.” That’s easy for him to say after he’s pocketed $12 million.