Risk & Compliance

All in the Families

The SEC is aiming to sniff out improper relationships, including insider trading, between hedge funds and the companies they invest in.
Alix StuartMay 1, 2008

Pssst…Looking for a stock tip? So are federal investigators, and their efforts may have ramifications for CFOs. A recently reinvigorated Securities and Exchange Commission task force, having brought charges against 11 Wall Street insiders and three hedge funds a year ago, is now paying close attention in the wake of the Bear Stearns collapse and other Wall Street stumbles. “Any hedge fund or other large investor that thinks it will get away with dishonest and unfair dealing in our markets will face the concentrated resources of a relentless SEC,” chairman Christopher Cox said in February. The FBI is also looking for illegal insider trading, as part of a criminal investigation into 14 companies connected with the subprime-mortgage crisis.

C-suite officers connected to hedge-fund companies could feel the heat because, as Bruce Karpati, head of the SEC task force, says, “one aspect we look at routinely in reviews of institutional investors is strategic relationships,” such as those with clients who have high-level connections to public companies.

Relationships don’t necessarily need to be strategic, however. Former hedge-fund executive Rubin Chen, for example, is currently serving an 18-month jail term for trading on information he gleaned from wife Jennifer Wang, a former Morgan Stanley finance executive (also facing jail). In fact, nearly a quarter of the insider-trading cases recently brought by the SEC have been so-called pillow-talk cases, in which spouses or other family members shared and subsequently acted on inside information.

The recent boom in M&A has created plenty of opportunity — many of the cases revolve around trading before big deals. For example, a former Dow Jones board member, his friend, and the friend’s daughter are paying more than $24 million to settle SEC charges that they traded illegally ahead of the publishing company’s acquisition by News Corp.

How can CFOs protect themselves? Handling trades through a 10b-5 plan will usually shield a CFO from personal allegations of insider trading, lawyers say, but executives still need to take precautions against wittingly or unwittingly abetting others. Proctor & Gamble CFO Clayton Daley, who handles the consumer giant’s M&A department, says he has had to abandon his wife without explanation on several vacations when deals have come up. He also charged her with giving an appropriately benign explanation to family members when he had to race to the office the day after Thanksgiving to address the 2005 acquisition of Gillette. “You have to deal with everyone outside the company the same way,” he says, and “have a very clear idea as to what you can and can’t say.” Perhaps with an emphasis on the “can’t.”

An increasing number of the SEC's insider-trading cases involve friends and family.

Tipping Points
Who talked? Alleged gains Outcome
Consultant William G. Williams allegedly traded on quarterly earnings information that he obtained while visiting an unnamed college friend who is now an officer at a division of Chemed. $28,550 $58,256 settlement
Former Dow Jones board member David Li Kwok Po,
a close friend in Hong Kong, and the friend’s daughter and son-in-law allegedly traded ahead of the announcement about News Corp.’s buyout offer.
Stood to make over $8 million, but the SEC froze their bank accounts In total, the four paid more than $24 million
to settle.
Nathan Rosenblatt, former audit-committee member of NBTY, allegedly tipped his close friend Morris Gad about the company’s upcoming quarterly
revenue and earnings shortfall. Gad sold his entire position of NBTY stock, sold the stock short, purchased put contracts, and sold call contracts through the custodial accounts of his three children prior to NBTY’s release of its results.
Gad made $399,187.40 in profits and losses
Gad was ordered to pay $896,093 to settle.
The SEC charged two former PricewaterhouseCoopers employees, friends Gregory B. Raben and William Patrick Borchard, with trading on client information ahead of acquisition announcements. Raben gained about $20,000. Together they are paying close to $70,000 to
Former Morgan Stanley finance executive Jennifer Wang and husband Rubin Chen, a hedge-fund analyst, traded based on inside information about deals of Morgan Stanley clients, according to the SEC and the Department of Justice. More than $600,000 Each was sentenced to 18 months in jail.
Source: SEC litigation releases

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