The US Securities and Exchange Commission recently launched a formal investigation into possible insider trading at the Cambridge, Mass.-based biotechnology firm Biogen Idec. In March, Thomas Bucknum, the company's chief counsel, resigned following reports that he had sold stock in the firm just as potential safety problems with the multiple sclerosis drug Tysabri were coming to light. When those safety problems were made public in February, the drug was withdrawn from the market and Biogen's stock plummeted more than 40% in a single day.
Other company officials reportedly sold stock before the public announcement, and charges could be forthcoming. The scandal has been disturbing to the biotechnology and pharmaceutical industries, in part because it echoes the debacle that rocked ImClone Systems not long ago. Sam Waksal, ImClone's former CEO, is currently serving an 87-month prison sentence after pleading guilty in 2002 to securities fraud, bank fraud, and other charges related to his misuse of insider information regarding the company's cancer drug Erbitux.
The headlines generated by these cases and others may not indicate an increase in illegal activity but rather in the level of media coverage and public interest. "I don't know of any evidence that the insider-trading problem is getting worse," says Russell Ryan, a partner with the Washington, DC-based law firm King & Spalding and former assistant director of enforcement at the Securities and Exchange Commission (SEC).
Nevertheless, politicians and government enforcers, spurred by the headlines and resulting public outrage, are getting tougher on companies and individuals caught skirting the law. "The penalties have gone up substantially," says Jeffrey Plotkin, partner with the law firm of Pitney Hardin in New York City and a former SEC enforcement attorney.
Dealing with insider trading used to be almost exclusively the purview of the SEC, which is a regulatory rather than a criminal agency, but branches of the government that specialize in criminal matters are becoming increasingly involved. "Now you can expect that in almost any insider-trading case, there is bound to be a parallel criminal case, where you're not only dealing with the SEC, but also the US Attorney's Office and the FBI, and that's when things get really dicey," Plotkin says.
IS IT EVER LEGAL?
The term "insider trading" has distinctly negative connotations, but in fact, it simply refers to the purchase or sale of a company's stock by one of its officers, directors, or employees, which in many cases is perfectly legal. When insider trades are handled properly, the SEC does not object. After all, company stock is often an important part of employee-compensation packages, and if that stock couldn't be traded, it wouldn't hold much value as a recruitment and retention incentive.
An insider who trades in company stock must tread carefully, however, to ensure they are in compliance with all SEC regulations: For example, the trades must be registered with the agency. The challenge can be sorting out when a trade is legitimate and when it's not. And while it's the CEOs who are most likely to see themselves on the evening news if a scandal breaks out, all employees who own stock are responsible for knowing and following the laws. "The insider-trading rules apply to any employee of a firm, not just the top management or the board of directors," says Stephen Bain-bridge, a corporate law professor at University of California, Los Angeles, who has authored a book on insider trading.
Tips for Companies
Establish a clear policy on insider trading and be sure it is easily accessible to everyone at the company.
Provide employees with contact information for a well-informed compliance person who can answer specific questions.
Proactively remind employees about insider-trading rules at regular intervals, as well as at sensitive times, such as just before an FDA decision on a drug application.
Publicly disclose key information about company events in as timely a manner as possible, preventing a knowledge gap between employees and other shareholders.
Educate all company employees, not just those with the most prestigious or visible jobs.
Understanding the minutia of the SEC's regulations can require the help of a good securities lawyer, but the basics are relatively easy to comprehend. In broad terms, the SEC defines illegal insider trading as taking place when a trade is made by a company insider "in possession of material, nonpublic information about the security." Insiders can also cross the line by tipping off friends or family members, as was the charge against Waksal after he called his daughter and father to warn them of an impending rejection from the US Food and Drug Administration (FDA).
Information is considered material if it gives the insider an unfair advantage, but employees shouldn't feel paralyzed in the market simply because they're more clued in to the inner workings of their firm. "Insiders will always know more about what's going on inside the company than the average Joe on the street, but it's not always considered disclosable, material, nonpublic information," explains Plotkin.
"From a legal standpoint, you look at the question of whether a reasonable investor who didn't have the same knowledge would have considered the information to be key to the decision to buy, hold, or sell the stock," Plotkin says. If the information wouldn't have helped an outsider, then the knowledge isn't considered to have given the insider an illegal advantage.
Still, material, nonpublic information doesn't have to be about an imminent announcement, such as a drug approval or the halting of a study. "It certainly could be material, nonpublic information if you just happen to know that the outlook about something is generally pretty good or pretty bad, and that information is not out there in the public," Bainbridge cautions.
If in doubt, the insider should sit out the trade, or at the very least seek expert advice. Bainbridge says trouble can ensue even if an employee genuinely doesn't believe his or her knowledge about an event to be material. "The SEC's analysis is going to be affected by hindsight," he says. "If you traded, the information came out, the stock jumped way up, and you made a profit, obviously, it's going to be easy for the SEC to try and show the information was material. Their argument will simply be, 'Well, once it was announced, the markets moved.'"
One way insiders can protect themselves is to set up a plan for their trades well in advance, notes King & Spalding's Ryan. "An executive at a company can put in writing a plan that says, for example, 'Every three months, I'm going to sell 20,000 shares on a regular basis, no matter what happens.' That way, you can sell stock into the market and have a defense if it's claimed that you were selling because you had bad news."
Tips for Employees
Familiarize yourself with your company's insider-trading policy. Ask questions if there is anything you don't understand.
Ask yourself: "Would the insider information I possess help an outsider decide whether to buy or sell the company's stock?" If so, the information is considered material.
Consider setting up an advance plan for selling shares on a regular basis.
Remember that you don't have to conduct a trade yourself for it to be illegal: tipping off family and friends is also a violation.
Err on the side of caution. When in doubt, sit out the trade.
There are complex SEC regulations governing such plans, so it's key to seek expert help in drafting them, he notes. In addition, timing is important. "If you already know material, nonpublic information, it's too late," so it's best to set up the plan soon after being hired or to wait for a material event to pass and then put the plan into writing "at the next available opportunity, after all important information is out in the public."
To curb both intentional and inadvertent violations, employers should provide resources to help employees understand and comply with insider-trading rules. Failure to do so leaves a firm vulnerable, because companies can be held vicariously liable for employees' illegal insider trading if they fail to take adequate steps to prevent it, Plotkin notes.
Such precautions may be of particular importance in the biotech arena, since the industry's lifeblood is small, young companies – which are just the kind that can be most prone to insider-trading difficulties. "A lot of smaller companies are dependent on one or two major drugs or products, and the fortunes of the company may rise or fall with those products, so advance knowledge of what's happening with them is [perhaps] more valuable than in other industries," says Ryan.
Smart companies will proactively remind employees of the rules at sensitive times, such as when an impending FDA decision or the release of important data is likely to affect stock price, Ryan adds. "If there's something pending that's not yet public, whether it's good or bad, a lot of companies will send an internal message to top executives, or maybe even the whole company, to say that until further notice they are not allowed to buy or sell the company's stock in the market," he notes.
In addition, employees should know exactly where to turn when they have questions about the advisability of a trade. "Insider-trading law is a very dense field, and there are a million and one permutations," Plotkin says. "Every company should have an identifiable policy or compliance person who can tell employees whether a purchase or sale of stock should be avoided or whether it's OK to go ahead and do it."