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Insider Trading on Tender Offers Is Still Illegal

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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I like my insider trading coverage to be helpful, so here's a case that may be of interest to all the potential insider traders out there. NCR Corporation bought Radiant Corporation in a deal announced on July 11, 2011. Between May and July 2011, according to the Securities and Exchange Commission, Radiant's chief operating officer talked to a former fraternity brother of his and, "shared material, nonpublic information" with him "concerning NCR's potential acquisition of Radiant."

The fraternity brother, in turn, allegedly shared the information with his "close friend" of more than 20 years, Charles Hill. Hill, who "previously had never traded Radiant securities," then allegedly went out and bought a bunch of Radiant stock "in his two newly opened brokerage accounts, and in each of his three daughters’ custodial brokerage accounts." He sold the stock the day after the deal was announced, making a profit of about $744,000. The SEC is going after Hill for the money.

Remember U.S. v. Newman? That was the big federal appellate court decision from December, holding that you can't be guilty of insider trading for trading on a second-hand tip unless (1) the original tipper received a "personal benefit" in exchange for the illicit stock tip and (2) you knew about the personal benefit. Here, the SEC doesn't claim either of those things: There's no allegation that the COO got anything of value from his fraternity brother, and even if he did, there's no allegation that Hill knew anything about it. 

So how is this an insider trading case, after the Newman decisionThere are a couple of minor possible answers to that question. This is a civil case, not a criminal one, and perhaps the rules are different for civil and criminal insider trading.  Actually it isn't even really a civil case; it's an "administrative proceeding" in front of one of the SEC's own judges, where the rules are even more favorable to the SEC. Also, Newman is only binding in the Second Circuit (New York, Connecticut and Vermont), and these guys are in Georgia.

But the main reason that the SEC can bring this case is clearly that NCR bought Radiant using a tender offer. So Hill is not charged with regular insider trading. He's charged with 14e-3 insider trading. Rule 14e-3 says that you can't trade when you have material nonpublic information about a tender offer, if you got that information directly or indirectly from someone involved in the tender offer.  No personal benefit or misappropriation is required. Even an innocent tip from an insider -- or a not-so-innocent but uncompensated tip to his frat bro -- is enough to make it punishable insider trading. As long as it's a tender offer.

This is a weird distinction. There were two possible ways for NCR to acquire Radiant: a merger, or a tender offer. And there's not much difference between them. Thirty years ago, the difference was clear and important: If the companies agreed to a deal, they would do a merger, which would require the approval of the target company's board. If they didn't, then NCR would launch a hostile tender offer, which would go directly to shareholders, bypassing Radiant's board. But since 1985 or so, the poison pill has pretty much killed the hostile tender offer as a way to bypass the target's board.  To acquire a company, you now need the board to sign off on the deal, whether by tender offer or merger, though of course you can use hostile tactics -- public pressure, proxy fights, etc. -- to try to get the board's approval. So now the difference between tender offers and mergers is mostly pretty technical.

But insider trading ahead of a merger -- or an earnings announcement, or drug trial results, or whatever -- is now ... look, I don't want to say it's legal, but sometimes it's sort of legal! If you're in New York, and Newman doesn't get overturned, and you don't have any reason to know that the guy providing the information got a benefit for it, then, yeah, go ahead, insider trade, though please don't call me when you get caught.  On the other hand, insider trading ahead of a tender offer: Still just as illegal as it used to be.

I'm telling you this to be servicey, of course. I'm also telling you to propose a data project for some enterprising journalist or finance academic: If there are a lot more (fewer) tender offers, relative to mergers, over the next few years than there were over the last few years, then you could interpret that as evidence that public companies want to discourage (encourage) insider trading by the fraternity brothers and golf buddies of their executives.  

Mainly, though, I'm telling you this because it is a weird kink in the law, a place where the same behavior can be legal or illegal based on a seemingly meaningless technicality. Insider trading in front of a tender offer is not obviously more immoral or harmful than insider trading in front of a merger. I'd be surprised if Hill, "a self-employed real estate developer," ever gave any thought to the acquisition structure that NCR would use to buy Radiant. He knew (allegedly) that NCR would buy Radiant, and that the stock would go up. That was enough for him. But the SEC needed that one extra fact. If insider trading law is about leveling the playing field, increasing confidence in the market, and making investing fair for everyone, then why should the law turn on this distinction?

  1. I don't especially believe that, but Newman does talk about the beyond-a-reasonable-doubt standard of proof for criminal cases, so perhaps the SEC could find a way to limit it to those cases. 

    Disclosure: My wife is a criminal defense attorney and has had a client who is now facing a civil insider trading case. She is not representing him in the civil case. Nonetheless, my view that Newman applies to civil cases might be biased.

  2. More exactly:

    If any person has taken a substantial step or steps to commence, or has commenced, a tender offer (the “offering person”), it shall constitute a fraudulent, deceptive or manipulative act or practice within the meaning of section 14(e) of the Act for any other person who is in possession of material information relating to such tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from:

    1. The offering person,
    2. The issuer of the securities sought or to be sought by such tender offer, or
    3. Any officer, director, partner or employee or any other person acting on behalf of the offering person or such issuer, to purchase or sell or cause to be purchased or sold any of such securities or any securities convertible into or exchangeable for any such securities or any option or right to obtain or to dispose of any of the foregoing securities, unless within a reasonable time prior to any purchase or sale such information and its source are publicly disclosed by press release or otherwise.

    This rule caused some annoyance for Pershing Square in its efforts to get Valeant to buy Allergan, as we've previously discussed.

  3. We talked about this previously here. Further disclosure, my former employer invented the poison pill.

  4. Classically, tender offers tend to be faster, and mergers tend to have more flexibility in how you can pay people at the target company. 

    Also, in a hostile deal, launching a tender offer might help put additional pressure on the target board, as sort of a display of the bidder's seriousness. I don't really understand this, but people assure me that it's true.

  5. Kidding! I mean, definitely don't call me, that was serious, but also probably don't do it. That sentence was a quick jocular summary of my layman's view of what the law might be. Your mileage might vary, and might be in the direction of prison.

  6. Which would you bet on? My guess is that this has no effect -- that no one thinks about this in deciding on transaction structures -- but I am by no means 100 percent confident in that guess.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Tobin Harshaw at tharshaw@bloomberg.net