Panda Express's Life Coach Might Have Overshared a Bit
As you may know, this column never contains legal advice, but it does sometimes contain what you might call life advice. Specifically the following life advice: If you have inside information about an upcoming merger, don't buy short-dated out-of-the-money call options on the target. That's how they get you! Richard G. Condon is not, as far as I know, a lawyer, but he is a "life coach," 1 and he seems not to have passed on that particular piece of wisdom to his acolytes:
The SEC alleges that Richard G. Condon, a consultant to Panda Restaurant Group, tipped Jonathan Ross with confidential details about the bidding process for P.F. Chang’s that he learned while providing executive coaching services to Panda’s top management executives. Panda was involved in the bidding process, but did not ultimately make a tender offer for P.F. Chang’s. According to the SEC’s complaint, Ross then purchased risky, out-of-the-money call options for P.F. Chang’s securities and tipped his friend Ali Sagheb so he could do the same. Ross, Sagheb, and a third trader who is now deceased immediately sold their options for a combined total of approximately $300,000 following a public announcement about the tender offer by a third party for ownership of P.F. Chang’s.
That's from the Securities and Exchange Commission enforcement action against Condon. (Condon's lawyer "called the SEC's allegations 'speculative,' adding that his client 'made no money on a corporate deal that analysts and media sources had publicly predicted.'") The SEC's complaint alleges that in July 2011, Condon agreed "to provide executive coaching to Panda’s co-chief executive officers, senior management team, zone vice-presidents of operations, and other employees," for a fee of $10,000 a month. "Condon conducted individual coaching sessions with both of Panda’s co-CEOs, each of whom placed a great deal of trust in Condon," apparently from the beginning, because he was in the room for this:
In July 2011, Panda’s executives began discussing a possible acquisition of PF Chang’s, which Panda management code-named “Project Potsticker.”
On August 8, 2011, Condon attended a Panda senior team meeting during which Project Potsticker was discussed in detail.
At that August 8, 2011 senior team meeting, attendees – including Condon – were cautioned to keep discussions concerning the potential acquisition of PF Chang’s on a “need-to-know” basis, and to use the “Project Potsticker” code name at all times in both oral and written communications.
One of the great clichés of business reporting is that merger negotiations always take place over late-night dinners of takeout Chinese food, and what do you think they ate when they were plotting Project Potsticker? 2
Anyway Project Potsticker was extensively discussed during Panda's "operations leadership conference" in September 2011, which Condon of course attended; Condon called and texted Ross several times before and during the conference; and Ross and Sagheb bought PF Chang call options after hearing from Condon. Shortly after the conference, Condon had lunch with Schultz, and Schultz bought a lot of PF Chang stock the next day. In October, Potsticker fell through, Condon called and texted Ross, and Ross and Sagheb sold out of their call options, avoiding a loss. In the spring of 2012, PF Chang invited Panda to a bidding process, Condon "was briefed on the resumed acquisition discussions," he talked with Ross and Schultz, and Ross, Schultz and Sagheb bought more call options. Ultimately Centerbridge announced a $51.50 per share tender offer for PF Chang in May and completed it in July. If you bought short-dated out-of-the-money call options in April, and sold them in May, as Ross, Schultz and Sagheb did, you made out pretty well; combined they made about $300,000 in the spring. 3
As Condon's lawyer points out, this is a pretty speculative case: The SEC has circumstantial evidence of the timing of phone calls and options trades, but no direct evidence of what was said. Schultz died in 2014, and he, Ross and Condon refused to answer SEC questions about their trading. Sagheb settled with the SEC, agreeing to pay back $19,829, but he never seems to have talked directly to Condon. There's one other piece of circumstantial evidence -- Condon was asked directly by Panda's lawyers if he know a "Schultz, H. and/or T.," who traded in PF Chang stock, and denied it after talking to Schultz repeatedly 4 -- but not exactly a smoking gun.
But never mind the evidence right now, let's talk about the SEC's legal theory. 5 You might notice that Condon didn't make any money off of this alleged scheme. He (allegedly) tipped Schultz and Ross, but he never traded himself, and there's no allegation that he got any kickbacks from their trading. Insider trading law has traditionally required that, for a tipper (and thus his tippees) to be liable for illegal insider trading, he needs to have received some "personal benefit" from giving the tip. And the U.S. Court of Appeals for the Second Circuit, in New York, recently held, in U.S. v. Newman, that that requirement is real: "This standard, although permissive, does not suggest that the Government may prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature," though the government is appealing that holding to the Supreme Court.
Here the SEC sort of waves at facts that might imply a personal benefit. "In 2011, Condon and Ross discussed the possibility of opening a bicycle exchange business together," and "Ross provided copy-editing services for Condon’s executive coaching business, for no apparent fee." Schultz -- a reality-TV producer responsible for "Extreme Makeover" and other shows -- "invested in two of Condon’s businesses, a restaurant venture and a company called Botanicx"; the Botanicx investment occurred after the PF Chang trading. But the SEC doesn't really rely on the copy-editing and the investments. Instead it accuses Condon of "tipping Ross and Schultz with material non-public information misappropriated from Panda with the intent to benefit them" (emphasis added). To benefit them, not himself.
It's notable that this case was brought in California federal court. The Second Circuit's Newman ruling isn't binding in California, which is in the Ninth Circuit, and there's a recent Ninth Circuit case holding that "Proof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading." 6 Newman might also say the same thing -- it contains language saying that the "personal benefit" to the tipper may include "the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend," and or "an intention to benefit the" tippee -- though it is not especially clear. 7
So perhaps this is the sort of case that the SEC can now bring in California, but not in New York. I would like to at least hope that that's not how the law works, though. And there are other ways to distinguish the cases. The problem in Newman was not really whether the tippers -- investor relations and finance employees at Dell and Nvidia -- received a personal benefit from their tipping. The real problem was that it's not clear whether they tipped off investors to nonpublic information for good business reasons or corrupt personal reasons. If it was for personal reasons -- if they tipped the investors in exchange for a bribe, or out of friendship, or whatever -- then that seems like a violation of their duty to the company. (And remember that insider trading isn't about fairness, it's about theft; a tip for personal reasons is like stealing from the company.) But if it was for business reasons -- if they tipped the investors because they wanted, on behalf of Dell/Nvidia, to encourage the investors to invest, on behalf of their funds, in Dell/Nvidia -- then it is not insider trading. It might not be fair, and it might well be a violation of Regulation FD -- companies aren't supposed to share material nonpublic information with favored investors or analysts -- but that's the company's problem, not the investor's. Insider trading isn't about guaranteeing fairness; it's about protecting a company's information from employees and contractors who want to use it for their own benefit.
That is a very difficult line to police when, as in Newman, the tipper works in investor relations and is dealing with an institutional investor. How do you tell whether information was passed as part of the job or as part of a corrupt personal relationship? In Newman, a Dell investor relations employee, Rob Ray, talked to a Neuberger Berman analyst, Sandy Goyal. Like any two humans who have business dealings with each other, they had some personal relationship; they were cordial on the phone, talked about vacations, etc. The prosecutors' theory was that the tips came out of the personal relationship, not the business dealings, but there is no particularly objective way to tell. The "personal benefit" test is a nice simple bright-line way to check: If Ray got a personal benefit, it's insider trading; if not, it's not.
But outside of the context of a company employee talking to an institutional investor, it's much easier to tell which was which. 8 Whatever else was going on here, it is hard to imagine that Panda's executives' life coach needed to share information about an upcoming merger with a reality TV producer as part of his work for Panda. If he was tipping these guys, it was for personal reasons, not for business reasons, and it's not so important whether those personal reasons involved a benefit for him or just the warm feeling of helping his friends make money. The trick, I think, is that if there's an argument that the information was shared for a legitimate business reason, then proving a personal benefit for the tipper is the most sensible way for the government to disprove the legitimate business reason. If there's no argument for a legitimate business reason -- if the insider is just tipping his friend or relative or golf buddy -- then the personal benefit is less important.
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According to the SEC, "Condon worked for 21 years at Landmark Worldwide, a personal training and development company, and is an experienced 'life coach.'"
Though not without risk; I found this charming:
Two days after Ross and Sagheb completed their PF Chang’s option trades, Ross wrote the following email to Sagheb, with the subject line, “peanut butter & jelly ….”:
you know, i was just thinking about a bug in the ointment: what if they announce, but the price is lower than we think. what if they say buyout at 45, or 40?
i guess that’s the risk reward.
Because regulators notice when people trade short-dated out-of-the-money call options just before a merger announcement! Panda got a Finra inquiry with a "name recognition list," in which Finra "asked Panda to report back on whether those at Panda who had been aware of the potential PF Chang’s acquisition knew anyone on the name recognition list." Panda sent the list to Condon, and this happened:
The name recognition list included the entry, “Schultz, H. and/or T,” located in Pasadena, California.
Schultz’s wife was named Tana. At the time of the FINRA inquiry, Schultz and his wife lived in Pasadena, California.
Beginning at 9:15 p.m. PST, Condon and Schultz called one another eight times in the next 90 minutes.
In between calls with Schultz, Condon also telephoned Ross, at 9:25 p.m. PST. When Ross returned his call at 9:44 p.m. PST, he and Condon spoke for 20 minutes.
The following morning, on September 8, 2012, Condon phoned Ross again and spoke with him for 20 minutes, beginning at 9:02 a.m. PST.
At 10:13 a.m. PST, Condon responded to Panda’s email and falsely stated that he did not know anyone on FINRA’s name recognition list.
Ten minutes later, at 10:23 a.m. PST – and having just lied to Panda about not knowing a trader identified as “Schultz, H.” – Condon called Schultz and spoke with him for three minutes.
I mean. That doesn't look great?
In the text we'll talk about personal benefit, but down here let's also talk about misappropriation theory. Condon is not what is called in the law a "classical" insider: He was not an executive of Panda. Instead, he "owed a fiduciary duty of trust and confidence" to Panda not to disclose its inside information, as the SEC argues here. On the facts that seems pretty obviously correct: He had a consulting agreement with Panda, "the consulting agreement also contained a section entitled 'Confidential Information,'which prohibited Condon from 'disclos[ing] Panda’s Confidential Information to any third party, without the advanced written consent of Panda,'" and he was at a meeting where "Panda’s in-house attorney also educated the team about securities laws and regulations prohibiting insider trading, and instructed them not to talk to anyone about Panda’s interest in acquiring PF Chang’s."
But of course a lot of misappropriation cases don't involve written consulting agreements with confidentiality provisions. The SEC and prosecutors have notably argued that a "duty of trust and confidence" can arise from being an executive's golf buddy. (They got a criminal conviction in that case.) Many misappropriation cases are weird because, rather than stealing information directly from the company, the misappropriator steals it from an executive who probably wasn't supposed to share it with him. (Like, the golfing executive wasn't guilty of insider trading, because he discussed his work problems with his golf buddy for advice and stress-release purposes, not so the buddy could trade. But it's still not best practices to discuss material nonpublic information with your golf buddy.) I am looking forward to the day when a corporate executive goes to a life coach without his company's knowledge, and blabs about a merger, and the life coach trades on it.
Right near those gift and intent-to-benefit stuff are some famously inscrutable sentences:
To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades “resemble trading by the insider himself followed by a gift of the profits to the recipient,” see 643 U.S. at 664, we hold that such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.
While our case law at times emphasizes language from Dirks indicating that the tipper’s gain need not be immediately pecuniary, it does not erode the fundamental insight that, in order to form the basis for a fraudulent breach, the personal benefit received in exchange for confidential information must be of some consequence.
Does that mean that an intent to benefit the tippee is enough, if your relationship is close enough? Or do you need to expect something from the tippee in return, even if indirectly?
Well, there are other contexts where it's hard. For instance, if an analyst and a trader at the same bank talk about the analyst's research reports, is that a theft of the inside information in those reports? Or are they talking as part of their jobs? The way to decide, ruled an SEC administrative law judge recently, is by using the personal benefit test. As I've said previously:
But you get the idea: If there's no possible legitimate business purpose for the tip, if it's obvious to everyone that this was an exchange of secret information between close friends, it's illegal. If it occurs in, or around, or plausibly close to, the ordinary course of investor/company interaction, it's not a crime. Even if you went to school together.
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