By Douglas Kelly
EverFi Lead Legal Editor
A Litigation Release by the US Securities and Exchange Commission (SEC) shows that insider trading is not relegated to just senior executives and CEOs. Everyday people, including employees, commit illegal actions that necessarily have broader ethical considerations. Ethical considerations are even less clear cut than the law, but just as critical to effective ethics and compliance programs.
Tipping a Relative
Tipping off a family member is a common act of insider trading. According to a March 2017 SEC settlement, an employee who worked at Merck (the “Insider”) learned that his company intended to acquire Idenix, another pharmaceutical. Additionally, the Insider agreed to Merck’s policies regarding insider trading and safeguarding confidential information. Nonetheless, the Insider told a relative, Hartung, about the deal.
However, the Insider advised Hartung that he, the Insider, couldn’t trade on the information as it would be “insider trading” to buy Idenix stock. Then, Idenix was trading between $5-$7 per share. After Merck made the public announcement of the acquisition, the stock price jumped to approximately $24 per share. The Insider called Hartung about the deal and Hartung sold his shares, making almost $60,000 profit. The SEC later busted Hartung.
Both the Insider and Hartung’s actions were illegal. The Insider breached his commitment of trust and confidence to Merck by telling Hartung about the material, nonpublic information that Merck was acquiring Idenix, which led Hartung to sell Idenix securities. It does not matter that the Insider knew that it would be insider trading to personally trade on the information, and advised Hartung of this. Although we don’t know why the Insider wasn’t named in Hartung’s complaint, it’s common for accused criminals to strike plea bargains. This was true in US v. Salman where a Citigroup investment banker tipped his brother, who in turn tipped Salman. The first two pleaded out, and Salman was prosecuted like Hartung.
Note that the Insider didn’t gain any monetary benefit from tipping off his relative. A recent US Supreme Court decision made monetary gains from tipping off a relative irrelevant under the law, as covered by my colleague Steve Treagus in his post Tips as Gifts: Insider Trading Liability for Family & Friends After Salman. Tips to relatives or friends are illegal gifts of inside information. The tipper doesn’t have to make any money from the tip.
Ethical Conduct and Dilemma
There’s an ethical side. The Insider broke his agreement of trust with Merck, which is immoral if not unethical. It also created a conflict of interest that put the Insider’s interest, a familial relationship, before that of Merck. Additionally, many consider insider trading to be “cheating” in the colloquial sense, where people like Hartung gain an unfair advantage over other investors in the marketplace who didn’t have access to the Idenix deal and thus weren’t able to profit from it like Hartung did.
But as Professor John Anderson questions in his law review article, “Greed, Envy, and the Criminalization of Insider Trading,” if insider trading wasn’t illegal, would it still be unethical?
One is only cheating . . . if one breaks the law to take advantage of others’ compliance with the law. In other words, insider trading only meets the definition of cheating if it is first illegal.
Basing conduct merely on the law, and not higher concepts of ethics, is a fail-safe way to torpedo companies’ compliance programs, which increasingly involve ethics and culture. On the other hand, social and familial mores guide our actions as well. Maybe Hartung traded on confidential information because he needed the money to support his family. Under the broad umbrella of ethics, it’s a plausible consideration. Some behavioral economists show that our behavior can be irrational. It’s easy to see how ethics can lead to confusion, a dangerous ingredient in modern ethics and compliance programs.
Effective Codes of Conduct
The best course of action is to anchor illegal and unethical actions in a company’s code of conduct or code of ethics. According to an article in the Journal of Business Ethics, both are
formal document[s] containing a set of prescriptions developed by and for a company to guide present and future behavior on multiple issues of at least its managers and employees toward one another, the company, external stakeholders and/or society in general.
For example, conflicts of interest policies may provide examples of what can constitute a conflict, and requires appropriate disclosure if one exists. But as my colleague Karen Peterson warns, a company needs to take the extra step to develop and implement a code of conduct for it to be effective. She describes:
Effective implementation requires ethical leadership and support, training, and continuous reinforcement and updates to keep the code current. Ongoing administration and reinforcement of code standards embeds an organization’s values into its culture, which stimulates ethical reflection and action, and encourages compliance so that employees speak up when they see others engaging in unethical behavior.
One wonders if an effective development and implementation of a company’s code of conduct would have stopped both Hartung and the Insider’s actions.
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