On March 29, 2013, the Securities and Exchange Commission (SEC) announced the settlement of what appeared to be a routine insider trading case involving two traders. For foreign traders, the case is a wake-up call that the SEC is watching and will take action against violators, wherever they are in the world. Moreover, the case reveals the SEC’s patience in finding the insider traders and their courage in taking action. Indeed, the case may also serve as an investigatory template for the SEC’s global policing of U.S. securities laws in connection with insider trading violations by foreign traders.
While the settlement was recent, the case started in July 2012 when the SEC filed and obtained an emergency order to freeze multiple trading accounts in Hong Kong and Singapore related to suspicious trading in the securities of Nexen stock. Nexen is a global energy company headquartered in Calgary, Canada. On Monday, July 23, 2012, Nexen and CNOOC issued an announcement that CNOOC had entered into an agreement to acquire Nexen. CNOOC is an energy company incorporated and headquartered in Hong Kong, China. According to the SEC’s complaint, “[T]he deal price of $15.1 billion, or $27.50 per share, represented a premium of 61 percent over Nexten’s closing price on the preceding trading day, July 20, 2012.” Following the announcement, as you would expect, the stock price rose nearly 52% over the previous trading day’s closing price and the volume spiked to approximately 141.3 million, which was an increase of over 4,800% over the previous trading day’s volume. The SEC had clear materiality here and a huge net of potential insiders.
Remarkably, within days, the SEC made the following preliminary determinations: 1) there was suspicious trading coming from Well Advantage, a British Virgin Islands company headquartered in Hong Kong, China; 2) Well Advantage was indirectly wholly-owned by prominent Hong Kong businessman Zhang Zhi Rong, who also controlled China Rongsheng Heavy Industries; and 3) based on public news, China Rongsheng Heavy Industries had a close business relationship with CNOOC, the company acquiring Nexen. The SEC also learned that two days before the July 23, 2012 announcement, Well Advantage purchased 831,033 shares of Nexen stock through its U.S. brokers for approximately $14.3 million. The SEC then determined that Well Advantage had not traded any securities since January 2012. Armed with this information, the SEC acted and sought an emergency order freezing the U.S.-based accounts without the knowledge of who the actual traders were.
The March SEC Press Release states, “[T]he SEC’s investigation has identified Ren Feng and his wife Zeng Huiyu as previously unknown traders charged in the complaint as well as Ren’s private investment company CT Prime Assets Limited and four of Zeng’s brokerage customers on whose behalf she traded. They made a combined $2.3 million in illegal profits from Nexen stock trades made by Ren and Zeng.”
Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office said in the SEC Press Release, “This settlement requires full disgorgement of the insider trading profits of this group of foreign traders, and Ren and Zeng must additionally pay sizeable penalties… This should send a stern warning to anyone contemplating insider trading in U.S. markets from abroad that the SEC uncovers such misconduct and the end result is a severe financial setback rather than a windfall.”
The SEC’s message to foreign traders is that it is imperative to have an understanding of U.S. insider trading laws if you are trading in U.S. markets. The purpose of this posting is not to weigh the guilt or innocence of Ren or Zeng, but rather to highlight the risks that foreign traders face in connection with U.S. insider trading laws.
There are many legitimate reasons why a foreign trader would engage in stock trading that does not violate U.S. federal securities laws. However, according to U.S. law, when an individual gains access to material, non-public information about a security, and the individual has a fiduciary duty, or other relationship of trust and confidence, they cannot use that information to trade in that security. The SEC has brought cases against spouses, family members, friends, business associates, and other persons who have misappropriated confidential, material, nonpublic information. Indeed, the SEC has crafted specific rules to address insider trading issues—Rules 10b5-1 and 10b5-2. Rule 10b5-1 answers the ‘use” versus “possession” argument. Meaning, the SEC believes that an insider trading violations occurs so long as the trader had possession of the material, nonpublic information. The SEC has taken the position that it is not required to show that the insider trader “used” the information. The bottom line is that merely being “aware” of the information may be sufficient to establish a violation.
Rule 10b5-2 clarifies the misappropriate theory and essentially sets forth how a “duty of trust or confidence” can exist:
(b) Enumerated “duties of trust or confidence.” For purposes of this section, a “duty of trust or confidence” exists in the following circumstances, among others:
(1) Whenever a person agrees to maintain information in confidence;
(2) Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or
(3) Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties’ history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.
For foreign traders, this means that if a duty of trust or confidence is created, you cannot trade on material, nonpublic information.
The U.S. law on insider trading can be complex and uncertain. If you have any concerns, it is best to speak to a competent U.S. attorney who can provide guidance about the proposed trading activity. It is always better to be safe than sorry and potentially cost yourself millions in lost profits, fines, and penalties, like the traders in the Nexen acquisition case.