Alison Frankel reports:
Everyone knows that the hedge fund SAC Capital, now known as Point72, made a bundle when it ditched shares of the pharmaceutical companies Wyeth and Elan based on inside information that their jointly developed Alzheimer’s drug, bapineuzumab (better known as bapi), was a bust. SAC supposedly realized $555 million in profits and avoided losses because trader Mathew Martoma got early word about disappointing bapi test results from a doctor involved in the clinical trials. Both SAC and Martoma have, of course, been held to account for the trades: Martoma was convicted at trial and SAC pled guilty. In all, the hedge fund has forked over nearly $2 billion to the government because it illegally traded on inside information about the bapi trials.
Two days after the rest of the world heard about the discouraging bapi clinical trial results – in other words, after SAC had sold off its stake in Wyeth and Elan – Elan revealed even more bad news. Two patients had contracted a rare and frequently fatal brain disease after taking Elan’s major product, the multiple sclerosis drug Tysabri. Shares of the Ireland-based company, which had already taken a beating after the bapi disclosure, fell another 50 percent on the Tysabri news.
SAC didn’t trade on inside information about Tysabri, and the drop in Elan’s share price after the Tysabri disclosure had nothing to do with SAC’s inside information about bapi. Yet according to a decision Thursday by U.S. District Judge Victor Marrero of Manhattan, the hedge fund may still be liable for an additional $107 million it avoided losing because it had already sold its stake in Elan before the Tysabri news broke. Marrero ruled that holders of Elan American Depository Receipts can proceed with class action claims that SAC must disgorge the losses it avoided incurring in Elan’s Tysabri-related stock drop because it had illegally sold its Elan shares based on inside information about an entirely unrelated drug trial.
As Alison then notes:
This is nuts. Suppose SAC knew that bad news was coming that would chop 10% or so off the stock price. It sells the stock. After the stock is sold by SAC, bad news previously known only to the issuer's CEO is released and the stock drops 50%. Should SAC really face liability? See e.g. Fridrich v. Bradford, 542 F.2d 307 (6th Cir. 1976) (disgorgement balances the desire to deter insider trading without imposing extremely large damage awards).
Donald Langevoort explains that:
In Elkind v. Liggett & Myers Inc., the court held that the plaintiff class is limited in its recovery to the amount of the profits made (in that particular instance, by the defendant-tipper's tippees as a result of the unlawful trading, effectively, a disgorgement measure of damages. In the court's view, such a measure nicely balances the desire to deter insider tipping and trading with the need to avoid "windfall recoveries of exorbitant amounts bearing no relation to the seriousness of the misconduct." Moreover, it is easy to apply:A plaintiff would simply be required to prove (1) the time, amount, and price per share of his purchase, (2) that a reasonable investor would not have paid as high a price or made the purchase at all if he had the information in the tippee's possession, and (3) the price to which the security had declined by the time he learned the tipped information or at a reasonable time after it became public, whichever event first occurred. He would then have a claim and, up to the limits of the tippee's gain, could recover the decline in market value of his shares before the information became public or known to him.
Elkind is fairly candid in its recognition that the principal objective of the insider trading prohibition is the avoidance of unjust enrichment on the part of the insider rather than the prevention of actual harm or injury to other marketplace traders: according to the court, "the reason for the 'abstain or disclose rule' is the unfairness in permitting an insider to trade for his own account on the basis of material inside information not available to others."