There's a great op-ed in today's WSJ by David Rosenfeld about the Phil Mickelson insider trading non-case. You may recall that I wrote about this case in The Absurd Insider Trading Case Against Phil Mickelson. In that post, I explained that:
None of the players in this case are insiders of Clorox, so the classic disclose or abstain rule would not apply. Instead, the SEC would have to proceed under a misappropriation theory. In order for that to work, the SEC at a minimum would have to prove that (1) Icahn tipped the information to Walters in breach of a fiduciary duty owed to the person or entity who owned the information, (2) that Icahn got a personal benefit for doing so, (3) that Walters passed the information to Mickelson, (4) Mickelson knew or should have known that the information came was material, nonpublic, and had been disclosed to him in violation of a fiduciary duty by the source. It should also be the case that the SEC will have to prove that Mickelson knew or should have known that Icahn got a personal benefit from making the tip ....
Because the SEC could not make out at least # 4, it had no case against Mickelson. Yet, as Rosenfeld points out:
Mr. Mickelson was named as a “Relief Defendant” in the SEC’s complaint, meaning that Mr. Mickelson was not accused of any legal violations but was alleged to be in possession of ill-gotten gains to which he had no lawful claim. ... As part of a settlement, Mr. Mickelson agreed to surrender the profits from those trades, plus interest. ...
... The money Mr. Mickelson was forced to give up was the proceeds of his own trades. And based on the current state of the law—along with the fact that the SEC declined to charge Mr. Mickelson—it appears that those trades were not legally actionable. If so, it is hard to see a lawful basis for the disgorgement order.
Indeed, not only was there no lawful basis for the order, the order was affirmatively unlawful:
The SEC appears to be taking the position that whenever there has been unlawful conduct by a tipper, any profits derived from trades by a tippee are ill-gotten gains, even if the tippee didn’t have knowledge of a personal benefit, and even if the trades themselves violated no law.
And that's clearly a gross abuse of the SEC's prosecutorial power.
So why did Mickelson settle? As I have noted before, the SEC has a huge advantage in extorting settlements out of innocent defendants:
In civil cases, the government can ask the court to force the defendant to disgorge his ill-gotten gains and, under the Insider Trading Sanctions Act, impose an additional civil fine of up to 3 times the amount of the illegal profit.
So if Mickelson made a profit of about $1 million (the amount he disgorged), went to trial, lost, and got hit with the maximum civil sanction, he'd face a total liability of $4 million. Assume Mickelson's lawyers told him that he had a two in three chance of winning at trial. That mean he still faced an expected sanction of $1.33 million. Settling for $1 million thus made economic sense. (Setting aside the cost of legal fees, the opportunity costs associated with opting for trial, etc..., which make settlement even more attractive.)
In sum, ITSA gives the government a huge club to coerce settlements out of even innocent defendants.
I'm not sure what can be done about this problem, if anything. But at the very least the SEC needs to be named and shamed when they abuse their power in this way.