Can “Outside Traders” be involved in Insider Trading? A case study of Icahn, Mickelson and 18 USC 1348

Much has been written over the last week about the purported FBI “insider trading” investigation into the purchase of Clorox stock options by legendary golfer Phil Mickelson and infamous sports gambler William Walters.  If this story didn’t involve famous people such as Mickelson and Carl Icahn, it wouldn’t be much of a story – or a criminal case – at all.  Here’s why:

On July 15, 2011, billionaire Carl Icahn announced his interest in taking Clorox, a public company, private in a deal worth approximately $12.6 million.  Four days earlier, there was unusual trading involving Clorox options; presumably involving Mickelson and Walters.  After the announcement, Clorox’s stock price went up considerably – from about $70 per share to $75 per share — providing Mickelson and Walters (and presumably a lot of other people) with a quick, substantial profit.

The million dollar question that the FBI is trying to answer is:  Did Mickelson and Walters know about Icahn’s interest before it became public?  If they did, and they traded on that information, then maybe they engaged in insider trading or securities fraud.  Or maybe not.

On the surface it might sound as if this type of conduct is illegal – knowing something that is material about a stock that is not public and trading on that information.  However, we must look more closely at the securities law, rules and regulations to analyze this situation.

The potential crime is the Federal securities fraud statute, 18 U.S.C. § 1348, which states that anyone who defrauds another person (or company) in connection to any security, or anyone who fraudulently obtains any money related to the sale of a security is guilty of the offense and subject to jail of up to 25 years and a $250,000 fine.

Under existing law, securities fraud based on insider trading must involve the intentional trade (either a sale or purchase) of any security by an insider based upon material, non-public information.

When this law is parsed out, it becomes apparent that, even if the FBI could show that Mickelson and Walters knew Icahn and knew about his plan before it became public, Mickelson and Walter’s conduct very well may not be illegal.

Let’s take a look at why.  There are five things the FBI will have to prove to snare Mickelson or Icahn:  First, that Mickelson and Walters traded in a security.  This will be easy enough, as buying options qualify as securities.  Second, the information must be material to that transaction.  In other words, there must be a substantial likelihood that a reasonable investor would consider it important in making the decision that Mickelson and Walters made.  Here, it is likely that the FBI will be able to show that Icahn’s desire to take Clorox private would be material information.  Next, the information must be non-public.  In this case, it would have been non-public on July 11th (the date of the supposed options purchase) as Icahn made the information public on July 15th.  Fourth, the trade must be based upon the material information, which means that the trader was consciously aware of the material non-public information when they traded. Again, it is likely that the FBI and prosecutors would be able to show (at least circumstantially) that Mickelson and Walters’ trades were based upon Icahn’s information – although this may be difficult.  There does not seem to be any evidence (at least that has been made public) that shows Mickelson and Icahn knew each other or even met.  Finally, the person making the trade must be an “insider.”  Now that term is much more inclusive than you might think.  Obviously it includes an employee of a company whose stock was traded. But who else is an “insider.” Peculiarly, the term “insider” is not specifically defined; however, it includes anyone who has a fiduciary duty to the company based upon knowledge of non-public material information.  Interestingly, anyone who becomes aware of material, non-public information is deemed to have the same fiduciary duty as an employee or owner of the company.

It is this last “element” that will pose the greatest challenge to the FBI in its investigation of Mickelson, Walters and Icahn.  First, it is likely that Icahn had no fiduciary duty to Clorox.  Yes, he was a shareholder; however, he was not a corporate officer or employee of the company.  Merely being a shareholder does not confer a financial, or fiduciary, duty to the company.  So, if Icahn did not have a fiduciary duty, then he was not an insider.  If Icahn was not an insider, then Mickelson did not obtain information from an insider.  Even if that information was material and non-public, Mickelson and Walters’ trades would not be insider trading, or a violation of the securities fraud statute.

In addition, Icahn’s announcement was by letter and not a formal “tender offer.”  This is significant because the SEC has very specific rules regarding tender offers that might convey a fiduciary duty on Icahn.  However, since he did not make a tender offer, it is likely that he will not be adjudged to have had a fiduciary duty to Clorox.

So, while it is salacious and makes for front page news, and possibly will alter Mickelson’s mental state at his next tournament, it is unlikely to put him in jail or require him to pay a hefty fine.

As you can see, the law surrounding insider trading and securities fraud are subtle as well as complex.  If you find yourself in a situation such as Phil Mickelson or Carl Icahn, it is important that you seek out and retain a federal criminal defense attorney that is well versed in the nuances of the securities law.

To read more about Federal Securities Fraud crimes and Insider Trading, review this blog and the Saland Law PC website.

To learn more about FederalSecuries Fraud and Insider Trading crimes, contact Saland Law PC or follow the links throughout this blog entry.  A Federal criminal defense law firm located in lower Manhattan, the Federal criminal defense attorneys and former Federal prosecutors at Saland Law PC represent clients throughout the New York metropolitan area, as well as nationwide.


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