In February 2014, Chinese antitrust regulators announced that they suspected wireless technology company Qualcomm Inc. of overcharging its customers and abusing its powerful market position. According to reports, Qualcomm could face fines of up to $1 billion (cue Austin Powers-like smirk here).
This information is public. It’s all over the news. Qualcomm investors can judge Qualcomm’s current value by taking this information into account. All’s fair in love and stock trading, right?
But some Qualcomm employees allegedly acquired inside information from the company related to a merger with a semiconductor developer called Atheros and traded stocks based on it. In early May 2014, the SEC sued three Qualcomm employees for insider trading based on these trades. The sanctions faced by those employees won’t approach $1 billion, but the lawsuit shows that the SEC’s focus on insider trading has not lessened in recent months.
On May 12, 104, the SEC filed a complaint in the Southern District of California against three Qualcomm employees–Derek Cohen, Michael Fleischli and Robert Herman–for insider trading.
In a parallel action, the U.S. Attorney’s Office announced that Mr. Cohen and Mr. Herman were criminally charged with insider trading.
Qualcomm’s Atheros Acquisition
When Qualcomm entered into negotiations to buy Atheros in 2010, Qualcomm executives tried awfully hard—as they should have—to keep the acquisition a secret. For example, Atheros personnel who knew about the acquisition were required to sign confidentiality agreements and speak in code during internal discussions. However, the three defendants learned of the Atheros deal several days before the information was released to the public, according to the SEC.
According to the SEC complaint, Qualcomm has a written policy against insider trading and all three defendants received that policy.
The three defendants pieced together the relevant details of the acquisition from information they received in internal emails and during a January 2011 sales meeting. On December 30, 2010, the three men received an email from their superiors that Qualcomm would be making an important announcement during the Consumer Electronic Show the following week.
Then, on January 3, the defendants each received a reminder email from the head of North American Sales about a “major announcement.” According to the SEC, because the January 3rd email noted that Qualcomm’s Executive Vice President would be involved with the announcement, the three defendants realized that the announcement would be a big one.
Qualcomm’s North American Sales team also held a meeting on January 3. During this meeting, the head of North American Sales noted that Qualcomm’s announcement involved a company called Atheros. According to the SEC, Mr. Cohen and Mr. Fleischli both attended the meeting. There they learned that Qualcomm would acquire Atheros, and were given detailed information regarding Atheros’ business. At the close of the meeting, the head of sales reminded the attendees that the information they learned that day was confidential.
Before January 4, 2011, none of the three defendants had ever bought Atheros stock. Nevertheless the SEC alleges that, on the day following their sales meeting, the three defendants each bought a number of Atheros shares. In its complaint, the SEC adds that the three men made “suspiciously-timed phone calls” before making their Atheros trades.
Specifically, the SEC claims that Mr. Fleischli traded Atheros shares first, after which he called Mr. Cohen. After Mr. Cohen received the call, he bought a number of Atheros shares. Finally, after completing his trades, Mr. Cohen called Mr. Herman who then made his trades.
Changes in Atheros Stock Value
The New York Times announced the acquisition at high noon on January 4, 2011, in its online Dealbook column. (If you don’t read Dealbook, you should. It’s the best business-legal blog out there.)
The Dealbook article stated that Qualcomm would buy Atheros for $3.5 billion. That figure amounted to $45 per share, a 22% premium on Atheros’ stock price on the morning of January 4. According to the SEC, as a result of the article, trading in Atheros common stock increased from 1.2 million on January 3 to 70 million on January 5. In response to the increased trading and the approaching deal, Atheros stock price increased from $37.02 to $44.64 per share on January 4, 2011.
That’s a substantial jump in value.
At the time the information was released, the three defendants already owned a number of Atheros shares and options. They therefore allegedly benefited from the rapidly increasing price. According to the SEC, Mr. Cohen made the largest profit from his Atheros trades. Performing three transactions between January 4 and January 12, he supposedly realized a profit of $205,375. By January 12, he had bought more than twenty thousand Atheros shares and 375 call options for the upcoming February and June.
The SEC paints Mr. Fleischli as a bit more conservative. He only bought 500 shares of Atheros, returning a profit of about $3000 in the five hours he held those stocks on January 4.
Like Mr. Fleischli, Mr. Herman only traded for a few hours on January 4. Between 11 a.m. and 1 p.m. that day, he made nearly $30,000 by buying 4000 shares of Atheros common stock and selling them after Qualcomm’s acquisition was announced.
Attempted Cover Up
The SEC also alleges that Mr. Herman and Mr. Cohen attempted to mislead Qualcomm when they were questioned about their Atheros trading activity. Mr. Herman allegedly told Qualcomm’s internal investigators that he had not learned about the acquisition until it was made public by the Times. Mr. Cohen initially gave the same account as Mr. Herman.
In a subsequent interview, though, Mr. Cohen allegedly changed his story. He told his employer that he only purchased Atheros securities after seeing a spike in trading activity on January 3. Nevertheless, the SEC alleges that the three defendants began trading Atheros stock before Dealbook’s noon publication.
Why These Cases Are Hard to Defend
It seems likely that the SEC does not have any incriminating emails among the defendants, or it would have quoted them in the complaint. It’s common in insider trading cases for the government to make their case based on circumstantial evidence: usually the record of a phone call and then the record of stock trades made shortly thereafter.
It’s a frustrating position for defendants. After all, who can recall why a colleague phoned you on a particular day and at a particular time? But if you can’t come up with a neutral explanation, then you are stuck with the appearance that the call was why you bought the stock that day. And if you made money on the transaction? Well, you aren’t a savvy trader–you are a criminal or at least liable for civil penalties.
It can be difficult–if not impossible–to defend against this type circumstantial evidence of a supposed “pattern” of calls and trades. (See, e.g., Rajat Gupta).
Given that only Mr. Cohen and Mr. Herman were criminally indicted suggests that Mr. Fleischli is cooperating with the government. His profits were much lower than either Mr. Cohen or Mr. Herman and he was not alleged to have engaged in any cover-up. The government may have viewed him as easiest to entice with a generous plea deal. We’ll know more as the criminal case progresses. Having a cooperator will undoubtedly make the government’s job of converting circumstantial evidence into a conviction (or into a finding of civil liability) much easier.