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APRIL 22, 2013, 12:19 PM

Deductive Reasoning Can Be a Dangerous Thing

By PETER J. HENNING

A recent case involving a Canadian investment banker raises an interesting question about
whether a persons own intuition about a merger constitutes illegal insider trading charge.
The answer becomes even more difficult when two securities regulators reach different
conclusions about whether there was any confidential information involved.

The Securities and Exchange Commission in the United States and Canadas Ontario
Securities Commission filed separate cases against Richard Bruce Moore, who had worked at
Canadian Imperial Bank of Commerce. He agreed to settlements with each, paying about
$850,000 and accepting restrictions on any future work in the securities industry.

The trading involved Tomkins, a British maker of car parts, before it received a takeover
offer in July 2010 that led its stock price to rise nearly 30 percent. The circumstances by
which Mr. Moore gathered the information about the offer make it hard to find any clear line
that separates good deductive reasoning from illegal trading.

At the time, one of Mr. Moores clients was the Canadian Pension Plan Investment Board,
which was planning an offer for Tomkins along with a private equity firm. Mr. Moore
regularly dealt with one of the pension plans senior representatives about providing
investment banking services. He learned there was a significant transaction involving the
pension board, but that C.I.B.C. would not be involved in it.

Over the course of the next few months, Mr. Moore gleaned additional tidbits about the
transaction from his interactions with the pension board representative. In this case, no one
tipped him off about the deal, at least not in the traditional sense. In essence, he put two and
two together after he saw the pension board representative speaking with someone at a
charity event, and the representative refused to introduce them or even identify who he was
speaking with. A short time later, another person identified the unknown person as the chief
executive of Tomkins.

Having figured out the likely target of the deal, the next day Mr. Moore started buying
Tomkins stock through an offshore account, ultimately putting approximately one-third of
his net worth into its shares. His trades included buying American depositary receipts in the
company that were traded on the New York Stock Exchange, which gave the S.E.C.
jurisdiction over the case.

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Under United States law, the so-called misappropriation theory of insider trading requires
proof that a defendant took information from a party to whom he owed a fiduciary duty and
then converted it to his own use by trading. In its complaint, the S.E.C. claimed that by
pulling together different strands of information about the impending deal from a client, Mr.
Moore misappropriated that information from his employer by purchasing Tomkins
securities.

The Ontario Securities Commission, however, took a different path in concluding that Mr.
Moore traded improperly in Tomkins shares. In its settlement with Mr. Moore, it stated that
at no time did the pension board representative ever provide Moore with any material,
generally undisclosed information.

Instead, the regulator said he ought not to have made use of information obtained in part
by virtue of his position as an employee of a registrant prior to its general disclosure to the
public. In doing so, the commission said, Mr. Moore acted contrary to the public interest.

Unlike the S.E.C., the Ontario commission did not find that he engaged in insider trading, but
only that he acted inappropriately given his position in the securities industry. This is in part
a result of a limitation in Section 76 of the Ontario Securities Act, which requires that a
defendant be in a special relationship with a reporting issuer when trading in its securities
to violate the law.

Was the information on which Mr. Moore traded really a breach of a fiduciary duty to
C.I.B.C. under the misappropriation theory?

The transactions have many hallmarks of insider trading: a quick purchase of shares shortly
after gaining information, resulting in a quick profit. Moreover, this is the type of all in bet
involving a significant amount of a defendants net worth that shows a belief that the
information was quite valuable. Add to that Mr. Moores position in the securities industry,
and this seems to add up to an insider trading case.

Yet, Mr. Moore did not obtain any confidential information from a source at the pension
board about the Tomkins offer, as the Canadian authorities make clear. Seeing someone at
an event and making deductions based on circumspect conduct about the identity of a
corporate executive is hardly the type of confidential information normally identified as the
basis for an insider trading charge.

Nor did Mr. Moore use information provided to C.I.B.C. for his trading because the bank was
not a participant in the transaction. The only basis on which one could say that Mr. Moore
misused his employers confidential information would be to use the legal fiction that
everything he knew was attributable to his employer and therefore his use of it somehow
resulted in a breach of fiduciary duty. In other words, he misappropriated the information
from himself.

While that is a pretty convoluted theory of insider trading, it looks as if the S.E.C. is saying

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that using your job to deduce something going on at another company that is your client can
be enough to violate the insider trading prohibition. In a sense, the S.E.C. seems to be
applying the theory of if it quacks like a duck then it must be insider trading.
To add another layer to the intrigue, Mr. Moores settlement with the Ontario commission
included a description of real insider trading when he bought shares in a different company
that was being advised by an investment bank where he was working after leaving C.I.B.C.
His apparent willingness to abuse his position would have made it difficult to defend charges
related to his trading in Tomkins.

The S.E.C.s case shows that it continues to take an aggressive approach to insider trading,
pushing the limits of when transactions based on a persons special access to important
information can be enough to pursue charges. The deduction should be fairly simple: be very
careful when you figure out something about a company and then try to take advantage of it
by going all in to generate a quick profit.

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