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It is discovered that 2 weeks before the Ellen show, her partner had sold $2 million Answer

It is discovered that 2 weeks before the Ellen show, her partner had sold $2 million in JOSB stock (at a gain of about $2,200). The morning after Ellen’s show, Ellen’s partner shorted the JOSB stock (which is a bet that the price will go down), and she made another $210,000 from that trade. The swing in the price was not 100% directly tied to Ellen’s comments, as JOSB had issued a recall of their white, long-sleeved shirts when they were found to have been sewed with brown thread, making them unwearable. Ellen’s partner’s previous trading activity shows that she made it a normal practice to “vigorously trade” the stock of any company with which Ellen did business. A review of her trading activity for the past year showed that she had bought and sold JOSB stock 25 different times. Further, she typically used “short” sales when companies had issues with their products. Do you think the SEC will file anything against Ellen or her partner for these sales of JOSB? Is there any cause to do so? Analyze the transactions with respect to insider trading activity (based on what you know) and whether Ellen or her partner should be concerned. Is the prior trading activity a defense? Analyze and explain fully. (Points : 30)

Ans:

One of the most important purposes of Section 10(b) and Rule I0b-5 is to prevent insider trading. Insider trading occurs when a company employee or company advisor uses material nonpublic information to make a profit by trading in the securities of the company. This practice is considered illegal because it allows insiders to take advantage of the investing public. Classical theory of insider trading targets a corporate insider’s breach of duty to shareholders with whom the insider transacts. The misappropriation theory outlaws trading on the basis of nonpublic information by a corporate “outsider” in breach of a duty owed not to a trading party but to the source of the information. Classical insider trading involves trading by a corporate insider on the basis of material and nonpublic information. The fiduciary relationship that an insider owes to shareholders “gives rise to a duty to disclose or abstain from trading” because of the necessity of preventing the corporate insider from taking unfair advantage of uninformed shareholders.

The fact pattern tends to suggests that the SEC will not file. First, the trading of the stock occurred the morning after the issuance of bad news regarding JOSB. Therefore, Ellen’s rant was public knowledge. Thus, there is no element of inside information. Second, Ellen Degeneres or her partner owed no duty to the JOSB corporation. The fact pattern states that JOSB used an Ellen look alike. There is no information that Ellen was associated with the corporation in any way. So Ellen owed no duty and, therefore, was not an insider. Since Ellen was not an insider, Ellen could not be found to owe a duty through the misappropriation theory. Third, Ellen’s partner regularly and vigorously traded the JOSB stock over the past year. So the activity by Ellen or her partner was not out of the ordinary. This would be a defense to insider trading even if the trade occurred before the issuance of non-public information and Ellen were an insider. Though, the material component of insider trading is satisfied since a reasonable trader would figure a negative statement from Ellen would hurt a company that was using an Ellen look alike and marketed to the gay and cross dressing community. However, since the other elements fail, there is no insider trading and no SEC filing against Ellen can be considered.

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