Insider Trading Laws and SEC Rule 10b-5 (Case Study 12)

Insider Trading Laws and SEC Rule 10b-5

Background and Analysis:
All the information in this background comes from government press releases and articles referenced below.

George Matus, Senior V.P. of Investor Relations at Carreker Corporation, learned from company accountants that the quarterly earnings would be well short of analysts’ estimates. On May 16, after participating in discussions regarding a press release, he learned that the negative announcement would occur after close of trading on May 22nd.

Soon after, George Matus placed several calls and transferred funds to Peter Matus, his brother, a licensed stockbroker. George wanted Peter to trade in Carreker Corporation’s securities. George intended to capitalize on the confidential insider information he learned during confidential corporate meetings. Peter Matus purchased 750 put options with respect to Carreker Corp., in his own personal account, approximately four hours before the close of trading on May 22nd. Put options react inversely to the value of a company’s commonly traded stock. This trade created an opportunity to profit from the decline of the underlying Carreker stock price.

Carreker’s stock price declined after issuance of the press release, just as the Matus brothers anticipated. The stock price fell 43% over the next four days (from $18.67 to $10.62). The eventual sale of the put options purchased by Peter Matus yielded a profit of approximately $210,000 for the benefit of both George and Peter Matus. This unique, perfectly timed trade and the resulting sizable profit attracted the attention of the SEC.

The brothers gave conflicting explanations to the SEC when questioned informally about their suspicious trading activity. Their conflicting statements led the Commission to formally request that both brothers testify under oath regarding the trades. Both brothers invoked their Fifth Amendment rights and refused to testify.

Their refusal to testify led the SEC to formally enjoin each of the defendants from further violations of Sec. 10(b) of the Exchange Act and Rule 10b-5. They also requested an order for disgorgement of their ill-gotten gains plus interest; as well as requiring both defendants to pay civil penalties of three times the profit realized as a result of their unlawful acts.

As Senior Vice President of Investor Relations, George Matus served in a fiduciarily position at Carreker Corporation. His inclusion in meetings regarding the negative quarterly earnings and participation in formulating a notice to shareholders gave him special inside knowledge. Management discussions regarding the specific timing of the press release confirmed the need to keep such information confidential and “non-public” until its appropriate release.

George Matus reacted inappropriately and unlawfully in trading for his personal benefit based on his knowledge of this negative news. In fact, part of his job description entailed just that, keeping such information private until it became appropriate to share with shareholders. By notifying and funding his brother Peter’s account in order to trade on the inside information confirmed his fraudulent intent.

Peter Matus, a registered broker-dealer, also knew or should have known better. The information he received from his brother, a senior executive and fiduciary of Carreker., and trading on that information, constituted an illegal use of confidential information. Peter’s experience as a registered broker-dealer suggested that he understood his behavior may be construed as both illegal and unethical, as a related party. His actions, both before, during and after the release of the negative information confirmed his willful participation in the fraud.

The decision to use sophisticated means to game the system for extra profits on their illegal trading also indicates a measure of intent. They seemingly hoped to hide their illegal activity by using put options. Using put options would make their activity less obvious, decreasing the likelihood of discovery. They also sought to take advantage of the leverage afforded by trading in put options, enabling them to earn a higher rate of return on the fixed amount of money they had to invest.

The Matus brothers’ subsequent invoking of their Fifth Amendment rights did not put them in a favorable position. Investigators likely interpreted their silence as an indication of their guilt. Although they had every right not to incriminate themselves, their inability to defend their actions enabled the SEC to obtain a punishing judgment against the brothers.