How a PR mistake could absolve Kodak of insider trading fees

If you are unfamiliar with the details of what has happened with Kodak stocks over the past few weeks, you can catch up here and here. In short, here’s what you need to know for the purposes of this article:

Tuesday July 28e, the Trump administration, in a move similar to that it has taken with other venerable American companies (Ford and GM), has announced that it is asking Kodak to devote some of its vast underutilized capacity to start manufacturing advanced pharmaceutical ingredients. In return, the government promised to give the former photography giant a loan of $ 765 million.

This action was announced with bipartisan support. No less a critic of Trump than New York State Governor Andrew Cuomo welcomed the move, saying, “We never want to rely on shipments from China or elsewhere for medical supplies again. vital. “

But the applause didn’t last long, as he quickly fell victim to partisan criticism.

Politics aside, and perhaps fueling this criticism, a series of strangely fortuitous deals occurred a day before the White House announcement.

Monday July 27e, on a day when Kodak shares “exploded” by 25% to end the day at $ 2.62 per share, Kodak executives were given stock options. James Continenza, CEO of Kodak, received approximately 1.75 million stock options with exercise prices of $ 3.03, $ 4.53, $ 6.03 and $ 12, according to a filing with the SEC. This is almost three times the 650,000 shares he already owned. These shares have been allocated to Continenza in five different tranches since August 2019.

It is the timing of these options that has become the subject of an investigation by the Securities and Exchange Commission (“SEC”) for possible insider trading. Senator Elizabeth Warren (D-Mass.) Asked the SEC in an open letter to review the transactions citing “insider trading” and “unauthorized disclosure of material, non-public information.” As a result, the Kodak loan was suspended pending the results of the investigation.

But that’s not all that happened on Monday July 27e. At one point, Kodak issued a press release detailing its receipt of the government loan. Two large affiliate networks from Rochester, NY, published the article. Additionally, the story was posted on Twitter.

Kodak said it made the mistake of not putting an “embargo” on the press release. An embargo prohibits the media from broadcasting the content of a press release until a specific time. Without an embargo, journalists were quick to report the news, not wanting to be picked up by a rival.

The news apparently had an impact on trading as Kodak stock, which had long languished at just over two dollars a share, climbed 25% on larger-than-normal volume.

This PR error, however, may make it difficult for the SEC to prove insider trading with respect to options issued on July 27.e. Ironically, this is due to a rule the SEC put in place two decades ago to thwart insider trading.

It’s called Regulation FD (“Reg FD”) and it was enacted by the SEC in 2000 to limit the practice of “selective disclosure”, which gave traders (usually greater) advantages over other investors. Prior to Reg FD, insider trading laws did not adequately identify where and when the “insider trading” line was crossed.

“As a primary issue,” says David Oliwenstein, until recently Senior Counsel at the SEC, Division of Enforcement, Market Abuse Unit, and currently a lawyer at Pillsbury Winthrop Shaw Pittman LLP in New York, “US insider trading laws were (and remain, in some respects) insufficient because insider trading is governed by the Exchange’s General Anti-Fraud Ban Act – there is no specific law on insider trading. This leads to confusion among market players regarding the scope of permitted transactions as well as loopholes in the applicability of insider trading laws to certain behaviors.

The aim of Reg FD was to clarify what specific actions must be taken before traders can act on important information once it has been made public.

“Reg FD is designed to prohibit selective disclosure to the public (often to privileged analysts),” says John (Jack) Sylvia; Co-Chair, Securities Litigation Practice at Mintz Levin in Boston. “The purpose is to prevent favored parties from gaining a trading advantage even when the executive may have been authorized to do selective disclosure, making it difficult to accuse traders of insider trading (i.e. ie no breach of obligation or misappropriation of information). ”

More proactively, Reg FD not only guides how important information should be disclosed, but it also prescribes when it should be disclosed.

“One of those loopholes that existed in the 1990s was that issuers would selectively disclose confidential information to certain analysts and institutional investors, who could then trade profitably on that information,” Oliwenstein explains. “In response to this loophole, the SEC adopted the FD Regulation to promote full and fair disclosure. The gist of the FD rule is that once a public company shares confidential information with certain people specified in the rule, that company must immediately disclose that information publicly (the rule also applies to accidental disclosures).

This is where the word “accidental” becomes relevant. It is then a question of timing of events as to whether there may be “insider trading” (and places the relative burden of proof on the SEC).

“From an insider trading perspective – assuming the options were issued and exercised after news reports – I think the SEC is unlikely to pursue insider trading charges here,” he said. said Kurt Wolfe, a Troutman Pepper lawyer based at the national law firm Richmond. , Virginia and Washington DC offices. “The material information was known to the market and seems to have moved the price.”

So it may be that Reg FD’s nuances, although sparked by Kodak’s failure to impose an embargo on its press release, could be a significant obstacle in the SEC investigation.

“If the reports were released via public disclosure under Reg FD, it may not be a violation,” said Braden Perry, former federal law enforcement attorney and CCO of a financial firm, who is currently an attorney for regulatory and government investigations in Kansas. Kennyhertz Perry, LLC, based in town. “Public disclosure in this case is dissemination by any method or combination of methods reasonably designed to provide wide, non-exclusive distribution. “

On the other hand, Kodak’s attempt to “right the wrong” of premature disclosure of loan information may jeopardize its Reg FD defense.

“The question arises as to whether the FD regulations were met, whether or not the information was public for insider trading purposes,” says Oliwenstein. “The ‘reasonably designed to provide wide and non-exclusive distribution’ standard requires that information be disseminated widely and potentially through various mechanisms designed to reach a large population. The SEC could credibly say that publication by two local news sources is insufficient, even with discussions in national discussion forums. If this is correct, the SEC would expect Kodak to treat the early release of information as accidental disclosure and to disclose it promptly in a manner “reasonably designed to provide wide and non-exclusive distribution.” Instead, the company appears to have done the opposite and asked reporters to suppress the information. The SEC might view this as a violation of FD regulation.

Even if Reg FD turns out to be irrelevant, there are other circumstances in which the issuance of options would not constitute an act of insider trading. The fact that the CEO of Kodak has been granted options frequently over the past twelve months, and certainly before Kodak entered negotiations with the government, suggests a pattern of behavior.

“One scenario in which options trading would likely not constitute insider trading is if the trades were made in accordance with a so-called 10b5-1 scheme, which is essentially a trading program that takes away all power.” discretionary to the officer or director, ”says Oliwenstein. “Some caveats about 10b-5-1 plans are that in order to provide a defense to an allegation of insider trading, a 10b5-1 plan must be in good faith and faithfully adhered to. Once implemented, the plan must be able to function without interference (and, of course, it must be created at a time when insiders are not in possession of important non-public information). In these circumstances, the transactions entered into should not form the basis of liability for insider trading, even if they took place at a time when management clearly had access to material and non-public information. If Kodak or its executives use rule 10b5-1 as a defense with the SEC, expect staff to review issues to determine the legitimacy of the plans, including when the plans were created, whether the plans were changed and, if so, how often and under what circumstances, and whether the plans were created when the company was in possession of confidential information.

It is not uncommon for the SEC to investigate strange coincidences in trading. However, it is rare for such investigations to take place in a politicized environment. And if this is just a coincidence, that’s a shame, because unless Andrew Cuomo steps up to defend a major employer in his state, Kodak may never have the chance. to produce the advanced pharmaceutical ingredients America needs, in the words of New York State Governor, “no longer relies on shipments from China or elsewhere for vital medical supplies.”

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