The federal government’s focus on insider trading and hedge funds continues, with the recent filing of a criminal complaint and SEC enforcement action against a French medical doctor, who served on a steering committee overseeing a clinical trial of a drug under development by Human Genome Sciences, Inc. (“HGSI”). US v. Benhamou, 10-MAG-2424 (S.D.N.Y. Nov. 1, 2010); SEC v. Benhamou, 10-CV-8266 (DAB) (S.D.N.Y. Nov. 2, 2010). The doctor also had a consulting arrangement with a hedge fund portfolio manager, who he allegedly tipped concerning unfavorable developments in the clinical trial. The case highlights the potential risks entailed in obtaining information from industry consultants.
According to the government allegations, under his contract with HGSI, the doctor had a duty to maintain the confidentiality of information concerning the drug trial. The doctor participated in a series of meetings concerning adverse developments in the trial and was aware that HGSI was preparing to make a public disclosure. The criminal complaint alleges that the doctor simultaneously engaged in a series of communications with the fund portfolio manager, in which the doctor divulged material confidential information concerning the drug trial. Although the fund manager allegedly knew that the doctor was breaching his duty of confidentiality to HGSI, he caused six hedge funds that he co-managed to sell their holdings of HGSI stock. When HGSI made its disclosure, its stock price plummeted. The hedge funds allegedly avoided $30 million in losses through these trades.
This case is a timely reminder to investment managers to review their policies and procedures concerning the use of consultants and the nature of information being obtained. While consultants remain a useful source of industry information, targeted training and controls are necessary to assure that firm personnel understand the circumstances in which they can receive and use such information. While taking care to assemble appropriate underlying documentation for consultant relationships is important, it is not the end of the inquiry. The SEC alleged here, for example, that the doctor signed agreements in connection with his consulting work for investors that prohibited him from disclosing confidential information (including information from clinical trials) to those consulting clients.
Finally, there is every reason to expect the focus by the Department of Justice and the SEC on insider trading and hedge funds to continue, if not intensify. Preet Bharara, U.S. Attorney for the Southern District of New York, delivered that message in a speech on October 20, in which he expressed the view that “illegal insider trading is rampant and may even be on the rise.” Mr. Bharara indicated that his office’s investigations are continuing to focus on financial services professionals, among others. SEC Director of Enforcement Robert Khuzami has made equally clear that insider trading cases remain a high priority for his agency. In congressional testimony on September 22, for example, Mr. Khuzami described sophisticated new analytical tools that the enforcement staff is using to identify patterns and possible relationships among traders so as to isolate possible instances of misuse of material non-public information. The continuing investigative spotlight reinforces the importance of a proactive review of information-gathering practices and controls.