Party Is Over for Insiders
After Nvidia Corp. won a lucrative contract from Microsoft Corp., the electronic game developer’s future seemed assured.
As soon as 11 Nvidia employees heard the secret news, securities regulators say, they called their brokers and tried to sweeten their prospects.
The employees, along with four friends and relatives they allegedly tipped off, are accused of making a total of $1.7 million in illegal profit over the course of a week in March 2000. Four of the accused have settled with the government.
“It’s unusual; it looks kind of funny,” said Michael Hara, Nvidia’s director of investor relations. “Hard to argue with that.”
The really funny thing is that insider trading appears to be pretty routine in Silicon Valley. The late-’90s technology boom sparked stock speculation across the nation, but nowhere was the fever more intense than on this peninsula.
The official propaganda was that no one was here for the money, but in reality “just about everyone was cashing in, and you didn’t want to be stupid by missing the opportunity,” said Randy Komisar, author of “The Monk and the Riddle,” a critical look at entrepreneurial culture.
Inside tips were passed around like party favors. One prominent fund-raiser recalls being in a meeting with a prospective donor and hearing the executive say his company would be the subject of a friendly takeover bid the next week. It was an open invitation to make a few bucks on the side, said the fund-raiser, who asked to be anonymous.
The avarice was fueled by the fact that Silicon Valley was geographically and spiritually a long way from the regulators in Washington.
“Silicon Valley thinks that the Securities and Exchange Commission’s jurisdiction ends at the Sierra Nevada,” said Scott Rafer, a tech consultant who is a former New York investment bank analyst. “A lot of valley execs simply don’t understand that trading on inside information is illegal.”
For a long time, regulators didn’t do much to change that understanding. Before Robert Mueller was named U.S. attorney here in late 1999, “the office was an embarrassment,” one local lawyer said. “It was viewed as a place where assistant U.S. attorneys were happily put out to pasture.”
Mueller created a seven-member securities fraud team before becoming FBI director last fall. The local SEC office, meanwhile, staffed up from 19 to 26 accountants and lawyers. The effect can be measured: Of the 11 high-tech insider trading cases brought nationwide in 2001, five were prosecuted here.
Recent settlements include cases brought against a law firm partner, the husband of a prominent public relations executive, a vice president for sales at an e-mail software company and an investor who was casually dating a second-year associate at a prominent law firm.
“These are people who had good jobs,” said Helane Morrison, district administrator for the SEC. “It’s not need, it’s greed.”
A case in point would be Malcolm Wittenberg, until recently a partner at law firm Crosby, Heafey, Roach & May. On Aug. 16, 1999, Wittenberg was asked to work on a deal in which Sun Microsystems Inc. would buy Forte Software, a Crosby Heafey client.
While the deal was being secretly negotiated, Wittenberg bought 2,000 shares of Forte stock. When the deal became public Aug. 23, the price of Forte shares spiked. Wittenberg’s profit: $14,000. It’s a sizable chunk of change for most people, but not for a lawyer making half a million a year.
“I was not thinking clearly,” Wittenberg told the SEC. He must have thought either that he wouldn’t get caught or that at most he’d get a quiet slap on the wrist. That’s how first-time insider trading offenders traditionally were treated, especially if the amounts involved were small and the defendant was an upstanding member of the community.
It therefore sent a tremor through legal circles when not only did the SEC file civil charges against Wittenberg, but also the U.S. attorney’s new securities team filed criminal charges.
Wittenberg pleaded guilty to one count of insider trading. He settled with the SEC by forfeiting his $14,000 profit and paying another $14,000 in fines. The State Bar of California placed him on interim suspension.
In December, a San Francisco judge sentenced Wittenberg to one month in a halfway house, three months of home detention and a $10,000 fine. He won’t have any problem paying, because he has a new job with intellectual property firm Dergosits & Noah for a reported $240,000 a year.
If prosecutors, who sought a four-month jail sentence, weren’t completely successful in making an example of Wittenberg, they at least succeeded in raising the fear level.
Fuzzy Memories
Like revelers after a wild party, the inhabitants of Silicon Valley are struggling to remember just what they did, and whether there’s any evidence. The statute of limitations for insider trading is five years, which encompasses the height of the boom. And insider trading is just as illegal when executives use their privileged information to cut their losses by selling shares.
Crosby Heafey, based in Oakland, does not have a major Silicon Valley presence. That, according to managing partner Kurt Peterson, has only increased the unease.
“I have definitely heard the sentiment that, if they came after this guy at Crosby, a lot of people at the big Silicon Valley high-tech firms are really thinking back to what they’ve been up to,” Peterson said.
Insider trading often can be murky. The most clear-cut cases are those such as Wittenberg’s, in which a lawyer or other corporate executive who has material nonpublic information uses it to buy or sell stock. This violates his duty to the company and its shareholders by placing his interest above theirs.
In the 1980s, the scope of insider trading was widened under the so-called misappropriation theory, which holds that even those who are not employees of the company in question can be guilty if they breached a trust or confidence. In one misappropriation case, the SEC pursued charges against a psychiatrist who had learned confidential information from a patient who was the wife of the president of American Express. The psychiatrist was found guilty, and his conviction was upheld by an appeals court.
Such an expansive definition means insider trading is almost certainly the most common form of securities fraud. Yet it’s impossible to get a handle on how widespread it is. For one thing, there are no individual victims.
“It’s almost certain that 99% of cases go undetected and certainly unprosecuted,” UCLA law professor Stephen Bainbridge said.
But those few that become public tend to be very revealing, said Bainbridge, author of a textbook on insider trading. “A lot of cases would make interesting novels. The way that greed causes people to do things that they know are wrong and are very often stupid never fails to surprise me.”
One case that seems to fall into that category began Friday, Oct. 15, 1999, when Maureen Blanc phoned her husband, George Brandt, and said she would be working late.
Blanc, a co-founder of public relations powerhouse Blanc & Otus, told Brandt that one of her clients, software firm Clarify Inc., was being acquired by Nortel Networks Corp. in a deal that would be announced after the close of trading Monday.
“I tell my husband about what goes on in my life,” Blanc said in an interview. “I tell him about a lot of things.” She warned Brandt that this news was confidential. According to SEC documents, he expressly agreed not to purchase Clarify stock. Nevertheless, on Monday he bought 600 shares, making a quick profit of $12,750.
Blanc, using a defense that Wittenberg also tried, said the amount of money earned was so small as to be “insignificant.” She noted that her husband, a writer of mystery novels, was well-off.
“Certainly he didn’t do it for the money,” Blanc said. “He was naive. This was not premeditated.” Through his lawyer, Brandt declined to be interviewed.
Sued for insider trading by the SEC, Brandt settled the case by paying the government his profit and another $12,750 in penalties.
Such settlements, in which the individual pays restitution and a fine but does not admit wrongdoing, are the typical resolution in insider trading cases. Occasionally, though, cases go to court, and sometimes the government loses.
That happened with Keith J. Kim, an Oakland venture capitalist who was a member of the Young Presidents’ Organization, a group of businessmen younger than 50. Kim was a passenger on a private plane taking YPO members to a retreat. Over the intercom, it was announced that one member would not be attending because his company, Meridian Data, was being bought by Quantum Corp.
When Kim got off the plane, he bought 187,300 shares of Meridian stock, earning a profit of $832,877 when the deal was announced.
But is merely being a member of a fraternal organization enough to qualify for insider trading status? In this case, U.S. District Judge Charles Breyer decided late last year that the misappropriation theory had its limits.
“While members of a club may feel a special bond, there is nothing so special about their relationship . . . that it gives rise to a legal duty not to trade on confidential information,” Breyer concluded, saying Kim would not have to face two counts of securities fraud.
A Slip of the E-Mail
The government was more successful in an earlier case against a Nvidia engineer named Manu Shrivastava. He pleaded guilty in federal court and was sentenced to one year of home detention. He forfeited his $446,000 profit and was ordered in December to pay a fine of $250,000.
That case, like the more recent cases of the 11 Nvidia employees and four friends and relatives, developed from an e-mail that the Santa Clara, Calif., company’s chief executive sent the firm’s 350 employees late on a Sunday night, March 5, 2000. The e-mail said Nvidia had won a contract potentially worth $2 billion to make a graphics processor for Microsoft’s video game console, the Xbox. A follow-up e-mail the next morning from the company’s vice president of marketing, titled “xbox shhhhhh . . . “ reminded everyone “to keep the news quiet. Not a word to anyone outside our walls.”
That Monday, Nvidia stock closed at $58.50. On Friday, before the market opened, Microsoft announced it had awarded the contract to Nvidia. The stock rose as high as $145 before closing at $118.
“This is not as black and white as the SEC’s press releases would have you think,” said investor relations director Hara.
For one thing, he said, it was possible the employees had planned to buy stock that Monday before they heard about the contract.
Morrison, the SEC administrator, dismissed that argument. “We believe that the people we sued used the hot inside information they learned from the chief executive’s e-mail, which makes their trading illegal.”
Five of the defendants also were indicted on criminal charges; two of those pleaded guilty and are awaiting sentencing. The trial of a third defendant began this week. The nine Nvidia employees who maintain their innocence have been placed on six-month leaves of absence, with pay.
“It would be hard for them to focus on their work if they’re worrying about how to defend themselves,” Hara said. “We wish these people the best of luck.”
