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If you’re not familiar with the details on what happened with Kodak stock in the last few weeks, you can catch up here and here. In a nutshell, though, this is what you need to know for the purposes of this article:
On Tuesday, July 28th, the Trump administration, in a move similar to the ones it made with other venerable American companies (Ford and GM), announced it was asking Kodak to devote some of its vast underutilized capacity to begin the manufacture of advanced pharmaceutical ingredients. In exchange, the government promised to award the former photography giant a loan of $765 million.
This action was heralded with bipartisan support. No less a Trump critic than New York State Governor Andrew Cuomo lauded the move, saying, “Never again do we want to rely on shipments from China or elsewhere in order to get lifesaving medical supplies.”
But the applause did not last long, as it soon fell victim to partisan criticism.
Politics aside, and perhaps fueling this criticism, a series of suspiciously coincidental transactions occurred a day before the White House announcement.
On Monday, July 27th, a day when Kodak stock “rocketed” up 25% to close the day at $2.62 per share, Kodak executives received stock options. James Continenza, CEO of Kodak, received roughly 1.75 million stock options with exercise prices of $3.03, $4,53, $6,03 and $12, according to an SEC filing. This is nearly triple the 650,000 shares he had already owned. Those shares were awarded to Continenza in five different tranches since August of 2019.
It is the timing of these options which has become the focus of a Securities and Exchange Commission (“SEC”) investigation for possible insider trading. Senator Elizabeth Warren (D-Mass.) asked the SEC in an open letter to examine these transactions citing “insider trading” and “unauthorized disclosure of material, nonpublic information.” As a result, the Kodak loan has been placed on hold pending the results of the investigation.
But that’s not all that happened on Monday, July 27th. At some point, Kodak issued a press release detailing its receipt of the government loan. Two Rochester, N.Y.-based major network affiliates ran the story. In addition, the story was placed on Twitter.
Kodak said it made the mistake of not placing an “embargo” on the press release. An embargo prohibits the media from broadcasting the contents of a press release until a specified time. Without the embargo, journalists were quick to report the news, not wanting to be scooped by a rival.
The news apparently impacted trading, as Kodak stock, long languishing a little over two dollars a share, shot up 25% on heavier than normal volume.
That PR error, however, may make it difficult for the SEC to prove insider trading with regards to the options issued on July 27th. Ironically, this is because of a rule the SEC put in place two decades ago to thwart insider trading.
It’s called Regulation FD (“Reg FD”) and it was promulgated by the SEC in 2000 to limit the practice of “selective disclosure,” which gave (generally larger) traders advantages over other investors. Prior to Reg FD, insider trading laws failed to adequate identify where and when the line of “insider trading” was crossed.
“As an overarching matter,” says David Oliwenstein, until recently Senior Counsel at the SEC, Division of Enforcement, Market Abuse Unit (the unit responsible for insider trading enforcement), and presently Counsel at Pillsbury Winthrop Shaw Pittman LLP in New York City, “U.S. insider trading laws were (and remain, in certain respects) insufficient because insider trading is governed by the general antifraud prohibition of the Exchange Act—there is no specific insider trading statute. This leads to confusion among market participants regarding the scope of permissible trading as well as gaps in the applicability of insider trading laws to certain conduct.”
The purpose of Reg FD was to make it clearer what precise actions need to occur before traders could act on material information once it was made public.
“Reg FD is designed to prohibit selective disclosure to the public (often to favored analysts),” says John (Jack) Sylvia; Co-chair, Securities Litigation Practice at Mintz Levin in Boston. “The purpose is to prevent favored parties from obtaining a trading advantage even where the executive may have been authorized to make the selective disclosure, thus making it difficult to charge the traders with insider trading (i.e., no breach of a duty or misappropriation of information).”
More proactively, Reg FD not only guides how material information should be disclosed, it also mandates when it should be disclosed.
“One of those gaps that existed in the 1990s is that issuers would selectively disclose confidential information to certain analysts and institutional investors, who would then profitably trade on that information,” says Oliwenstein. “In response to this gap, the SEC adopted Regulation FD to promote full and fair disclosure. The crux of Regulation FD is that once a public company shares confidential information with certain individuals specified in the rule, that company must immediately disclose that information publicly (the rule also applies to accidental disclosures).”
It’s here where the word “accidental” becomes relevant. It then is a matter of the timing of events as to whether “insider trading” may exist (and places the relative burden of proof upon the SEC).
“From an insider trading standpoint—assuming the options were issued and exercised after news reports—I think it’s unlikely that the SEC would pursue insider trading charges here,” says Kurt Wolfe, an attorney with Troutman Pepper based out of the national law firm’s Richmond, Virginia and Washington DC offices. “The material information was known to the market, and seems to have moved the price.”
It may be, then, that the nuances of Reg FD, though triggered by Kodak’s failure to place an embargo on its press release, may provide a significant obstacle in the SEC’s investigation.
“If the reports were published via a public disclosure under Reg FD, then it may not be a violation,” says Braden Perry, a former federal enforcement attorney and CCO of a financial firm, who is presently a regulatory and government investigations attorney with Kansas City-based Kennyhertz Perry, LLC. “A public disclosure in this case is dissemination by a method or combination of methods reasonably designed to provide broad, non-exclusionary distribution.”
On the other hand, Kodak’s attempt to “right the wrong” of the premature release of the information regarding the loan may jeopardize its Reg FD defense.
“There is a question as to whether Regulation FD was satisfied regardless of whether the information was nonpublic for insider trading purposes,” says Oliwenstein. “The ‘reasonably designed to provide broad, non-exclusionary distribution’ standard requires that information be disseminated widely and potentially through various mechanisms designed to reach a broad population. The SEC could credibly take the position that publication by two local news sources is insufficient, even with the discussions in national chatrooms. If that is correct, the SEC would expect Kodak to treat the early dissemination of the news as an accidental disclosure and promptly disclose it in a manner ‘reasonably designed to provide broad, non-exclusionary distribution.’ Instead, the company seems to have done the opposite and asked the reporters to remove the information. The SEC might see this as a Regulation FD violation.”
Even if Reg FD proves to be irrelevant, there are other circumstances under which the issuance of the options would not rise to an act of insider trading. The fact that Kodak’s CEO had been granted options frequently in the last twelve months, and certainly before Kodak began negotiations with the government, would suggest a pattern of behavior.
“One scenario in which the options trading would be unlikely to constitute insider trading is if the transactions were made pursuant to a so-called Rule 10b5-1 plan, which is essentially a trading program that removes all discretion from the officer or director,” says Oliwenstein. “A few caveats on 10b-5-1 plans are that in order to provide a defense to an insider trading allegation, a 10b5-1 plan must be bona fide and adhered to faithfully. Once implemented, the plan must be left to operate without interference (and, of course, it must be created at a time when the insiders are not in possession of material nonpublic information). Under these circumstances, transactions entered into should not form the basis of insider trading liability even if they occurred at a time when the executives clearly had access to material, nonpublic information. If Kodak or its executives assert Rule 10b5-1 as a defense to the SEC, expect the staff to probe issues designed to get at the legitimacy of the plans including when the plans were created, whether the plans were amended, 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’s not unusual for the SEC to investigation odd coincidences in trading. It is rare, however, that such investigations play out in the backdrop of a politicized environment. And if this is a mere coincidence, that’s too bad, 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 to, in the words of the New York State Governor, no longer “rely on shipments from China or elsewhere in order to get lifesaving medical supplies.”