As Rodney Tonkovic discusses in more detail, the plaintiff in Fried v. Stiefel Labs, 814 F.3d 1288 (11th Cir. 2016), has petitioned the Supreme Court to delineate disclosure duties in the context of trading by private companies.
Richard Fried was the former CFO of Stiefel Labs, which was privately held. As an employee, he received stock as part of a pension plan. When he retired, he sold the stock back to Stiefel (I don’t know much about the market for Stiefel stock, but I’m guessing that, since it was privately held, Fried didn’t think he had many alternative options). Sadly for Fried, shortly after his sale, it was announced that Stiefel was being acquired by GlaxoSmithKline, and that negotiations had been in the works at the time of his sale. By selling to Steifel instead of waiting for GSK’s acquisition, he missed out on, roughly, an additional $1.62 million. He sued Stiefel, alleging that Stiefel had been obligated to disclose the negotiations to him at the time of his sale.
This is not something that comes up very often, but the case law that does exist tends to hold that insider trading principles apply both to private and public companies and, in particular, that when a company buys its own stock back from an employee, it has a duty to disclose material inside information. See, e.g., Castellano v. Young & Rubicam, Inc., 257 F.3d 171 (2d Cir. 2001); Jordan v. Duff & Phelps, Inc., 815 F.2d 429 (7th Cir. 1987).
The issue is a bit of a theoretical muddle, though, not least because it is the company – not a particular employee – who is doing the trading, and thus the precise fiduciary duty at issue is harder to nail down. The employee knows the price is not being set by the market generally, and the employee’s expectations regarding the company’s superior information depend – well – on the existing background legal regime of required disclosures. (The SEC filed a brief in a related case, where it argued that “where a company trades in its own stock it does have a duty to disclose material information or abstain from trading.” SEC Brief, Finnerty v. Stiefel Labs, 2013 WL 2903651, at *9-*10. This was an odd statement because that’s a hard case to make if the company is selling its stock, at least to the extent it’s relying on a Section 5 exemption.) So what the employee might reasonably expect, or rely upon – and thus be deceived by – is something of a moving target.
I’m not going to hazard a guess as to whether the Supreme Court is likely to grant cert in the Fried case– my track record on these sorts of predictions is embarrassingly terrible – but I will say that there are some uphill battles Fried may have to climb. First and most importantly, the Eleventh Circuit never actually decided the issue of whether a private corporation counts as an “insider” for insider trading purposes, because it rejected the claim on essentially technical grounds – i.e., that Fried should have requested jury instructions under 10b-5(a) or 10b-5(c), not 10b-5(b). The Circuit’s failure to address the substantive issues detract from its utility as a vehicle for addressing the duties of a private corporation. Indeed, the “questions presented” in Fried’s petition do not even mention the Eleventh Circuit’s focus on the distinctions between 10b-5(a), (b), and (c) – which, as we know, are really important distinctions to the Supreme Court, see Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011).
Even leaving that point aside, because of the dearth of caselaw, the Court might reasonably say these issues need more development in the lower courts. And though Fried argues that this case involves the question whether 10b-5 prohibits trading in possession of material inside information, or only trading on the basis of inside information, that point was only mentioned by the Eleventh Circuit in passing, and it certainly has nothing to do with the far more interesting question of the duties owed by private companies repurchasing their stock.
But, as I said, I’m not going to try to predict what the Court is likely to do here. I’ll simply say that assuming the Supreme Court rejects Fried’s petition, it almost certainly will have other chances to get at these problems, because of the increasing tendency of companies to stay private for prolonged periods of time, and to go through multiple rounds of financing. As Bloomberg reports:
[T]he more money you have, the more information you get in private markets. Sven Weber launched the SharesPost 100 index fund in 2012 to let unaccredited investors (with a net worth below $1 million) own shares in late-stage startups, including DocuSign Inc., Spotify AB and Social Finance Inc., with a minimum investment of $2,500. He could only write $500,000 checks at first and it was hard to get information to gauge if he was getting a fair price. As the SharesPost 100 grew to 34 startup positions and $71 million under management, he got more access.
Weber said one Silicon Valley unicorn provided virtually no information when he was trying to purchase shares last year. Based on historical statements and publicly available documents like articles of incorporation, he invested anyway. During the past year, he increased his stake, got to know company executives and eventually convinced them to share quarterly revenue updates and forward-looking statements.
The differential access to information has attracted not only SEC attention, but also other lawsuits like Fried’s – and I’m assuming there will be more to follow. So the really interesting question is, when you invest in a private company, to what extent are you assuming the risk of this kind of informational asymmetry?