New York State, among other states, has a “shield law” that gives journalists the right to keep their sources confidential. This law may prove problematic for cases of insider trading. Consider the following recent scenario: Reorg Research Inc (“Reorg”), a subscriber newsletter that covers bankruptcy and distressed debt, published an article about Murray Energy Corporation (“Murray”), one of the largest coal mining companies in the US. Given the confidential nature of the information published, Murray assessed that the information had to have come from some of its private investors, and as such the disclosure of this information to Reorg constituted a breach of Murray confidentiality covenants.
Murray proceeded to sue Reorg, (Murray Energy Corporation v. Reorg Research Inc. 55 Misc.3d 669, 47 N.Y.S.3d 871, 45 Media L. Rep. 1301, 2017 N.Y. Slip Op. 27036) demanding that the source who disclosed information on Murray financials be revealed. The court ordered Reorg to reveal the sources. Reorg appealed, and on July 13, 2017 won the appeal, with the Supreme Court Appellate Division First Department of New York ruling: “we find that the Respondent is except from having to disclose names of its confidential sources from New York’s Shield Law, because it is a professional medium or agency which has one of its main functions the dissemination of news to the public.”
The court made the determination that despite the fact Reorg has only 375 subscriber firms who each pay tens of thousands of dollars a year for access to the publication, Reorg covers a niche market—distressed debt—that is of vital public interest. According to the court, Respondents argued persuasively that the public benefits secondarily from the information Reorg provides to its high paying subscribers, because that audience is comprised of “people most interested in this information and most able to benefit from it” and from this network distributes the information and its pricing effects to the wider public.
In its ruling, the court wrote:
Significantly, respondent established that its editorial staff is solely responsible for deciding what to report on and that it does not accept compensation for writing about specific topics or permit its subscribers to dictate the content of its reporting. Other courts have found the extent of a publication’s independence and editorial control to be important in determining whether to apply the Shield Law (see e.g. Pan Am Corp. v. Delta Air Lines, Inc., 161 BR 577, 584 [SD N.Y.1993]; In re Scott Paper Co. Sec. Litig., 145 FRD 366, 370 [ED Pa 1992]; cf. In re Fitch, Inc., 330 F3d 104, 111 [2d Cir2003] [credit reporting agency not protected by Shield Law where communications with the client “reveal a level of involvement with the client’s transactions that is not typical of the relationship between a journalist and the activities upon which the journalist reports”]; LaSalle Natl. Bank v. Duff & Phelps Credit Rating Co., 951 F Supp 1071, 1096 [SD N.Y.1996] [credit reporting agency not protected by Shield Law where, inter alia, its rating “was privately contracted for and intended for us in the private placement Offering Memoranda”] ). We concur.
As we have discussed in prior blog posts, this ruling is yet another example of the opacity and complexity of current insider trading laws in securities markets, and the sometimes-conflicting differentiations. It also opens up a variety of structures in which one could disseminate nonpublic, market moving information to specific subscriber parties, while protecting the insider via the shield laws, and potentially profiting by taking market positions prior to the publication. Ongoing cases involving this type of scenario include United States of America v. Blaszczak, which involve trading on “political intelligence” that specialist investigative firms in Washington D.C. produce for hedge-fund subscribers. These D.C. investigative firms discover government “secrets” regarding market moving regulation, and publish this information to subscribers, whereupon subscribers presumably trade on the information. The benefit to subscribers is they have plausible deniability regarding whether the secrets came from insiders, and the benefit to the publication is they can protect sources from inquiry through journalistic confidentiality protections such as shield laws.
The dissemination of market moving material by insiders, and the legality surrounding the various contingencies on which such information can or cannot be leaked, is significant due to the prevalence of this activity. A famous study of insider trading, titled “Informed Options Trading prior to M&A Announcements: Insider Trading?” by NYU Stern Professors Menachem Brenner and Marti Subrahmanyam, found that, in a systemic analysis of option trades prior to M&A announcements, approximately 25% of all mergers involved insider trading. The most probable explanation for patterns of option trading (in relation to demand, bid-ask-spreads, and implied volatility 30 days prior to a merger) in the wide data sets Brenner and Subrahmanyam studied was insider knowledge. For option chains to deviate that much from their historical averages, and deviate so significantly right before M&A announcements, coincidence is virtually a mathematical impossibility.
Given the complexity of insider trading laws, and the nuances surrounding how they are applied, it is advised to speak with an attorney before making a securities transaction that may put yourself at risk. If you are under investigation for insider trading, or have traded on information that you believe may have been obtained by an insider, it is wise to seek counsel. Lax & Neville LLP has nationally represented small broker-dealers, financial services professionals, and securities industry companies in regulatory matters and securities-related and commercial litigation. Please contact our team of attorneys for a consultation at (212) 696-1999.