By PAUL BERGMAN is a professor of law emeritus at UCLA.
“PEOPLE COMMIT THE TYPES OF CRIMES that they have the ability to commit.” I was reminded of this aphorism recently by Sandy Banks’ articles in the L.A. Times describing the repugnant behavior of a large group of teenagers. They brazenly ran through a convenience store in their lower-income neighborhood, created havoc and took whatever they wanted as the frightened shopkeeper looked on, and then left as though they hadn’t a care in the world. The story was especially sad because the teenagers were all (or almost all) black, and they invaded the store on Martin Luther King Day, at the conclusion of a neighborhood parade honoring Dr. King.
While we should all deplore the teenagers’ criminal actions, we should keep in mind that this street crime is the type of crime that they are able to commit. Its visibility and immediacy contribute to public perceptions of “the crime problem.” Corporate insiders, by contrast, have the ability to commit other types of crime. Ironically, their crimes may produce many more victims compared to street crimes.
For example, consider a number of corporate insiders’ stock transactions as reported recently by the NY Times (Sunday Business, Feb. 3, 2008). John Johnston, the former CEO of the Western Division of American Home Mortgage, sold over $7 million worth of his company’s stock in October 2006, just before the company issued a report describing huge loan defaults. (The company filed for bankruptcy in 2007.) Edward Gotschall, a founder of New Century Financial, sold $24 million worth of his company’s stock, again shortly before public disclosure of the company’s disastrous drop in earnings and a few months before the company filed for bankruptcy.
Perhaps the king of them all is Countrywide Financial’s CEO,Angelo Mozilo. From mid-2006 to mid-2007, until just before the share price plummeted, Mozilo sold company stock worth about $129 million.
As you read about these transactions, do you catch a whiff of “insider trading?” Insider trading (buying or selling securities “on the basis of material non-public information”) is illegal.
In response to claims that they sold their companies’ shares because they knew well before the public that their companies were headed for the dumpster, Johnston, Gotschall and Mozilo would no doubt argue that they did nothing wrong because they sold pursuant to written plans that were created before they knew that their companies were in trouble. Their argument is supported by a provision in Title 17 of the Code of Federal Regulation known as Rule 240.10b5-1. As luck would have, the Securities and Exchange Commission promulgated this rule in the year 2000, just in time for these insiders (and others) to begin drafting their plans.
Rule 240.10b5-1 creates a “safe harbor” for innocent, pre-planned trading. In other words, Johnston, Gotschall and Mozilo can argue that they are really good planners — if not for their companies’ and employees’ futures, at least for knowing when to sell their personal stakes in their companies.
The rule seems sensible, because stock-transaction plans provide safe harbors only if they are not based on inside information. However, a 2007 research project by a doctoral student at Stanford’s Graduate School of Business concludes that participants in Rule 240.10b5-1 plans are able to make strategic trade decisions that “generate abnormal trade returns,” and that many plans are initiated in advance of adverse news disclosures. While the author was careful to say that the results of his study were “not necessarily indicative of illegal behavior,” he thought that the evidence he gathered should be known to regulators and others with “interesting inferences” about the behavior of corporate insiders.
Ultimately, the question of whether the corporate insiders identified in the NY Times article (and others) violated insider trading laws can be resolved only by our formal legal system. My point is simply that if they are guilty of any crimes, they committed the types of crimes that they had the ability to commit. Perhaps some of the urban criminals who trampled on Dr. King’s teachings by ransacking a small local store would prefer that they had the ability to commit supersized white collar crimes. But they don’t, and out of people’s differing abilities to commit different types of crimes arises popular perceptions of “the crime problem.”
Originally published in the Santa Monica Daily Press print edition on February 11, 2008. Read the original PDF.