Faculty Notes

Prof. Ronald Colombo Comments in Forbes.com Story on SEC’s Herbalife Insider-Trading Case

Ronald J. Colombo, Associate Dean for Academic Affairs and Professor of Law

Is The SEC Punishing Herbalife ‘Insider’ For Front-Running Bill Ackman?
By Daniel Fisher
Oct. 1, 2014


The Securities and Exchange Commission’s Herbalife insider-trading case is unusual for several reasons, not least the fact that nobody involved had any legal relationship with Herbalife. But here’s what really puzzles me: Why is the SEC using its vast enforcement firepower to go after a guy who, at the end of the day, may be guilty only of front-running billionaire William Ackman and his Pershing Square Capital Management? …

“There’s an ancient struggle between SEC and courts,” said Ronald Colombo, a professor at Hofstra Law School and former Morgan Stanley securities attorney. “The SEC has been exercised over the fact people are able to trade on non-public, material information, and it has time and again tried to outlaw it. And the  Supreme Court has repeatedly rejected that theory.”

Ironically, the SEC has no case against people in Ackman’s position, who assemble a huge trade in a stock and then publicize the reason they’ve done so, in hopes of convincing other investors to bet the same way. Ackman has no fiduciary duty to himself to keep the information secret, Colombo said. (Although many have raised questions about his attempt to engineer Valeant’s takeover  of Botox-maker Allergan.)

“What’s at work here is the SEC wants to go after trading involving information disparities,” Colombo said. “In this case they can go after the minion instead of the boss.”

While both Huey-Burns and Colombo agree the facts in the Herbalife case are unusual, they say the chain of liability the SEC alleges is actually quite plausible under current law. “There would be a huge loophole,” Colombo said, if an insider could tip an outsider and that person was free to trade, a la Martha Stewart, who was convicted of selling Imclone shares after her  broker tipped her that Imclone Chief Executive Sam Waksal  was dumping his own stock. Courts assume anybody who tips a friend or relative gets some benefit from the action.

The SEC also has an interest in appearing tough on trading that undermines confidence in the fairness of the public markets, Colombo said. The Herbalife case could represent a “broken windows” form of policing designed to reassure small investors that people can’t profit by trading on information Aunt Sally in Dubuque can’t hope to obtain.

“Is it a good use of their limited resources? Maybe not,” he said.

Read the full article.