Brad Allen reports on the implications for IROs of a recent insider trading case
‘My first response was that this is unbelievable, un-bee-lieve-able!’ The incredulous speaker, a Wall Street veteran, has worked in and around stock exchanges for more than 25 years. He was describing the shared reaction he and two colleagues had on hearing the news that Donald Johnson, a former managing director of NASDAQ, had pleaded guilty in federal court to trading on inside information gleaned in his role as market intelligence desk liaison. Robert Khuzami, enforcement director at the SEC, called the incident ‘the insider trading version of the fox guarding the henhouse’ when announcing a related civil complaint.
The exchange veteran, who asked to remain anonymous because he’s still in the industry, says he and his companions couldn’t fathom how Johnson thought he would get away with it. ‘We all said the same thing: It’s unbelievable! As an employee of an exchange, you know the regulatory framework,’ he says. ‘You know the analysis the exchange goes through to monitor suspicious trading.’
Quite apart from the obvious risk of being caught, there was something else this veteran couldn’t grasp: how could a senior exchange official willfully violate his trust with listed companies? ‘That relationship is the golden goose,’ he explains. ‘That’s what a company is to you. To violate that type of relationship is completely incomprehensible.’
Among corporate officers and IR professionals, however, the Johnson story should provoke more than mere incredulity. Johnson actively preyed on his corporate contacts – IROs, CFOs and general counsel – relying on their presumption of a confidential and trusted relationship, akin to what they have with their external counsel or auditors. Shock, anger, fear, sober reflection and caution are all natural reactions.
Johnson retired in the fall of 2009 and NASDAQ refused to comment when the story first broke in spring this year. During an era in which expert networks have allegedly compromised true corporate insiders – from a supply chain manager, business development director and sales manager all the way up to a CEO heir-apparent and a corporate director – Johnson’s confession may seem like one more tawdry news item in a string of crass revelations.
But markets matter, and expectations of performance by market participants are important. IROs and other listed company executives have no choice but to interact with the exchanges. So a couple of key questions need to be addressed: does this breach alter how IR professionals and listed company officials should deal with exchanges in the future? And how can trust be restored?
Angry exchanges
It may be too soon to draw any kind of definitive answer, but IR magazine put the question to several people. The issue generated a lively and expletive-filled conversation at the recent NIRI conference, including a comment from one IRO who is still waiting for his NASDAQ rep to address the issue. Few were willing to speak on the record, however.
Likewise, a query to the exchange watchdog agency, FINRA, was politely declined. A spokesperson for the NYSE also demurred. ‘We’re not in a position to comment on the NASDAQ/Johnson matter. It’s NASDAQ’s concern, not ours,’ he said, before recounting the NYSE’s internal rules prohibiting senior officials from trading listed stocks.
The six companies Johnson admitted preying upon were also approached: most of them declined to talk, but two were willing to share their views.
‘Confidentiality was always a part of my job; it just seemed natural,’ says Michael Schostak, IRO at Energy Conversion Devices. Schostak joined the Auburn Hills, Michigan company a little more than a year ago, or nearly two years after Johnson had a preview of better-than-expected earnings from a previous IRO, which he used to help him pocket a cool $114,000 profit in two days.
Schostak previously worked in investment banking at Lehman Brothers and in M&A consulting for Booz Allen Hamilton. ‘If my NASDAQ rep on the markets intelligence desk had asked me about our earnings ahead of time, that would have set alarm bells off,’ he says. ‘I don’t know that I’d have been comfortable talking about that even before this thing broke.’
If he has material news pending, Schostak alerts the exchange early in the morning that the company expects to make an announcement before pre-open, but does not reveal anything more. ‘In general we don’t give the market intelligence desk any confidential information,’ he says.
When Johnson pleaded guilty, Schostak’s NASDAQ account manager ‘obviously reaffirmed’ the exchange’s confidentiality safeguards, including background checks on employees. ‘In general our interactions with [NASDAQ] haven’t changed,’ Schostak maintains. ‘We respect that any interaction is confidential.’
Hard to prevent
United Therapeutics Corporation of Silver Spring, Maryland was the victim of two illicit Johnson trades. On two separate occasions the firm had consulted with the NASDAQ official on pending announcements of successful FDA drug trials, including one fast-breaking announcement intraday. The two trades netted Johnson $286,000 in profits.
Andrew Fisher, deputy general counsel and IR contact for the company, says in an email that ‘isolated actions of individuals like Don are unfortunate but very difficult to prevent: when someone wants to do wrong, he or she can usually find a way to do it.’
Fisher says NASDAQ has been a very good partner for the company over the past dozen years. ‘And this incident hasn’t changed our relationship with it,’ he maintains. ‘It has certainly provided reassurances to us in the wake of the Johnson incident, and that was welcome. It wasn’t really necessary, however.’
Joe Christinat, newly minted vice president of media relations for NASDAQ, knew nothing about the pending Johnson plea when he joined the exchange. His second day on the job, he was escorting the Philadelphia Phillies baseball team around the exchange for a photo op; the following day the news broke. Christinat quickly immersed himself in the employee ethics guidelines and policies not just of NASDAQ but also of the NYSE and major Wall Street firms.
After that under-the-gun review he was able to assert to the press that NASDAQ’s policies on pre-clearance, insider trading, trading windows and conflicts are as stringent as anyone else’s. Ironically, a periodic reminder on the policy was sent to NASDAQ employees a few days after Johnson’s plea hit the wires.
In fact, NASDAQ has not made any changes in policy or practice in the aftermath of Johnson’s violations, Christinat says. When probed about a Wall Street Journal story reporting inadequate background checks on Johnson, Christinat notes that every employer conducts more diligent and thorough background checks today than it did in 1989, when Johnson first joined NASADQ.
Moreover, NASDAQ has not explicitly communicated with listed companies about the Johnson case, according to Christinat. ‘We’re in constant contact with all our listings, on a variety of topics,’ he says, adding that his firm did talk to some customers ‘and reiterated our stringent policies, walked them through those policies and answered any questions. I don’t know exactly how many we talked to.’
Overall, Christinat reckons the exchange has worked hard to maintain client trust. But what has been the reaction of NASDAQ employees? ‘Shock, anger – all the normal things you would expect to feel when betrayed,’ he replies.
No change for clients
Veteran IR counselor Keith Mabee, vice chairman of Dix & Eaton, has several clients listed on NASDAQ. He says he hasn’t noticed any change in attitude or practice among his clients. He views Johnson as ‘a bad actor, one person run amok’ but says the incident raises a cautionary flag ‘about how much you say.’
The relationship between issuers and exchanges is fragile unless we can trust ‘it’s a safe exchange’ of information, Mabee adds. He counsels clients to aim for releasing material information either pre or post-market hours and to alert their exchange, whether that’s the NYSE or NASDAQ, no more than half an hour before issuing news.
But the anonymous exchange veteran remains skeptical. ‘I think these things go over corporations’ heads,’ he concludes. ‘I really don’t think they focus on it. They think, Oh, this happens. But what can we do? That’s why you have a regulator – to deter this type of activity. So the more it gets publicized and the more people recognize that Big Brother is watching, the better for the market and the better for companies.’
This article appeared in the August print edition of IR magazine.
