The David Einhorn Affair

Would the outspoken hedge fund activist really have been free to trade in the U.S.?

As a securities attorney, I am baffled by the news reports on hedge fund manager David Einhorn’s insider trading run-in with the U.K.’s Financial Services Authority (FSA), which Einhorn just settled for $11.2 million.

Article after article takes the position that, in the U.S., Einhorn would not have been charged with insider trading for selling shares of a public company after learning of its planned secondary offering in a private conversation with company executives.

On June 8, 2009, a Bank of America Merrill Lynch broker representing Punch Taverns, a publicly-traded British pub chain, reportedly asked Einhorn if he wanted confidential information about the company. At the time, Einhorn’s $8 billion hedge fund, Greenlight Capital, owned more than 13% of Punch’s stock. Einhorn rejected the offer — specifically to remain unrestricted — but told the broker that he would nevertheless be “happy to talk” to company management.

The next day, Einhorn was invited by the BofA broker to participate in a conference call with Punch’s CEO and CFO who told him of a large rights issue the company was planning for later in the month. Einhorn viewed the issuance of additional Punch stock as dilutive of Greenlight’s investment, and, immediately after the call, ordered the sale of the fund’s entire Punch position. Greenlight was able to sell about a third of its holdings (more than 11 million shares) over the next four days before the company publicly announced its rights offering on June 15th. The Punch stock price then fell by almost 30%, and Greenlight Capital saved over $9 million.

That’s it.

The FSA then stepped in and accused Einhorn of market abuse. Einhorn tried to justify his stock sale on the ground that, in the conference call, Punch’s CEO was pessimistic about the company’s business prospects. The FSA didn’t buy his story, and Einhorn decided to settle the matter as not worth fighting.

Every piece I’ve read about the settlement has reported the affair as an example of the broad reach of U.K. market abuse rules — which capture even arguably unintentional insider dealings such as Einhorn’s – as compared to the narrower U.S. law which technically requires a breach of duty by the alleged “inside trader” in order for the government to sustain a fraud claim.

So, what is it about Einhorn’s conduct in this case that offended market standards in the U.K. – one London banker reportedly asked “why isn’t he in jail?”– that would supposedly have raised no eyebrows in the U.S.?

As reported, Einhorn got what he knew to be a market-sensitive tip directly from company insiders, knew that Punch’s upcoming rights issue was not yet public information and nevertheless sold his Punch stock to avoid a loss. On those facts, how does an experienced hedge fund operator like David Einhorn elude an insider trading violation in the U.S.?

If the answer is that Einhorn’s rejection of the BofA broker’s offer of confidential information insulated him from breaching a legally-required duty to the broker, the company, the other Punch shareholders or the securities markets in general, we in the U.S. should now be turning our attention to plugging a serious gap in our insider trading laws.