I’m really starting to worry about the lawyers for former Qwest CEO, Joseph Nacchio. (I first expressed concern here.) Mr. Nacchio has been charged with 42 counts of criminal insider trading. The charges are based on allegations that Mr. Nacchio learned, after Qwest had made some rosy public statements, that business wasn’t going as well as predicted, and he then sold $101 million worth of stock on the basis of that non-public information.
According to today’s W$J, the defense is arguing “that the information Mr. Nacchio had was, by definition, not significant since the prosecution hasn’t claimed that it needed to be disclosed to investors.” In other words, the bad news couldn’t have been “material” (illegal insider trading must involve material non-public information), for there was no affirmative duty to disclose it.
The law, though, does not require immediate disclosure of all material information, so the fact that the information did not have to be disclosed does not imply that it was immaterial as a matter of law.
As Judge Easterbrook explained in Gallagher v. Abbott Labs., 269 F.3d 806 (7th Cir. 2001),
Much of plaintiffs’ argument reads as if firms have an absolute duty to disclose all information material to stock prices as soon as news comes into their possession. Yet that is not the way the securities laws work. We do not have a system of continuous disclosure. Instead firms are entitled to keep silent (about good news as well as bad news) unless positive law creates a duty to disclose.
Judge Easterbrook went on to discuss when the securities laws create disclosure requirements (i.e., the Securities Act does so prior to issuance; the Exchange Act mandates various periodic disclosures). If none of those disclosure requirements has kicked in, then negative information–even highly material negative information–need not be immediately disclosed. It is thus entirely possible that information could be material (as required for insider trading liability) but not subject to an immediate disclosure requirement. The assertion by Nacchio’s lawyers that there could no materiality if the information didn’t have to be disclosed doesn’t hold water.