On September 21, 2011, the US Securities and Exchange Commission (SEC) brought its first insider trading action involving exchange-traded funds (ETFs) (In the Matter of Spencer Mindlin and Alfred Mindlin, SEC Admin. Proc. File No. 3-14557, 9/21/11). ETFs, which are traded like stocks, track stocks or other investments like an index. The SEC alleges that a father and son traded in ETFs while in possession of material nonpublic information regarding “massive, market-moving trades” that the son’s employer, a major investment bank, intended to make.

This action reflects the SEC’s continuing pursuit of aggressive interpretations of established insider trade law. Existing precedent holds that trading in “material” nonpublic information, in breach of a duty to keep the information private, is illegal. However, the standard for “materiality”, i.e., information a reasonable investor would consider important, is less clear.

Here, the SEC alleges that using information about a large upcoming purchase of an individual security, which is part of a composite index of securities, to purchase the composite index, violates the law. Had the misappropriated information been used to invest in the underlying individual security prior to the bank's investment, a violation could have occurred. However, whether information about an upcoming purchase of an individual security, which is only part of a composite index, would be considered “material,” is the question.

One thing is certain, however, the SEC intends to continue pushing the boundaries of what is deemed illegal in the insider trading arena. ETFs, which have gone from relative obscurity to mainstream investments in the last decade, appear to be the SEC’s latest frontier in this regard. The SEC’s press release may be viewed by clicking here.

Peter V. B. Unger
unger.peter@arentfox.com
202.857.6220

Mark S. Radke
radke.mark@arentfox.com
202.715.8431