Don’t Trade Stock in Your Friend’s Company, Illegally

Ladislav “Larry” Schvacho purchased approximately 72,000 shares of Comsys IT Partners, Inc. stock between November 9, 2009 and February 1, 2010. On February 2, 2010, Manpower, Inc. and Comsys publicly announced a merger, resulting in a 31% percent increase in the share price of Comsys from its prior day’s close. As a result of his trading in Comsys stock, Schvacho obtained profits of  over $500,000.

The SEC thinks Schvacho made those trades because he was a friend of the CEO of Comsys and was illegally trading on inside information. At this time, Schvacho is contesting the charges so the allegations may or may not be true. I’m assuming they are true to see if we can learn some lessons from this case.

Schvacho and Larry Enterline worked at several companies together starting in the 1970s, including an investment fund. They also developed a close personal relationship and Enterline named Schvacho as executor of his estate. Enterline was the CEO of Comsys.

According to the SEC complaint Enterline was not cautious in speaking about the company’s business when Schvacho was around. Enterline spoke on the phone to other Comsys executives about the merger in the presence of Schvacho. The SEC also alleges Schvacho had access to merger-related documents during a vacation with Enterline.

The transactions smell like insider trading. The easiest problem for the SEC will proving that Schvacho knew about the confidential merger information. From the statements in the complaint it sounds like Enterline has provided the SEC with some specific information about what was said in the presence of Schvacho.

The tough battle for the SEC will be proving that Schvacho had a duty to keep the information confidential and not trade in the stock. Schvacho himself was not an insider. He was merely the friend of an insider. The SEC contends that “Enterline reasonably expected that Schvacho would refrain from disclosing or otherwise misusing the confidential information.” The SEC will have to show that Schvacho violated a fiduciary duty to Enterline based on their long friendship. That duty is part of the law of insider trading cases under 10b-5.

Even if the SEC cannot show insider trading, the SEC also accused Schvacho of violating Rule 14e-3, which prohibits insider trading on information about a tender offer. Unlike insider trading, Rule 14e-3 does not require proving a breach of a fiduciary duty, The SEC will merely need to prove that the person knew the information was confidential. This was just luck for the SEC in this case. The Comsys transaction happened by a tender offer instead of the more traditional merger or reverse merger.

Sources:

• SEC Charges Close Friend of Staffing Company CEO with Insider Trading Around Acquisition
• SEC Complaint against Ladislav “Larry” Schvacho
• SEC Charges Friend of Comsys CEO with Insider Trading Around Manpower Acquisition by Victoria Stilwell in the Wall Street Journal
• The Evolving Contours of Insider Trading by Peter Henning in NYTimes.com’s DealBook