What to Do When You Almost Have Inside Information


I have spent my career in the investment business and have participated in thousands of meetings or calls with managements of public companies. A few times, I have received inside information, and I guarantee that you know when you’ve got it. When I worked at a large mutual fund company, we had ample instruction on how to identify what was “material and non-public” information, and what action to take immediately. Even without any training, if someone tells you not to buy his firm’s stock because they will probably miss earnings this quarter, your “insider” antenna should be vibrating like crazy.

There were a couple of times when I raised my hand, explaining that I was pretty sure that I had heard something privileged for which I didn’t want anyone to get into trouble. After being coached and rehearsing my testimony with legal counsel, in anticipation of an SEC deposition, I realized what a Godsend insider trading cases were to attorneys, whose self interests had to be biased toward co-opting the most possible hours of my time.

I was also interviewed several times by the SEC for a case in which Pan American Airways, allegedly, gave some analysts inside information about the value of their South American route system. I spent a full day explaining, in many different versions of the same sentence, that I could not remember anything relevant to the SEC claim from my most recent meeting or calls with the airline. Once you have these types of experiences, you’ll do anything to avoid it another time.

Which brings me to a few weeks ago, when I was flying to Los Angeles to meet with clients and companies. When the plane landed, I turned my phone on and there was an email from Kythera, a biotechnology company I was visiting the next day. Kythera recently received FDA approval to sell a product called Kybella, that treats double chins but absorbing subliminal fat. Our firm has owned Kythera for over two years during which the stock has been very volatile at times, but basically became a big winner for us due to its successful drug development. We’ve spoken to the company many times, at their headquarters, in Boston, conferences, and on the phone.

The email, from the director of investor relations, told me that, unfortunately, the CEO could not meet with me the next day, and they apologized for the inconvenience. INCONVENIENCE!!! I had only just flown 3000 miles and had blocked out half the day between the drive there and back and meeting with top management. I called her immediately and could get no information about the reason for the cancellation except that the CEO was not gravely ill. No one else in the management team was available either to see me. She knew I was upset but didn’t give me anything more.

I called my office to speak with one of my partners and we ran through the various scenarios of why a company cancels a meeting. Kythera could be making an acquisition, which would be a negative but unlikely because they were about to launch their first product. The FDA could have found a fault in the production facility, which would delay manufacturing. They could be ready to announce a secondary stock offering, which is never a positive for stocks.

On the plus side, Kythera could have signed a partnership deal on either Kybella for overseas rights or on another drug. A larger firm might be buying a minority interest in the corporation. Or, they could have agreed to be acquired by a larger biopharmaceutical company. This is always a possibility with smaller public biotech corporations, one that we expected would happen to Kythera when a large entity wanted to fill out its aesthetics product line.

Even though the buyout seemed most likely, a manufacturing problem was conceivable or even a strange lawsuit filing. Also, the obvious buyer was Allergan, the maker of Botox, which itself had recently been purchased for $66 billion by a specialty drug company called Actavis, dramatically stretching that firm’s balance sheet.

So we had to decide if there was any action we should take about our Kythera stock. The first question was whether we received any inside information. I have described this scenario to several people well schooled in the insider trading rules, including looking over the SEC website, and we did not possess anything non-public and material. I only knew that Kythera cancelled my meeting and that the CEO was not deathly ill. Therefore, we were free to buy and sell stock.

We felt reasonably sure that something positive would happen, although not certain. We ruled out selling any stock, which was already at a 3% position in most of our portfolios. If we added to it and then the stock spiked after an event, Kythera might become our top holding.

While positive for performance, this increased the risk that the SEC would take notice. You can bet that the SEC reviews the trading of equities in the weeks preceding a major announcement. Having been through SEC inquiries before, I knew all about the heavy time commitment. Also, I wouldn’t like a client to see me walk into the SEC’s Boston office for a tete-a-tete with the local bureau if we were summoned, or have people hear that we were involved in an insider trading investigation. The mere implication would be enough to hurt our reputation. No, we decided, it was too much risk to Aureus, our company.

The next day, June 17, 2015, Kythera announced that it was being acquired by Actavis, which coincidentally, had changed its name to Allergan after it bought that company. Despite its mountainous debt, Actavis obviously wanted to build out the Allergan aesthetics franchise. Kythera stock price jumped 22% that day and we were thrilled with our profit on the stock, but also relieved that we didn’t take any action.

Although we never possessed any inside information, it wouldn’t have been worth the risk to increase the scope of our position in the stock. We passed up some incremental gain for the security of knowing that we avoided a potential headache and costs to our firm and even our clients.