The FSA vs. David Einhorn: A Case of Regulatory Overreach?


The Financial Services Authority (FSA) of the United Kingdom, imposed record fines against David Einhorn and his hedge fund Greenlight Capital for market abuse in the form of insider trading. This article describes Einhorn’s actions. It gives reasons the FSA imposed the punitive judgment based on the FSA’s statutory provisions and regulatory guide. The article analyzes the ethics of Einhorn’s actions and concludes the FSA imposed the large fine for two reasons: first, to show there exist laws by which the financial industry and its members must abide and second, to emphasize to and inform practitioners there also are expectations of a standard of ethics financial professionals must achieve. The emphasis on meeting a standard of ethics also bolsters flagging public confidence in regulators and the financial industry.

The Case:

On January 25th 2012, the U.K. Financial Services Authority (FSA) filed a civil suit against David Einhorn, President of the celebrated hedge fund, Greenlight Capital. The FSA imposed a fine on Einhorn and Greenlight of £7.2 million (US$12.5 million) for insider trading.[i]  According to the FSA, in early June 2009, David Einhorn was given inside information on Punch Taverns (PUB) [ii], a publicly listed company. The information fits the criteria for insider trading i.e., information of a precise nature that:

  1.  Is not generally available
  2.  Relates, directly or indirectly, to one or more issuers of the qualifying investments or to one of more of the qualifying investments
  3.  Would, if generally available, be likely to have a significant effect on the price of the qualifying investments.[iii]

Andrew Osborne, a senior corporate broker with Merill Lynch, on a call with Punch Taverns CEO disclosed information to Einhorn that Punch Taverns was at an advanced stage of equity fundraising.[iv] As a result of this disclosure, Einhorn ordered his traders to sell Greenlight’s shares in Punch Taverns.  Greenlight was able to sell over 11 million shares, reducing its ownership of Punch’s equity from 13.3% to 8.89%.  Days later, the Punch CEO publically announced fundraising of £375 million ($582 million) resulting in Punch’s shares falling nearly 30%.  Greenlight capital was able to avoid £5.8 million ($9 million) in losses.[v]

After an investigation the FSA decided Andrew Osborne, David Einhorn, and Greenlight Capital, had committed insider trading and would be fined for market abuse.

The FSA fined Osborne £350,000 for market abuse.  The FSA stated that Osborne disclosed inside information to Einhorn without signing a Non-Disclosure Agreement (NDA).   While the nature of Osborne’s offense was not deliberate the FSA reasons action is necessary to ensure the high standard of market integrity and, in turn, facilitate market confidence.  The FSA explains that as Osborne was a senior broker with extensive experience in wall-crossing procedures, Osborne should have taken greater care to avoid disclosing sensitive information, to comply with the regulatory requirements, in the absence of an NDA.[vi]  (To be wall-crossed is to make an investor an insider. Hence, the investor crosses the wall that separates investors from insiders.)

Furthermore, because of Osborne’s familiarity with NDAs, Osborne was at fault for not realizing the disclosure of inside information had occurred and did nothing to present this information to senior Merill Lynch management as a potential concern.

The FSA fined Einhorn and Greenlight capital £3,638,000 ($5.7 million) and £3,650,795 respectively. The FSA stated that while Einhorn’s actions were not deliberate, “investment professionals are expected to handle inside information carefully regardless of whether they have been formally wall-crossed.”

Tracey McDermott, acting director of enforcement and financial crime, explains that because Einhorn is an experienced professional with a high profile in the industry, he is expected to be able to identify inside information when he receives it and should act appropriately. His actions breached the FSA’s expected standards of market conduct.[vii]

Einhorn’s Argument Against the FSA Judgment:

Einhorn maintains he was not involved in insider dealing. Einhorn never intended to receive inside information and refused to sign an NDA. “[Greenlight] had no interest in becoming an insider,” he said recalling he told the company he would be, “…happy to talk to management, but not interested in receiving information to trade stock.”[viii] He believes the FSA’s action is “truly frightening.” [ix]

Why this dramatic statement? First, Einhorn argues he declined to sign an NDA. Secondly he declared his intention to sell his stake. Third, there was no blatant disclosure of inside information.

The phone call between Einhorn, Osborne, and the Punch CEO began with the Punch CEO explaining to Einhorn the company had sold 11 of its pubs that morning. The company was considering strategic options such as raising equity with the purpose of repaying Punch’s convertible bond and creating a cash buffer.  When asked about the share price, the CEO answers the company’s shares were fairly priced.  Einhorn was concerned by the CEO’s pessimism and believed raising equity to be a terrible idea for Greenlight and its shareholders.[x]

Consequently, Greenlight sold some of its shares and avoided large losses.  Einhorn believes this is not a case of insider trading and says that these actions “resemble insider dealing as much as soccer resembles [American] football.” Although Einhorn does not agree with the FSA’s decision he and Greenlight capital will not seek to appeal the fine.

Regulatory Implications:

In analyzing the British FSA’s decision there are a number of variables to which one should look to determine the intention and ultimately the purpose of the statement made by the FSA.  In the actions taken against Osborne and Einhorn, the British FSA is more than penalizing individual decisions and lack of awareness.  The regulator is making a larger statement to the entire finance industry. The first statement notes that there exist laws by which the industry and its members must abide. The second statement emphasizes to and informs practitioners there also are expectations of a standard of ethics that financial professionals must work towards achieving. This second statement is also meant to bolster flagging public confidence in regulators and the financial industry.

Ethical Analysis:

Determining the ethical implications of the FSA decision requires consideration of the role of the FSA. The institution is a financial regulatory body, independent from the UK government. Although independent, the FSA is run by a non-executive board of members appointed by the National Treasury.  The FSA’s main goal is to regulate close to every financial service in the U.K. The FSA Act of 2000 sets out four statutory objectives for the institution:

  1. Market confidence – maintaining confidence in the U.K. financial system
  2. Financial stability – contributing to the protection and enhancement of stability of the U.K. financial system
  3. Consumer protection – securing the appropriate degree of protection for consumers
  4. Reduce financial crime – reducing the extent to which it is possible for a regulated business to be used for a purpose connected with financial crime.[xi]

Although the main goal is to protect and regulate the U.K. financial system, the FSA assumes a larger responsibility over international finance. To achieve its goals, the FSA took action against Greenlight and David Einhorn. In the FSA’s opinion, Einhorn was able to act on inside information because of his privileged position at Greenlight.  The FSA’s apparent motivation to fine Osborne and Einhorn was to punish market abuses and to uphold market confidence and stability.

Consider the magnitude of the fine imposed by the FSA.  In November of 2011, the FSA fined Dubai-based investor Rameshkumar Goenka a record $9.6 million for market abuse.  This record fine was exceeded no more than two months later by the $12.5 million in fines levied on David Einhorn and Greenlight Capital.  In a statement Tracey McDermott explains that, “the fine levied against Goenka was high because of his extensive experience as an investor.” McDermott uses a similar reason for the fines against Einhorn. Furthermore, “[Goenka’s] action was pre-planned and intentional, and, because he intended to take the same action in relation to another structured product.”[xii]  In contrast, the FSA publicly said that Einhorn’s actions were not a deliberate exhibit of market abuse.  By setting a new record in fines, the sanctions imposed on Greenlight, however, imply Einhorn’s offense was somehow worse than Goenka’s intentional market abuse.  The FSA’s explanation for the fines seems inconsistent with dollar amounts when comparing similar cases.

The FSA claims Einhorn’s position necessitates better ethical conduct in dealing with information of this type. From Einhorn’s perspective, he was in contact with the Punch CEO and Andrew Osborne in June about the then state and plan for Punch Taverns.  When prompted, Einhorn refused to be wall-crossed and refused to sign an NDA.  This meant that Einhorn refused to receive any inside information regarding the status and management of Punch Taverns.  Any further conversation between the two parties would be on an open basis.  During the call, the Punch CEO and Osborne discussed a potential equity call and plans for upcoming fundraising.  Einhorn expressed his displeasure with the plan saying it would be, “shockingly horrible from my perspective.”  So horrible that Greenlight sold over 11 million shares.  The question to which the FSA vehemently answered affirmatively was, can Einhorn’s subsequent action to the call be considered market abuse?

Einhorn refused an NDA. With the refusal, there was to be no disclosure of inside information. Einhorn could have inferred that a potentially adverse change was coming when asked if he wanted to sign an NDA, as Greenlight capital was one of Punch Taverns largest investors.  At this point Einhorn was smart to refuse being wall-crossed and may have realized that Punch Taverns was in trouble.  On the offer of an NDA alone Einhorn could have decided to sell significant shares in Punch Taverns.  If this had been the case the FSA would have little basis to fine Einhorn for market abuse. Einhorn was merely acting on his deductive reasoning.  However, the talks between the two parties continued on an open-basis.

Andrew Osborne was fined by the FSA for market abuse by disclosing sensitive inside information without an NDA.  The FSA claimed that a man in Osborne’s position and experience should know better. The FSA deemed Osborne’s conduct as being subject to punishment. Should Einhorn have foreseen Osborne’s negligence and refused the open basis phone call with a company in which Greenlight, and Einhorn himself, had a large stake?  Refusal would have been detrimental to Greenlight’s investors.

What seems to have occurred in this instance is that Punch Taverns, after selling 11 of its pubs that morning, was in serious financial need.  In asking Einhorn to be wall-crossed, the hope was that he would agree. Thus, if Einhorn had agreed to be wall-crossed, he could not sell shares in Punch, possibly decreasing confidence in the company.  After Einhorn refused, the conversation continued. Einhorn was made aware of the upcoming fundraising plans for Punch Taverns.   The information meets all three criteria of the FSA’s definition of insider dealing.  Punch Taverns may have intentionally disclosed information as a tactic to force Einhorn to stay on board.

Facing a dilemma, Einhorn acted to the benefit of Greenlight capital and sold shares, avoiding large losses. Einhorn could have planned on selling shares simply on the basis of being asked to sign an NDA.  He could have assumed that things for Punch were going downhill.  Osborne and the Punch CEO broke the law by disclosing inside information to Einhorn when he refused to be wall-crossed.  Einhorn was put in an undesirable position.  Where do his obligations lie – obey the law, or protect his shareholders? In this case, if Einhorn did what the FSA considered right, he would have watched as Greenlight capital and its investors suffered large losses as a result of the equity call. Einhorn merely acted to protect Greenlight’s investments.

The response to the question of Einhorn’s fiduciary duty is clear and indisputable: no one has a fiduciary duty or obligation to act unethically. An agent has a fiduciary duty to act in the best interest of the client – but never if the act is unethical.

Yet, it seems redundant to penalize Einhorn for someone else’s, intentional or unintentional, negligence. Should we blame Einhorn for being given information he openly declined?  Did the FSA over reach its authority in penalizing Einhorn?

The response to whether Einhorn is blameworthy for his act is given by the FSA when it imposed the largest individual fine in FSA history at that time.  Einhorn and all others in a similar position should recognize insider dealing when it occurs and are obligated to inform the advisor (i.e. Merrill Lynch) of a potential concern.

The record setting fines may seem unfair especially considering the circumstances.  The last fine of this magnitude, in the Goenka case, penalized an individual for blatant and pre-meditated market abuse.  The FSA openly stated that Einhorn’s actions were neither planned nor deliberate.  However, the FSA is not required to act on precedent.  The regulator reasoned this kind of abuse had to be prevented.  Accordingly, in punishing Osborne, the FSA points fault at one of the parties of the insider trading.  It was Osborne who failed to uphold Einhorn’s refusal to be wall-crossed.

Einhorn may be considered a victim.  Some believe he only acted to preserve his company’s interests.  Yet, it takes two to tango.  For insider trading to occur there must be a tipper (the one who discloses the insider information) and the tippee (the one who receives the insider information and acts on that information). Einhorn should not have acted on that information. Even though Einhorn maintains no real inside information was disclosed, his professional experience should have served him better.  The information transmitted does fall under the criteria set out by section 118C(2) of annex one of the Relevant Statutory Provisions and Regulatory Guide.  Although Einhorn refused to receive information of this type, the fact is, he did.  From a legal perspective, the law was broken whether deliberately or not, and the FSA has to uphold a standard of ethical conduct.

There may be more debate about the degree to which the FSA punished Einhorn.  Einhorn may be “shocked” by the FSA’s sanctions in light of the Goenka case.  However, the FSA’s actions are a statement to financial professionals everywhere that there is a standard of ethic necessary to promote market confidence and protect the financial industry.  The sanctions levied against Einhorn will hopefully deter future issues of this type.  The FSA displayed a large degree of the autonomy, showing the regulator’s adherence to its four core objectives.  Einhorn may be unsatisfied with the FSA’s decision and may maintain that his actions resemble insider trading as much “as soccer resembles football”. While soccer and football are different in their scoring, speed of the game, even shape of the ball, the two have one crucial factor in common.  Without referees to ensure fairness and rules of the game to give all participants an equal chance of success, games cannot be played and the sports cannot prosper.  The FSA may not be wearing stripes or blowing whistles but imposing the $12 million dollar yellow-card on Einhorn is a statement to all players that the rules are real and must be followed.















Photograph: Courtesy of Swansea photographer at Flickr