USA v. Edward Kosinski, 2nd Circuit Court of Appeal, filed 9/22/20– Insider Trading
Principal Investigators in Medical Clinical Trials May Be Found to be “Temporary Insiders” and Liable under Section 10(b) of the Securities and Exchange Act of 1934.
The Second Circuit Court of Appeals issued its opinion in USA v. Edward Kosinski, No. 18-3065 on September 22, 2020. It’s an interesting case. Dr. Kosinski was a principal investigator in a clinical trial for a heart-related drug, a publicly traded biopharmaceutical company whose stock traded on NASDAQ. He solicited some of the patients who were in the trial and was paid by the company. He was also responsible for making sure the patients understood the risks, etc. He had a very large role in assessing the safety and efficacy of this early-stage heart medication.
During the course of this clinical trial, however, he secretly purchased approximately $250,000 of the company’s stock in breach of his agreement to disclose his holdings over $50,000. Federal regulations provide that a “potential source of bias…is a financial interest of the clinical investigator in the outcome of the study” which includes “an equity interest in the sponsor of the covered study.” 21 C.F.R. §54.1(b). Then, having been advised by the company of information likely to adversely impact the clinical trial, he traded his stock based on that nonpublic inside information.
After trial, he was convicted of violating Section 10(b) of the Securities Exchange Act of 1934 and was sentenced to 6 months imprisonment and a $500,000 fine. He appealed.
One of his claims was a general sufficiency of the evidence claim which one should read if you’re interested in this specific case. I find the opinion interesting because it addresses the concept of a “temporary insider.” The Court articulates the distinction between “classical” and “misappropriation” theories of insider trading. The classical, or traditional theory is that the securities laws are violated when a corporate insider trades in the securities of her corporation on the basis of material, nonpublic information. The “misappropriation theory” holds that a person commits fraud “in connection with” a securities transaction when she misappropriates confidential information for securities trading purposes in breach of a duty owed to the source of the information. The qualifying relationship does not require that one be a traditional corporate insider. As the United States has explained in Dirks v. SEC, 463 U.S. 646 (1983), under some circumstances, such as when corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for a corporation, these “outsiders” may become fiduciaries of the shareholders “due to their special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes.” Id. at 655 n. 14. These are called “temporary insiders.”
The Court here found that Kosinki’s role as a principal investigator “fit[s] squarely” within Dirks’s recognition of “temporary insiders” who have fiduciary-like roles. Further, the Court found that this sort of trading vitiates the principal investigator’s function, by placing his attention on his own monetary gain and depriving the company of the independent assessment its needs for FDA approval. The Court affirmed Kosinski’s convictions and sentence. Pro tip: Don’t trade on information that other people don’t have access to, especially if your knowledge of that information comes from a close working relationship with the company whose stock you’re selling. Honestly, you would think Dr. Kosinski would have known better.