Jonathan Fickies/Bloomberg News

The settlement of charges filed by the Financial Services Authority, Britain’s financial regulator, against David Einhorn and his hedge fund, Greenlight Capital, for trading on confidential information highlights how malleable the term “insider trading” can be.

While insider trading cases have garnered significant attention lately, it is unlikely the Securities and Exchange Commission would pursue securities fraud charges based on the information that led the F.S.A. to impose approximately $11.6 million in civil penalties.

The case centers on a conference call between Mr. Einhorn and the management of Punch Taverns and its corporate broker a few days before an impending sale of shares by the company to raise capital. Shortly after the call, Greenlight began selling a large block of Punch shares. The stock fell nearly 30 percent after the announcement, and Greenlight avoided a loss of approximately 5.8 million pounds.

The case has the hallmarks of insider trading seen in recent cases: disclosure of sensitive corporate information about an impending transaction and quick trading by a hedge fund in response to it. But there are crucial differences that would make it impossible for the S.E.C. to bring charges against Mr. Einhorn.

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Prior to the conference call, Punch and its broker asked Greenlight to accept a nondisclosure agreement. In Britain, this is called “wall crossing,” which the F.S.A. described in its charges as “a process whereby a company can legitimately provide inside information to a third party.” The S.E.C.’s Regulation FD prohibits companies from making selective disclosures to outside investors without a confidentiality agreement, so if inside information were passed, it would to be a violation.

Mr. Einhorn rejected the request, yet the call took place anyway. The F.S.A. asserted that the information imparted during the 45-minute discussion amounted to inside information because it indicated that the share issuance would take place in a few days. Mr. Einhorn argued that because he did not sign a nondisclosure agreement, he did not receive confidential information and so did not engage in insider trading.

Despite the absence of a confidentiality agreement, there is a good argument that the information disclosed in the call would be considered material nonpublic information under United States law. The test is whether a reasonable investor would consider it important, and whether the company took steps to maintain its confidentiality. Both of those criteria appear to be met.

The crucial difference between British and American insider trading law centers on when liability attaches for trading on confidential information. The violation charged against Mr. Einhorn and Greenlight was “market abuse” under § 118 of the Financial Services and Markets Act of 2000, which makes it a violation for an insider to buy or sell shares “on the basis of inside information relating to the investment in question.”

The definition of an “insider” is quite broad, encompassing any person who learns confidential information “as a result of having access to the information through the exercise of his employment, profession or duties” or which was “obtained by other means and which he knows, or could reasonably be expected to know, is inside information.” This has been called the “possession theory” of insider trading, so that simply receiving confidential information means that investors violate the law if they then trade on it.

The possession theory was once the basis for insider trading liability in the United States. In SEC v. Texas Gulf Sulphur Co., the first major insider trading case, the United States Court of Appeals for the Second Circuit held that “anyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.”

The Supreme Court rejected the “possession theory” for insider trading liability in Chiarella v. United States, where it overturned the conviction of a financial printer who learned the identities of takeover targets and then bought their stock before the deal announcements. According to the court, insider trading requires the government to prove the person charged had “a duty to disclose arising from a relationship of trust and confidence between parties to a transaction.”

Mr. Einhorn does not appear to have had any such relationship with Punch, and so absent a fiduciary duty there would be no basis to charge insider trading in the United States. Nor did Mr. Einhorn agree to maintain the confidentiality of any information he received from the company, which could also be grounds to pursue securities fraud charges. That distinguishes Mr. Einhorn’s case from the S.E.C.’s insider trading charges against Mark Cuban, the owner of the Dallas Mavericks. Mr. Cuban is accused of selling shares in a company after allegedly agreeing not to do so when he received confidential information about an impending sale of stock.

Although the court stated in the Chiarella case that a violation “does not arise from the mere possession of nonpublic market information,” the S.E.C. has adopted something close to that approach when the information relates to a tender offer. Rule 14e-3 makes it a violation for any person to trade “who is in possession of material information relating to such tender offer” that the person knows or has reason to know came from any party to the transaction.

Mr. Einhorn maintains he did not violate British law, and the F.S.A. acknowledged that his trading “was not deliberate because he did not believe that it was inside information.” The case is a close one even under British law because Punch itself made the disclosures, and Mr. Einhorn complied with the technical requirements of the law by not accepting the request to enter into a confidentiality agreement.

By applying the “possession theory,” British insider trading law is broader than that of the United States, which means investors dealing with companies there will have to be even more diligent in determining when they can or – more importantly – cannot trade after receiving corporate information.

Financial Services Authority Ruling on David Einhorn

Financial Services Authority Ruling on Greenlight Capital