Why the SEC May Be Overreaching in Heinz Trading Case

But that's not enough to prove a violation of securities laws. In order for the SEC to show that the trader engaged in illegal insider trading, the agency would have to also show that the information about the merger was obtained in breach of a fiduciary duty. In other words, some insider with knowledge of the merger would have had to tip off or otherwise collaborate with the trader.

What's more, the SEC will also need to show that the trader understood that the insider was violating his fiduciary duty by passing on word of the takeover. Or, at least, that an ordinary person would have understood this when they got word of the deal.

There's every indication that the SEC has no idea that it can show any of these things. It admits that it doesn't know the identity of the trader—so it certainly doesn't know how the trader (allegedly) came to know about the pending acquisition. It appears that the SEC—and federal Judge Jed Rakoff, who approved the asset freeze—think the existence of the well-timed trade implies (a) knowledge of the deal and (b) a breach of duty to obtain that knowledge.

No doubt the reason the SEC rushed in here is that it wants to prevent the options from being exercised and the proceeds moved abroad. At that point, it would be hard for the SEC to pursue wrongdoers even if it figured out who tipped whom off.

As New York Times DealBook's Peter Henning explains, the freeze gives the SEC a good deal of leverage here.

If the securities are frozen in a Goldman account in the United States, then anyone who wants to claim them will need to make an appearance in this country and agree to be subject to the jurisdiction of the federal court. That would give the SEC a big carrot to try to lure the trader out into the open. But that person will have to act fairly quickly because the options are set to expire in four months, after which they are worthless.

Henning is too polite to describe the options expiration date as a "stick" but that's exactly what it is. If the trader seeks to unfreeze the assets and collect his $1.8 million, he'll have to come forward. At that point, the SEC will likely publicly brand this person a securities fraud. If the trader doesn't come forward by June, his investment goes to zero.

With not even the barest of evidence that any wrongdoing took place—other than the timing of the trade—this seems like an awfully big stick for the SEC to wield.