Insider Trading at American Home?

CEO Strauss' sale of 2.9 million shares five days before the company's bankruptcy was announced raises plenty of questions

by Jane Sasseen

Women hug outside the offices of American Home Mortgage Investment Corporation in Melville, New York, Thursday, Aug. 2, 2007. American Home plans to shut down, becoming the second-biggest residential lender to fail this year. Bloomberg News

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Michael Strauss, the founder and chief executive of American Home Mortgage Investment (AHMIQ), has faced a swarm of problems in recent months. One of the biggest, fastest-growing mortgage lenders in the country, its shares had slipped from a high of $36.40 last December to $10.47 by late July as the housing crisis deepened.

On July 31, things got decidedly worse. After the Melville (N.Y.) company announced that it would delay its dividend amid growing cash woes, panicked investors fled, sending the shares tumbling $1.04 by the end of the day. Six days later, American Home Mortgage filed for bankruptcy in Delaware (see BusinessWeek.com, 7/30/07, "American Home's Credit Crisis").

Now, could Strauss potentially face civil insider trading charges as well?

Timing Draws Scrutiny

On Aug. 1, with the stock trading at $1.17, Strauss sold 2.97 million shares worth $3.5 million, according to filings with the Securities & Exchange Commission. With American Home's bankruptcy filing on Aug. 6, those shares—along with another 1.57 million shares Strauss did not sell—became virtually worthless.

Such a well-timed sale would typically draw regulatory scrutiny, since it raises the question of whether the CEO would have possessed material, nonpublic information. The CEO would reasonably be expected to know about deteriorating financials and the possibility of a pending bankruptcy at the time of any stock sale.

Yet Strauss, 47, may have a compelling reason for his sizable sale. According to his SEC filings, the shares were sold by a third party to satisfy a margin call. They had been pledged as collateral for a margin loan Strauss had taken out in October, 2005, and were liquidated during the stock's sharp plunge. They were the only shares he had sold for at least the past three years.

Neither Strauss nor the company returned calls for comment.

Parsing a Margin Call

Securities lawyers say that if the decision to sell was totally out of Strauss' hands, then he's unlikely to face legal risk. If his broker actually made the call, then the timing of the sale wouldn't matter, says Jesse Fried, co-director of the Berkeley Center for Law, Business & the Economy at the University of California, Berkeley. Even if Strauss possessed material insider information at the time, such a sale wouldn't violate insider trading laws.

Yet Fried and others argue that Strauss' position may not be as clear-cut as it first appears. Much will depend on whether he exercised any discretion over how the margin call was met. "It's a gray area of the law," says Fried. "The core issue is whether he had a choice."

One key question is whether Strauss had any other collateral in the account that he could have sold to meet the margin call or any other liquid assets outside of the account that he could have used to shore it up. If that were the case, Fried argues that Strauss may have had a responsibility to use those funds to meet the margin call, rather than allow the company shares to be sold.

Parallel with Martha Stewart Case

Equally critical is whether Strauss had any warning that the broker was going to sell. If the broker simply forced the sale amid the stock's sharp plunge, then it wouldn't have mattered if he had any other collateral. But if he was forewarned of a looming sale and actively chose to allow the shares to be sold rather than put up other funds, his legal risks could rise.

"If he had no other liquid assets to cover the call and there was really nothing he could do, it's hard to imagine anyone would allege insider trading," says Jacob Frenkel, a former federal prosecutor and SEC enforcement lawyer now with Shulman, Rogers, Gandal, Pordy & Ecker.