Insider Trading at American Home?

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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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"But if he made a decision to let the shares be sold when he could have provided new collateral, then there is an argument that regulators would consider—that if he could have prevented the sale, he should have."

Securities lawyers say they know of no other cases where an executive who sold shares to cover a margin call has faced insider-trading allegations. But Frenkel sees a parallel with the Martha Stewart case; the trading at issue in that case also did not fit the profile of a traditional or typical insider-trading case. Nevertheless, the SEC pursued a civil insider-trading case against the domestic doyenne in part to clarify what appeared to be a gray area of the law. If regulators found evidence to suggest that the circumstances surrounding Strauss' trade demonstrated that he had discretion over it, Frenkel believes they could take a similar one-off case to clarify the law around margin sales.

Defining the Gray Zone

"The kind of fact scenario we're looking at here with near certainty will invite regulatory scrutiny," he says. Depending on what regulators find, he says, this "could potentially expand or better define the gray zone of insider trading."

Of course, there is one prominent case where the stock sales an executive made to meet margin calls gained notoriety: the criminal case against Enron CEO Kenneth Lay. While Lay was not charged with insider trading, the issue of his stock sales figured prominently in the securities fraud case against him. Lay tried to fight the allegation that he was selling shares even while making materially false statements about Enron publicly by arguing that his sales had been forced by margin calls. But prosecutors demonstrated that Lay had considerable other assets with which he could have met those margin calls. Lay was convicted of securities fraud, although the verdict was later voided following Lay's July, 2006, death from heart disease.

John Hueston, the lead prosecutor in the Enron case who is now practicing with Irell & Manella in Los Angeles, said that regulators would also look closely for evidence of precisely when Strauss—who founded American Home in 1991—might have learned that a bankruptcy filing was planned. They would also assess what information might have already been in the public domain, such as whether analysts already were discussing the possibility of a pending bankruptcy.

Another consideration would be the long-term pattern of his sales, and the fact that he appears to have made no other sales before Aug 1. "Was this the only significant sale during the precipitous final decline of the stock? If so, it would appear to be a rather belated and inept attempt to profit from insider information," Hueston wrote in an e-mail to BusinessWeek. "On the other hand, $3 million is a significant sum, especially to jurors who will hear from investors who lost everything. That fact alone will keep regulators on the hunt."

Sasseen is a national correspondent for BusinessWeek.