Naveen Jain: Internet Success And Legal Duress: Looking Back

by drummer40 | October 9, 2012 at 07:11 pm

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Naveen Jain: Internet Success and Legal Duress Looking Back At His Alleged Insider Trading Days At InfoSpace

Bellevue, Wash., As the founder of InfoSpace, Naveen Jain is a perfect example of a Serial Internet Entrepreneur, a term coined by Wall Street for successful CEOS of the 1990s, who would found a company, take it public, cash out and move on. The term is more commonly known as “Pump and Dump.” These types of executives made history by changing the rules of Wall Street, and, in contrast to now, were successful since the SEC and other Wall Street watch dogs, allowed them to do this. It was a very different time as compared to now, where headlines are posted every day about The SEC investigating companies and their CEOs.

However, while Jain was extremely successful, his luck changed in 2001 when he and other InfoSpace executives were named in a $2 billion dollar shareholders “derivative” lawsuit that alleged that he was involved in insider trading. Jain’s wife was also included in the suit, which was originally filed in <?xml:namespace prefix = st1 />Seattle Washington’s King County Superior Court, according to The Seattle Post Intelligencer. (Note: Derivative law suits are different from a regular shareholder lawsuit. In the former, a suit is filed on behalf of the company by an individual investor.) In this case, the share holder was Nancy Youtz, who had bought 600 shares of InfoSpace in April of 2000.

The suit claimed that that Jain and company “profited from sales when they knew that the core advertising business was not working,” according to the Post Intelligencer article. Additionally, the article noted that “Infospace executives dumped stock after the $1.5 million acquisition of GO2Net, a merger, the suit claimed was an attempt to boost InfoSpace’s stock price.”

Media Madness

In addition to a number of articles published by The Seattle Intelligencer, The Jain case started media frenzy, both online and in major newspapers. Headlines, such as “InfoSpace Founder Forced to Pay Investors for Insider Trading” hit newsstands from coast to coast. CNET covered the case for quite some time. Even the Stanford newspaper wrote about the decision. Thus, this case demonstrated how powerful the Internet was for news coverage and how fast the news was moving regarding the case.

Additional Legal Aspects of The Case: 1934 Six Month “Short-Swing” Trade Rule However, the real legal question of the case was whether or not Jain and his wife had made transfers of InfoSpace stock to their family trusts in violation of the six-month “Short-Swing” trade rule of the 1934 Securities Act, which was key to Youtz’s case. Specifically, Youtz sued under Section 16 (b) of the Act, which requires any company insider who purchases and sells that company’ securities within the same six-month period to forfeit any profits to the company. But, the statute doesn’t require that the person actually have traded on insider knowledge nor does it prohibit the trades.

The Jain’s Defense

During litigations of the case, The Jains supported their case with four points: 1. None of the transactions in question constituted “purchases” under Section 16 (b) 2. It was undisputed that they had not benefited financially from the alleged transactions. 3. They provided evidence that they were not aware of the transactions, which were the result of mistakes made by other parties. 4. After learning of the transactions, they with due diligence corrected them.

And The Verdict Is? A Landmark Decision Prior to the case being settled and dismissed in 2005, the court entered a summary judgment against the Jains for violation of Section 16 (b). The decision was based on the fact that certain transfers made by the family constituted purchases without regard to whether they authorized or were aware of them. As a result, the court ruled that Jain pay $247 million dollars to his former company. At the time, this was the largest award under Section 16 (b) of The Securities Exchange Act of 1934.

The SEC Surprise

During the disposition of the case and what really made it significant, was that the SEC filed a brief in support of the Jains family. The SEC agreed with the Jains and filed a brief in support of their attempt to appeal, stipulating that the judgment should be reversed. The SEC argued that the district court had erred by considering the purchase price of the securities to be zero.

Additionally, The SEC noted that even if the court were to find 16 (b) liability at a minimum, the family should have been permitted to deduct the market value of the shares at the time of being acquired from the proceeds of their sales.The key legal point was that the SEC strongly disagreed with the amount of the judgment should have been much lower. However at that point, the case, as noted above, had been settled.

Final Analysis As discussed above, The SEC sided with the Jains and event though the court disagreed, getting advocacy from the organization is noteworthy when you look at current Wall Street activity. The SEC rarely supports executives in today’s climate on Wall Street. Again, it can’t be stressed enough that CEOS of publicly traded companies are under much more scrutiny today as compared to the Internet revolution that began in the late 1990s.