(CORRECTION: The March 7 story, “Insider Trading Charges Haunt Ryland,” incorrectly described allegations in a shareholder lawsuit against Ryland Group Inc., its chairman and chief executive, Chad Dreier, and its chief financial officer, Gordon Milne. Five senior vice presidents and a director of Ryland whose stock sales were mentioned in the suit are not defendants and no allegations of insider trading were made against them. In addition, the name and description of Ryland director Ned Mansour was incorrect. He is a former president of Mattel Inc.)
A series of insider stock sales that preceded an unexpected decline in new home orders at Ryland Group Inc. have led to a thicket of legal problems for the Los Angeles-based homebuilder and its executives.
Last week, a Ryland division president in Dallas, John Hutchinson, agreed to settle insider trading charges brought by the Securities and Exchange Commission, after he sold shares in January 2004 just days before Ryland announced a sharp decline in new home orders, with the biggest drop in Texas.
The SEC accused Hutchinson of using non-public information to avoid a $100,000 loss when the shares subsequently dropped 12.2 percent. In the settlement, Hutchinson agreed to pay $205,000 without admitting or denying guilt.
The same unexpected decline in new home orders is at the root of an ongoing shareholder lawsuit.
The suit, filed in U.S. District Court in Dallas, alleges that Ryland Chairman and Chief Executive Chad Dreier and Chief Financial Officer Gordon Milne, along with five senior vice presidents and one director, were aware that order figures from Texas were being overstated because cancellations weren’t being processed.
While hiding this information from the public, the lawsuit alleges, insiders sold $8.2 million of stock in the final months of 2003. Then, on Jan. 8, 2004, Ryland announced that new home orders for the fourth quarter of 2003 fell by 8.9 percent, with a 32.9 percent drop in new home orders in Texas. Ryland’s stock fell $11 that day, to $74 a share.
“The materially false and misleading statements and omissions of material facts resulted in an inflation in Ryland’s stock price,” the suit alleges. “Defendants knew or recklessly ignored that the company would have to process its previously unrecorded order cancellations by the end of its 2003 fourth quarter.”
Company spokeswoman Marya Jones said Ryland and the executives named in the lawsuit deny any wrongdoing and will defend themselves vigorously.
“The lawsuit is without merit,” she said, adding that there is “no connection” between the shareholder suit and the SEC settlement last week with Hutchinson, who remains on the job.
Cracking down
Allegations of insider trading remain a stubborn issue for regulators and investors, but these charges are often difficult to prove and law enforcement officials typically pass on cases that might not result in convictions. While numerous shareholder suits are filed against public companies each year, only two or three make it to trial.
Insider trading is prohibited under the Securities Exchange Act of 1934, but the language of that act is vague, which prompted the SEC to adopt new rules in 2000.
One rule addresses the issue of when insider trading arises in connection with the “knowing possession” of material non-public information and whether a person engages in trading “on the basis of” that information. The rule permits some trading under certain circumstances under which it is clear the information was not a factor in the decision to trade.
“The longer removed in time the sales are from the alleged corrective disclosure, the higher the burden on the plaintiffs to link the two,” said David Segal, managing partner at Irell & Manella LLP who specializes in defending companies against shareholder suits. “They need to show their knowledge extended back further in time, which is a challenging task.”
In the case of Martha Stewart, who was set to be released from prison last week after serving her sentence for lying during an investigation of insider trading, it took a low-level stockbroker’s testimony to obtain a conviction.
Most recently, officials of Cambridge, Mass.-based Biogen Idec sold stock prior to news that its drug for multiple sclerosis was being withdrawn from the market. Biogen officials said some of the sales were part of automated plans that sell executives’ shares at predetermined intervals. Another official, the company has maintained, was not aware of the pending news when he sold.
“The SEC is looking for unusual or suspicious practices during periods when executives may have access to confidential material that hasn’t been disclosed,” said Lionel Glancy, a partner at Glancy Binkow & Goldberg LLP who represents shareholder plaintiffs.
Another complication has been cooperation between the SEC and the self-regulating stock exchanges.
The New York Stock Exchange has a sophisticated market surveillance program that tracks trading anomalies before a significant drop or increase in a stock. The system is being used more frequently as the SEC, under political pressure, takes a tough stance on insider trading.
The SEC acknowledged the assistance of the NYSE in the Hutchinson settlement; a lawyer familiar with the settlement said the Ryland executive’s trades were first spotted by the New York exchange.
SEC spokesman Todd Brilliant declined to comment further on the case or say whether any investigation is continuing.
Shareholder case
The shareholder lawsuit against the other Ryland executives may be difficult to prove because they sold shares two months before the announcement that caused the stock to drop.
Shareholders maintain that Ryland executives made public statements painting a rosy picture of new home orders that caused the stock to increase artificially from October to January 2003.
The lawsuit includes interviews with unnamed former Ryland employees who say that top executives routinely overstated new home orders and failed to timely record order cancellations.
Dreier and Milne sold shares worth $3.7 million on Oct. 24, 2003, just two days after a conference call with analysts in which they referred to Ryland’s stock as a “good value,” according to the lawsuit.
Dreier and Milne made more than a dozen comments in press releases, SEC filings and to reporters about strong new home orders even though they allegedly had internal information showing orders were on the decline, the suit says. They then profited by exercising stock options and selling shares based on information that was not available to public shareholders, the suit alleges.
Dreier exercised options that netted $2.5 million on Oct. 24, 2003, and Milne sold shares worth $1.2 million, the suit alleges. Six other executives exercised options in October and November 2003, including five senior vice presidents: Mark Beisswanger, David Fristoe, Robert Cunnion, Timothy Geckle, and Eric Elder, and one board director, Neil Mansour, who is president of Mattel Inc. Their stock sales ranged from $457,000 to $920,000.
The lawsuit was re-filed in a Dallas last month with a new plaintiff and additional allegations; a previous lawsuit had been filed in 2004. The lawsuit seeks class status for investors who bought Ryland shares from Oct. 3, 2003 to Jan. 7, 2004.
Ryland filed a 23-page motion to dismiss the original lawsuit in September 2004, claiming the original lead plaintiff was a short-seller. It also claims that because the names of former Ryland employees were not provided in the lawsuit, they cannot be considered “reliable.” (A ruling has not yet been made.)
Moreover, the issue of inflating new home orders or underreporting new home cancellations was not “material” to shareholders, Ryland lawyers claimed, because those are not reflected in the company’s balance sheet, income statement or statement of cash flows.
(Federal securities law bars officers of public companies from knowingly making statements that are both false and material that is, statements that would affect a reasonable investor’s decision to buy or sell stock in a company.)
In explaining why the executives did not commit insider trading, the Ryland motion states: “It is hardly reasonable to infer that the defendants intentionally created the result that occurred in the fourth quarter of 2003, after which the defendants found themselves having to announce a decline in net new home sales.”
