Hearing Aid Insider Trading — Big Time or Bush League?

"Did you say fifty MILLION or BILLION?"

The hearing aid industry made the financial pages recently, when the CEO, CFO, and Chairman of Sonova Holding AG announced their resignations, simultaneously and suddenly.  Sonova says it is the “world’s largest hearing-aid maker” and I’ll take their word for it.  Sonova owns a number of well-known hearing aid brands, such as Phonak, Lyric, Hearing Planet, and others. 

Here is a time line of what is known and when:

1. Late in 2010:  The Swiss government proposes broader and stricter insider trading regulations.
2. February 1 to March 16:  Sonova directors and managers sell off 2.4 million shares.
3. March 4 and 8:  Sonova board members, including the 2^nd largest shareholder in the company, sell shares totaling over $41 million, at roughly $126/share.
4. March 16: Sonova announces a profit warning due to a product recall, product delays, and international currency fluctuations.
5. March 16:  Sonova stock falls 23%.
6. Sometime in here:  The Swiss stock exchange (SIX) begins an investigation into possible insider trading by Sonova executives.
7. March 30:  Sonova’s top management resigns.
8. March 31:  Shares drop to about $89/share.
9. April 8:  Zurich’s public prosecutor opens an inquiring, with possible criminal proceedings to ensue.

Oh those reticent Swiss!  When queried, a company spokesman commented that “It’s quite unusual that all three key people would leave at the same time.” Indeed!  Worried investors surely gained solace from a conference call in which they were reassured that estimated “additional costs” would probably not exceed a “single-digit million number.”

That single-digit million number certainly comes as a relief to me because I just calculated the money the directors and managers made by selling those 2.5 million shares.  It comes to $343.35 million, assuming Sonova shares stayed in the $126/share vicinity until the revised profit forecast announcement on March 16.  Thassa lotta hearing aids!  If the shareholders have already lost almost $350 million, what’s another million or so for additional costs (I hope they are not for directors’ legal fees).

How could this happen?  The principals claim that they sold their shares in “good faith.”  The SIX thinks it’s possible that shares were sold in what should have been a black-out period and that Sonova announced their profit warning too late.  The company acknowledges they were late in issuing the warning and did not impose a black-out in a timely manner.   A corporate attorney connected to the investigation states the obvious:  “You have to wonder whether the chairman of the board didn’t know how the business is doing, and if so, how is that possible?”  (editor’s note:  maybe the chairman should have read a blog I did on another site back in 10/2010 that called attention to product problems in one of Sonova’s acquisitions,  http://journals.lww.com/thehearingjournal/HearingPost/WealthOfNations/pages/post.aspx?PostID=15)

But, let’s be fair.  Even if you DO know something others don’t and you act on it, not everyone thinks that’s bad!  In the USA and a few other countries, insider trading by company officials is a big crime because owners and managers have a legal, fiduciary duty to company stockholders.  Other countries and trading centers (Japan, Hong Kong, India) don’t get too exercised about insider trading and either ignore the regulations or dispense with them entirely. I liked this quote on Wikipedia:  “Even today many Japanese do not understand why [insider trading] is illegal. Indeed, previously it was regarded as common sense to make a profit from your knowledge.”   Milton Friendman, a Nobel laureate in economics, was all for insider trading, on the rationale that people in the know will quickly buy or sell, which serves to inform and pressure the market.  I think most rich people in the know will agree with his view.  Switzerland seems to sit on the fence in this lively debate.  It investigates only about 1/5^th as many insider trading cases each year as are pursued in the US.

Here’s the current damage assessment estimate. The worst that can happen to Sonova under current Swiss law is a maximum fine of $10.9 million if it is found guilty of delaying profit warnings. This may be  the basis of the “single-digit millions” estimate for additional costs to the company.  In this corner, then, Sonova shareholders are down by over $350 million.  In the other corner, the deposed directors are out their jobs, so we have to subtract their salaries from the $343 million they already withdrew.  Conservatively, that leaves the three executives with only about $100 million each — probably enough to mount impressive legal defenses while they pursue other interests.

One of my (wealthy) patients scoffed at the Sonova debacle as “absolutely bush league.”  Probably so in the US, where getting caught carries severe penalties, but perhaps not in Switzerland.  For myself, I am a bit in awe that our little industry has grown, consolidated, and internationalized so much in the last decade that “single digit millions” are a trifle and hundreds of millions can be made with a little inside information.  I think, for better of for worse, we have hit the big leagues and those of us in the trenches need to learn a bit more about how it all works.  The next post will look at insider trading, fiduciary duty, and the stakeholder paradox.

http://online.wsj.com/article/SB10001424052748703712504576232033048717842.html

http://www.reuters.com/article/2011/03/30/sonova-idUSLDE72T04Z20110330

http://www.swissinfo.ch/eng/business/Inquiry_opens_into_Sonova_share_sell-off.html?cid=29961804

http://www.businessweek.com/news/2011-03-30/sonova-executives-resign-after-insider-trading-investigation.html

http://www.bloomberg.com/news/2011-03-30/sonova-probed-as-swiss-consider-stricter-insider-trading-laws.html

http://en.wikipedia.org/wiki/Insider_trading