A case of potential insider trading in Tennessee has highlighted the need for bank boards to police their own members, especially as more and more banks engage in confidential M&A negotiations.

A director at Pinnacle Financial Partners recently resigned after the Nashville, Tenn., company discovered that the person bought stock in Avenue Financial Holdings in early January after being briefed on the companies' merger discussions. Pinnacle, which made the disclosure in its proxy statement last week, agreed to buy Avenue, also based in Nashville, on Jan. 28.

The alleged trading took place despite efforts by the $8.7 billion-asset Pinnacle to prevent insider stock transactions, a company spokeswoman said. Pinnacle had brought in legal counsel as recently as October to brief directors on insider trading, and it held another session on April 5 to discuss the alleged incident and readdress the general issue, she said.

It is difficult, if not impossible, for banks to prevent insider trading, industry experts said. So it is critical for institutions to have policies in place, and constantly remind directors of those policies, particularly when they might possess material, nonpublic information.

Pinnacle appears to have followed that advice, said Chip MacDonald, a lawyer at Jones Day in Atlanta. "You have to give them credit because it sounds like they were very proactive" handling the situation, he said.

The issue "reflects the need to be vigilant," especially as more banks engage in merger talks, added MacDonald, who does not represent Pinnacle or Avenue. "Deal activity by its very nature creates inside information because it has a gestation period where people know things that may be material to making an investment decision."

Despite a slowdown in deal activity this year largely tied to low stock prices – 69 deals had been announced through Monday compared with 82 a year earlier, based on data from S&P Global Market Intelligence – most industry experts believe the pace will accelerate in coming months.

As a result management teams need to spend more time educating directors on the risks tied to handling nonpublic information. Doing so should help companies protect themselves, and their shareholders, should an executive or director make illegal trades, industry experts said.

"When we do our core courses for boards we spend a considerable amount of time on issues like insider trading," said David Baris, a partner at the law firm BuckleySandler and president of the American Association of Bank Directors. "Having policies in place is very important, whether it involves a public or nonpublic bank."

Pinnacle, for instance, looks to limit the access that personnel or directors have to sensitive information, the spokeswoman said. The company also provides notices on blackout periods, and it looks to clearly communicate when information should remain confidential.

Banks should also have signed statements from directors pledging to adhere to all policies and procedures, MacDonald said.

Pinnacle said in its proxy that the director served on the board's executive committee and was informed by management of merger discussions "early on the morning" of Jan. 5, including details on potential financial terms. The director allegedly bought shares of Avenue stock on Jan. 5 and Jan. 11, and the transactions were discovered March 21, the filing said.

"It is good news that they made him resign," MacDonald said. The director "will likely be barred from banking, and he'll have a lot of explaining to do."

While the proxy did not disclose the director's identity, Pinnacle noted in a separate filing that James Cope, a lawyer in Murfreesboro, Tenn., resigned from the board on April 1. The filing provided no explanation for his departure. Cope joined the board in 2006 after Pinnacle bought Cavalry Bancorp, where he had also been a director.

Pinnacle said in its proxy that the director allegedly bought 10,179 shares of Avenue stock. The value of the stock may have appreciated by more than $57,000, based on the closing prices of Avenue shares on the days of purchase and the closing price the day the deal was announced.

A call to Cope on Monday was not returned.

Baris commended Pinnacle for disclosing the trading and the resignation in its proxy materials. "It is better to get it out in the open now rather than later," he said, adding that insider trading often goes undetected until after a deal closes. In most instances, a routine examination by the Financial Industry Regulatory Authority unearths the suspicious trading, Baris said.

As for Pinnacle, MacDonald said the company will likely have to spend considerable time discussing the issue with its regulators. The Securities and Exchange Commission and Finra will likely initiate their own investigations.

"They'll want to know what Pinnacle knew," MacDonald said, adding that the company's openness about the incident should be viewed as a positive.

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