In a victory for the U.S. Securities and Exchange Commission (“SEC”), Judge Rakoff of the U.S. District Court for the Southern District of New York recently held that the U.S. Court of Appeals for the Second Circuit’s landmark insider trading ruling in United States v. Newman, 773 F. 3d 438 (2d Cir. 2014) did not preclude a civil enforcement action against two Euro Pacific Capital Inc. brokers (Daryl Payton and Benjamin Durant) whose criminal charges relating to the very same conduct were dismissed in January at the request of federal prosecutors.
The civil case and related criminal charges against the two brokers stem from allegations that an associate at the law firm Cravath Swaine & Moore LLP provided a former Bank of Scotland research analyst (Trent Martin) with material non-public information about a planned acquisition of SPSS Inc. by Cravath’s client IBM with the expectation that Martin would keep the information confidential and not use it for his own benefit. The associate was not charged and there was no allegation that he traded SPSS stock or in any way benefited financially from the information conveyed to Martin. As soon as practically possible, and while in possession of material non-public information, Martin bought SPSS stock and then tipped Euro Pacific broker Thomas Conradt, who in turn told Euro Pacific brokers Payton and Durant.
Judge Rakoff found that the SEC’s allegations that Conradt’s prior assistance with a criminal assault charge that allowed Martin to remain in the country satisfied Newman’s requirement that Martin, the tipper, “received a personal benefit for disclosing material nonpublic information about the SPSS acquisition to Conradt.” Opinion and Order at 12, SEC v. Payton et ano., 14 Civ. 4644 (JSR) (S.D.N.Y. Apr. 6, 2015), ECF No. 42. Judge Rakoff next addressed Payton’s and Durant’s “tippee” liability and held that the SEC need not plead that they “knew specifically about Conradt’s help to Martin on the criminal charge” because the civil knowledge standard of “knowing or reckless” was satisfied by the allegations that they “(a) knew that Martin was the source of the tip to Conradt; (b) knew that Conradt and Martin were friends and roommates; and (c) knew (at least in the case of defendant Payton) of Martin’s assault arrest.” Id. at 13-14 (complaint citations omitted). In addition, Judge Rakoff noted that Payton’s and Durant’s various efforts to conceal their trading in SPSS securities (including, among other things, paying for a lunch with cash to avoid a paper trail, agreeing with other “tippees” not to discuss their trading with anyone else, Payton transferring his holding – including his SPSS securities – from his employer to another brokerage firm, and lying to their employer about the origins of their interest in SPSS securities) was “further evidence of [Payton’s and Durant’s] knowledge that the inside information was the product of a breach of duty.” Id. at 15-16.
The decision is also notable for expressing Judge Rakoff’s apparent frustration with the current state of the law on insider trading: “But if unlawful insider trading is to be properly deterred, it must be adequately defined. The appropriate body to do so, one would think, is Congress; but in the absence of Congressional action, such definition has been largely left to the courts. This creates difficulties, because courts must proceed on a case-by-case basis.” Id. at 1. Ultimately, and when coupled with the Second Circuit’s denial of the Government’s request for rehearing in Newman, Judge Rakoff’s decision is a further example of the current uncertainty that exists as to “tippee” liability and hints at the possibility that civil enforcement actions could become, at least for the foreseeable future, the primary mechanism for policing “tipping” activity that involves remote tippees who do not have direct contact with the initial tipper.