- Regulator faces off with ex-traders who had charges dismissed
- Judge to decide whether landmark ruling bars regulator lawsuit
The U.S. Securities and Exchange Commission may gain clarity Friday when a judge decides how a seismic court ruling last year restricting insider-trading prosecutions affects regulatory lawsuits over the same trades.
The showdown between the SEC and two ex-brokers comes as the Obama administration waits on the U.S. Supreme Court. The justices are to decide whether to review an appellate court opinion seen as hobbling a multi-year crackdown on insider trading.
The U.S. Court of Appeals in New York, in reversing the convictions of two fund managers, said prosecutors must show a defendant knew a tip came from someone who was required to keep it secret, and was given something for leaking it.
Left unanswered was how the decision affects the SEC, which pursues most insider trading allegations and can file lawsuits requiring less proof than prosecutions. While many SEC insider suits have been resolved since the December ruling, this one has remained.
Former brokers Benjamin Durant and Daryl Payton were originally charged by federal prosecutors and sued by the SEC for profiting on knowledge of IBM Corp.’s $1.2 billion purchase of SPSS Inc. in 2009. After the appeals court threw out the convictions of fund managers Todd Newman and Anthony Chiasson in its landmark ruling, citing the two-prong test, the criminal case against Durant and Payton was also dismissed.
The SEC claims Durant and Payton illegally made $290,000 on the IBM information. The two men were allegedly tipped by a co-worker at their firm who obtained the deal info from his roommate, an equities salesman, who in turn got it from a friend, a lawyer working on the IBM transaction. Durant and Payton have asked U.S. District Judge Jed Rakoff in Manhattan to toss out the SEC lawsuit, saying that under the Newman ruling, they’re too far removed from the original source of the tip to be held liable.
Rakoff said he will decide Friday whether they must face trial Sept. 21.
“This is exactly the kind of tipping chain situation that the Newman case has made harder to prosecute,” said Sam Buell, a professor at Duke University School of Law. He noted however that “it might be somewhat easier in the SEC context,” since civil liability requires less proof of guilty knowledge.
Antonia Apps, a former federal prosecutor who worked on the Newman case, agreed the SEC faces a lower bar. But she added the Newman decision didn’t provide much of a road map.
“The Newman ruling on the definition of personal benefit is confusing and open to multiple interpretations,” Apps said.
The SEC told Rakoff that, unlike prosecutors, the agency isn’t necessarily required to show that Durant and Payton knew the supplier of the IBM tip got something for it. The SEC said it only has to prove they ignored red flags that clearly indicated the information was illegally obtained.
Those red flags may be what Rakoff was pointing to when he said earlier this year that the difference between criminal and civil insider trading is a matter of intent.
While someone can be convicted of insider trading if they are shown to have been dead-set upon it, defined by law as “willful,” a person can be held liable -- the lower civil standard -- if they “committed the offense recklessly, that is, in heedless disregard of the probable consequences," he said.
“With a lower burden of proof than in a criminal case, the SEC has a better chance of avoiding dismissal,” said David Miller, a partner at Morgan Lewis & Bockius LLP and a former federal prosecutor in Manhattan.
The unidentified IBM deal lawyer confided specific details of the transaction to his friend, Trent Martin, then a trader at the Royal Bank of Scotland Plc, the SEC said. Martin allegedly passed the information to his Manhattan roommate, Thomas Conradt, who then shared it with Payton and Durant, his co-workers at Euro Pacific Capital Inc.
The agency contends the lawyer unwittingly disclosed the information to Martin, not foreseeing his alleged “fraudulent betrayal.” But starting with Martin, the SEC told Rakoff, it should have been clear to anyone looking that the information was “misappropriated.”
The Newman decision requires two things for an insider trading conviction: that the defendant knew the person who spilled the information knew they were breaching a confidence, and that they received something for it -- be it money or favors.
Greg Morvillo, Durant’s lawyer, and Matthew Fishbein, a lawyer for Payton, argued Newman applies to the SEC case. They say their clients didn’t know anything about what the lawyer or Martin may have received or what duty of secrecy there was.
The defendants are placing bets on the “mundane” way the SEC defines benefits in their case -- specifically, what if anything Conradt gave his roommate Martin in exchange for the IBM tip.
Despite sharing a home, Martin and Conradt didn’t have a “sufficiently close relationship” to be considered friends, the defense argued. The SEC countered that Conradt provided Martin with “consequential benefits” for details on the IBM deal, and that both Durant and Payton were aware of them.
These included hiring a cleaning service for their apartment and fixing the doorbell and shower-head.
The defendants pointed to deposition testimony from Conradt, who claimed what the SEC labels a quid pro quo is in fact “the mundane minutia of the day-to-day-life of being a roommate.”
Morvillo, Fishbein and Andrew Schiff, director of marketing for Euro Pacific, declined to comment on the case.
SEC lawyer David Axelrod told Rakoff at a hearing Tuesday that Payton and Durant “consciously avoided” acknowledging the tips came from Martin, and that they knew the roommates were close, or “roommates-plus.” Their circle of friends and colleagues was much tighter than the one in the Newman case, where the defendants knew "next to nothing" about the sources of their tips, the government said.
Rakoff, who has strongly criticized the SEC in the past for its failure to require admissions of wrongdoing in settlements, already sided once with the agency in this case, refusing an initial bid to dismiss the lawsuit.
The judge rejected a defense claim that a benefit needs to be “consequential,” saying instead the gift or service to a tipper need only be of “reasonable” value. Such a standard is lower than that prosecutors face under Newman, and may explain why the SEC continues to pursue this case.
Judy Burns, an SEC spokeswoman, declined to comment on the hearing or the agency’s strategy.
The case is Securities and Exchange Commission v. Payton, 14-cv-04644, U.S. District Court for the Southern District of New York (Manhattan).