- Appeals court raised evidence bar for federal prosecutions
- Judge agrees to delay SEC trial until Supreme Court weighs in
The U.S. Securities and Exchange Commission was allowed to pursue a lawsuit against two former brokers who sought to upend how the regulator battles insider trading. But the victory may be short-lived.
A federal judge said SEC lawsuits don’t require the tougher evidence rules laid out for criminal cases in a December appeals court decision. He added that it was a tough call, and agreed to delay the civil trial of the two men until the U.S. Supreme Court decides whether to address the matter.
The showdown comes as the Obama administration seeks high court review of a ruling by the U.S. Court of Appeals in New York. In reversing the insider trading convictions of two fund managers, that court said prosecutors must show a defendant knew a tip came from someone required to keep it secret, and was given something for leaking it.
The landmark opinion was widely seen as partially unraveling the government’s multi-year crackdown on market manipulation. Left unanswered was how the decision affected the SEC, which pursues most insider trading allegations and can file lawsuits requiring less proof than criminal cases.
In his order Friday, U.S. District Judge Jed Rakoff in Manhattan said he was cognizant that the defense request to apply criminal rules to SEC lawsuits is a “much closer call” in light of the appeals court decision.
Judy Burns, a spokeswoman for the SEC, declined to comment on Rakoff’s decision.
The 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 insider trading convictions of fund managers Todd Newman and Anthony Chiasson, citing its 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 men were allegedly tipped by a co-worker at their firm who obtained the deal info from a roommate, an equities salesman, who in turn got it from a friend, a lawyer working on the IBM transaction. Durant and Payton had asked Rakoff 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 found liable.
“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 civil liability in an SEC lawsuit would generally require 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 if they are shown to have been dead-set upon the act, defined 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.
The unidentified IBM deal lawyer gave specific details of the transaction to his friend, Trent Martin, then 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.
Defense lawyer Greg Morvillo and co-counsel Matt Fishbein 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 pointed to the “mundane” way the SEC defines benefits in their case -- specifically, what if anything Conradt gave his roommate in exchange for the IBM tip.
Despite sharing a home, Martin and Conradt didn’t have a “sufficiently close relationship” to even 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.”
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.
The case is Securities and Exchange Commission v. Payton, 14-cv-04644, U.S. District Court for the Southern District of New York (Manhattan).