In addition to joining the DOJ in the effort to get the panel decision in United States v. Newman reconsidered en banc, the SEC continues to pursue arguments in lower courts to emasculate the substance of the Newman decision. The latest example of that is in SEC v. Payton and Durant, No. 14-cv-4644 (S.D.N.Y.), which is the SEC civil enforcement action that parallels DOJ criminal actions in U.S. v. Durant and U.S. v. Conradt.
These cases all involve the same factual circumstances – trading by alleged tippees in possession of inside information about a future IBM acquisition of SPSS, a software company. A law firm employee allegedly learned about the impending IBM acquisition of SPSS and improperly communicated that information to a friend. The friend told his roommate and friend about the SPSS deal, who then allegedly told Durant and Payton about the deal. We discussed the criminal cases against Durant and Conradt in earlier posts about the impact of the Newman decision here (U.S. v. Durant: DOJ Argument that Newman Reasoning Does Not Apply to Misappropriation Theory Misses the Mark) and here (First Post-Newman Shoe Drops: Insider Trading Guilty Pleas Vacated in U.S. v. Conradt).
The SEC’s civil action was originally filed against Payton and Durant in June 2014, well before the Second Circuit’s December 2014 Newman decision. The allegations were essentially as follows. Michael Dallas, a lawyer at the Cravath firm, learned about the IBM transaction from his work at the firm and discussed the impending IBM transaction with his close friend, Trent Martin. Dallas and Martin supposedly had a close confidential relationship, and Martin supposedly knew the information was to be kept confidential. Martin nevertheless traded securities based on that nonpublic information, which the SEC alleges was a “misappropriation” of the information. Martin also conveyed the information to his roommate, Thomas Conradt, but there was no allegation that Martin received anything for the information, told Conradt how he obtained the information, or intended it as a gift to Conradt. Conradt traded on the information and also shared the information with co-workers Payton and Durant. There was no allegation that Conradt told Payton or Durant how Martin learned the information. The original complaint can be found here: Original Complaint SEC v. Payton.
In short, defendants Payton and Durant are alleged to be tippees several times removed from the original source, Dallas, the Cravath lawyer. The SEC pleads Martin’s communication of the information as a “misappropriation,” but it was effectively an unauthorized transfer of information from Dallas. In any event, Payton and Durant were alleged to have no involvement in, or knowledge of, the circumstances of the Dallas to Martin information transfer, or the Martin to Conradt information transfer.
The allegations about the transfer of information from Conradt to Payton and Durant were slim, indeed. They all were alleged to be co-workers and friends, and then the complaint alleges:
- On or prior to July 20, 2009, Conradt disclosed to both Durant and Payton the Inside Information, including the names of the parties to the impending transaction, the price, and that the deal would occur soon.
- At the time Conradt disclosed this information to Durant and Payton, he also informed them that his friend and roommate had disclosed the information to him.
In other words, all that was alleged was that Conradt disclosed the information to Payton and Durant, and that he learned the information from his friend and roommate. There can be little doubt that this falls short of the Newman requirement that tippees must have specific grounds to believe that the original information transfer was fraudulent.
Thus, it seems pretty plain that the original complaint failed to support an insider trading claim under the Newman standards. But after Newman was decided, the SEC chose not to amend its complaint. On February 23, 2015, the defendants moved to dismiss the complaint, laying out the reasons why the allegations did not support a claim of insider trading fraud against either Payton or Durant. The memorandum in support of that motion is here: Motion To Dismiss in SEC v. Payton.
The SEC did not bother to defend the original complaint. After the motion to dismiss was filed, it amended the complaint. (See here: Amended Complaint SEC v. Payton.) This is not unusual. Like many plaintiffs, the SEC often files relatively minimalist complaints, hoping it can get by with only minimal factual allegations. That causes the defendants to incur costs on a motion to dismiss, and allows the plaintiff to learn from the motion papers, and respond by filing an amended complaint, without even trying to oppose the motion. (Other plaintiffs have the excuse that they often lack access to key information needed to draft a more complete complaint. But the SEC has no such excuse – it fully investigates the facts with subpoena power before a case gets filed.) Here, the legal insufficiency of the original complaint should have been obvious after Newman was decided. The SEC lawyers should not have caused the defendants the substantial expense of preparing motion papers on the original allegations if they knew – as they must have – that they would amend the complaint if a motion were filed. In a fair world, the costs of preparing that motion would be charged to the SEC.
In its amended complaint, the SEC expanded its discussion of the nature of the interactions between Martin and Conradt, including alleging that Conradt helped Martin with some legal problems, and Martin was grateful for the help. However, not much was added in the amended complaint about how much Payton and Durant knew about the Martin-Conradt interactions, or about how Martin came by the information. Here is what the amended complaint says on that issue:
- Both defendants Payton and Durant had experience in the securities industry prior to their employment at the Broker. Accordingly, Payton and Durant often assisted Conradt in his duties at the Broker. Among other things, Payton and Durant gave Conradt advice on good Broker-approved stocks for clients, helped him with work problems, and provided him leads for new clients. For example, in mid-June 2009 an issue arose regarding commissions Conradt felt he was owed by Broker. Conradt turned to Payton and Durant for their advice and Payton interceded with Conradt’s supervisor. Conradt thanked Payton and Durant for their help and wrote to Payton, “I owe you one.”
- Prior to July 20, 2009, Conradt had discussed both his apartment and his roommates with defendants Payton and Durant. Both Payton and Durant knew that Martin was Conradt’s roommate and friend, and that Martin worked at a securities firm. Additionally, Conradt told Payton about Martin’s assault arrest near Grand Central Station.
- On or before June 24, 2009, Conradt told RR1 the Inside Information. On June 25, 2009, RR1 purchased 20 July SPSS call options with a strike price of $35.
- On or before July 1, 2009, Conradt learned that RR1 had told defendant Durant the Inside Information that Conradt had previously told RR1. Conradt then personally told defendants Payton and Durant that his roommate Martin had told him that SPSS was likely going to be acquired. Knowing that Conradt was Martin’s roommate, Payton and Durant did not ask Conradt why Martin told Conradt the Inside Information and did not ask Conradt how Martin learned this information.
In other words, there is no allegation that Payton or Durant were told anything about the nature, propriety, or impropriety, of the transfer of information from Dallas to Martin, or the reason why the information was transferred by Martin to Conradt. The best the SEC could do on those points was alleged that they “did not ask why Martin told Conradt the Inside Information and did not ask Conradt how Martin learned this information.”
This would appear to fall well short of the Newman requirement that distant tippees have a factual basis to believe the earlier information transfers were fraudulent. Payton and Durant are alleged to have known nothing about those transfers – for all they knew, Martin’s knowledge and transfer of the information was not unlawful, nor was Conradt’s. The complaint tries to turn that lack of knowledge into an asset, on the apparent theory that Payton and Durant had a duty to learn the answer to those questions before trading on the information. If this theory of liability were accepted, Newman would be effectively nullified. Even without knowledge, distant tippees would become liable for not inquiring into the basis for information communicated to them. Here is the SEC’s memorandum arguing that the amended complaint is sufficient: Opposition to Motion To Dismiss in SEC v. Payton.
Judge Jed Rakoff, who is presiding over the case, had a hearing with counsel after the SEC amended its complaint. Presumably, at that hearing the court adopted a schedule for defendants to file a new motion to dismiss the amended complaint and supporting memorandum that addresses the new allegations in the amended complaint. I look forward to seeing how defense counsel treat the SEC’s latest legerdemain on stating insider trading fraud claims under section 10(b).
March 11, 2015
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