Tag Archives: U.S. v. Conradt

Why Judge Rakoff’s Decision in SEC v. Payton Should Not Have a Lasting Impact

Several commentators have speculated that Judge Rakoff’s denial of the defendants’ motion to dismiss in SEC v. Payton potentially stripped the Second Circuit’s U.S. v. Newman decision of significant impact in SEC insider trading enforcement proceedings.  See, for example, Remote Tippees Beware: Even if the DOJ Can’t Reach You After Newman, The SEC Can, and Insider Trading: Does Payton Begin the Erosion of the Newman Tipping Test?  Are they correct?  The short answer from this writer’s perspective is “No.”  I have two reasons for saying this.  First, it is a decision on a motion to dismiss, and almost all of the positions taken in it flow from the extremely low bar set for sufficiency of complaints, especially when the plaintiff is the government.  Second, the opinion is fundamentally flawed by the failure to perform the kind of analysis that Newman – and its doctrinal ancestors Chiarella v. United States and Dirks v. SEC – mandate.  Judge Rakoff’s opinion is available here: Denial of Motion To Dismiss in SEC v. Payton.

This Was Only a Ruling on a Motion To Dismiss.

First, the opinion addressed a motion to dismiss.  All such motions face steep obstacles, especially when the plaintiff is the government (I doubt if 0.1% of the motions to dismiss SEC actions are successful.)  The SEC knew that its amended complaint had to make allegations to get past a motion, and it was designed to do so.  Whether the evidence will support those allegations is another story entirely.

Judge Rakoff’s opinion is, as it must be, dependent on accepting all possible inferences that may be drawn from facts alleged in the complaint.  So, after reciting the allegations, he writes: “drawing (as required) every reasonable inference in plaintiff’s favor,” he finds the allegations of the tippers “intent to benefit” sufficient. Slip op. at 13.  He continues: “More generally, taking all the facts in the complaint as true and drawing all reasonable inferences in favor of the SEC, the amended Complaint more than sufficiently alleges that [the tipper and tippee] had a meaningfully close personal relationship and that [the tipper] disclosed the inside information for a personal benefit sufficient to satisfy the Newman standard.”  Id.  Likewise, his later discussion of allegations relating to the scienter of the downstream tippees who are the defendants in the action, Messrs. Payton and Durant, concludes: “Thus, taking these allegations as true and drawing all reasonable inferences in favor of the SEC, the Amended Complaint more than sufficiently alleges that defendants knew or recklessly disregarded that [the tipper] received a personal benefit in disclosing information to [the tippee], and that [the tipper] in doing so breached a duty of trust and confidence to the owner of the information.”  Slip op. at 16.

The rubber meets the road with the introduction of evidence, and its consideration by the trier of fact.  Judge Rakoff’s opinion says, and can say, little about that.  Especially if the trier of fact is a jury, the jurors’ willingness to find the tippee’s “intent to benefit” the tipper, and the remote tippees’ intent to engage in a fraud, based on the relatively meager facts alleged is another thing entirely.  Some people may think that Judge Rakoff’s willingness to draw those inferences from the allegations is powerful because he is a bright, outspoken, and well-regarded district court judge.  But they should first consider his background as a former prosecutor, and then recall that his most notable recent decisions involving SEC cases criticize the SEC for (i) not prosecuting aggressively enough, and (ii) accepting settlements without sufficient justification in support of the agreed-upon terms.  It is hardly surprising that his review of the complaint reflects a pro-prosecution frame of mind.

In the end, allegations about benefits allegedly flowing between tippers and tippees are bound up in the facts and circumstances of each case.  That Judge Rakoff found those allegations sufficient here says little about what another judge will say about other facts elsewhere, or what anyone, even Judge Rakoff, would do when faced with evidence, not allegations.  More important is the mindset that should be used to evaluate the sufficiency of such allegations.  It is in that respect that Judge Rakoff’s decision misses the mark, and why it should not be accorded future deference.

The Opinion Misses the Mark Because It Fails To Focus on Whether Fraud Is Alleged

Judge Rakoff seems so interested in exploring how the SEC might satisfy the “intent to benefit” standard laid out in U.S. v. Newman that he ignores the more critical issue raised by the allegations, and focused upon in Chiarella and Dirks.  He starts out on the wrong track, and never addresses the core, important issue.  His statement of the driving factors behind insider trading violations is wrong, and he immerses himself in issues that, while perhaps interesting from a jurisprudential standpoint, make little difference to the claims asserted in the complaint.  He fails to ask the most important question in these cases: accepting the allegations as stated, do they provide grounds for inferring that the defendants engaged in fraud in connection with their purchases or sales of securities.  The entire discussion of the facts alleged never once seeks to answer that question.

The opinion reflects this flaw from the outset.  Here is what Judge Rakoff says in his first paragraph:

As a general matter, there is nothing esoteric about insider trading. It is a form of cheating, of using purloined or embezzled information to gain an unfair trading advantage. The United States securities markets — the comparative honesty of which is one of our nation’s great business assets – cannot tolerate such cheating if those markets are to retain the confidence of investors and the public alike.

Slip op. at 1.

This may sound good, but it is wrong.  Insider trading is not “a form of cheating”; it is a form of “fraud” in the context of securities transactions.  Even if we give the judge the benefit of the doubt and assume that in his mind “cheating” and “fraud” are equivalents, the error of his statement is apparent in the remainder of that sentence, because insider trading certainly is not “using purloined or embezzled information to gain an unfair trading advantage.”  That is wrong in two respects.  The use of “purloined” information is not enough to support an insider trading violation because it lacks the aspect of deceit required to prove fraud.  (“Purloined” is a fancy way of saying “stolen.”)  And insider trading is not at all about having a “trading advantage,” fair or unfair.

In a “classical” insider trading case, one might argue that the transaction is “unfair” because the counter-party can theoretically expect an insider, under the law, to disclose material information before trading, but the real point is the breach of the disclosure duty (which constitutes fraud), not the fairness or unfairness of the transaction.  In a “misappropriation” case, this description makes no sense at all, because in such cases, the victim of insider trading fraud is the owner of the information, who was deceived into sharing that information with someone who used it for an unauthorized purpose.  The notion that the counter-party to the trade was a victim of an “unfair” transaction reflects acceptance of an equality of information standard in the marketplace, which plainly is not the law.  The securities transaction itself need not be “unfair,” and it probably is not, because the counter-party is a willing participant getting the price he wants in a transaction with a stranger.

I focus on this only to show that from the very outset, Judge Rakoff is using language and a mindset that is inconsistent with the law, as laid out by the Supreme Court.  As Judge Rakoff points out, there is no statute that prohibits insider trading, no less attempts to define it.  Instead, insider trading violates section 10(b) of the Securities Exchange Act of 1934 if, and only if, the transaction is accomplished by means of fraud.  This fundamental difference, between focusing on a concept of “fairness” rather than a concept of “fraud,” infects Judge Rakoff’s analysis.

Fraud, as we know, requires intentional deceit. Judge Rakoff says that because the Second Circuit’s opinion in Newman came in a criminal case, it may not control SEC civil cases because there may be instances where conduct that does not constitute criminal “insider trading” may still be considered “insider trading” in an SEC civil action.  To be sure, the state of mind requirement for a criminal conviction – “willfulness” – does not apply to SEC civil cases.  But even if one engages in a “reckless” fraud (if that concept makes sense, an issue not yet decided by the Supreme Court), it must nonetheless be a “fraud.”

To understand where Judge Rakoff’s opinion flies off the rails, we need to review the facts alleged in the complaint.  Defendants Payton and Durant, are what is known as “remote tippees.”  In this case, quite remote.

  • The “owner” of the information.  The information in question was a planned acquisition by IBM of another company, SPSS, Inc.  The “insider,” and “owner” of that nonpublic information was IBM and SPSS.  But no one at IBM or SPSS traded, or shared information with others for the purpose of trading.
  • The original “tipper” and original “tippee” of the information.  Instead, the information was learned by a lawyer at the Cravath law firm, Michael Dallas.  Mr. Dallas obtained the information lawfully; there is no suggestion he did so deceitfully.  Dallas had a close friend, Trent Martin.  They engaged in many allegedly confidential conversations, although Dallas surely must have understood that he was not supposed to share client information with a third party, even a close friend.  It is alleged that “Martin and Dallas had a history of sharing confidences such that a duty of trust and confidence existed between them. . . .  They each understood that the information they shared about their jobs was nonpublic and both expected the other to maintain confidentiality.”  Dallas allegedly shared specific information about the IBM/SPSS merger with Mr. Martin on several occasions.  There is no allegation that the conduct of either Dallas or Martin relating solely to the sharing of this information between them was fraudulent.  Since Dallas gained possession of the information as part of his work, he would not be a “tippee.”  But there is no apparent authorization for communicating the information to Martin, so Martin should be considered a “tippee.” That would make Dallas the original “tipper,” and Martin the original “tippee.”  Judge Rakoff calls Martin the “tipper”; that is right in the sense that he transferred the information to a second-level tippee, but Dallas plainly makes the first “tip,” although it was not alleged to be fraudulent, and Martin is not alleged to have traded SPSS securities.
  • The second-level tippee. Martin shared housing with Thomas Conradt.  It is alleged that “They shared a close, mutually-dependent financial relationship, and had a history of personal favors.”  Focusing on pleading facts that will pass muster under Newman, the complaint describes several respects in which they assisted or did favors for each other.  It also alleges that Martin, “in violation of his duty of trust and confidence to Dallas, tipped inside information about the SPSS acquisition to Conradt,” who bought SPSS securities.  This makes Mr. Conradt a “second-level tippee.”
  • The third-level tippee.  Conradt worked at the same brokerage firm as a registered representative identified as “RR1.”  Conradt allegedly told RR1 about the SPSS transaction.  That makes RR1 a “third-level tippee.”
  • The fourth-level tippees.  Defendants Payton and Durant also worked at the same brokerage firm as Conradt and RR1.  It is alleged that Conradt “learned that RRl had, in turn, shared the inside information with defendants Payton and Durant.”  That makes the defendants “fourth-level tippees.”  The complaint also alleges that after hearing about this, Conradt told Payton and Durant that he got the information about SPSS from his roommate, Martin.  “On the basis of the inside information they learned from RRl and Conradt, defendants purchased SPSS securities.”

The SEC cause of action is against Payton and Durant.  So the question to ask is: How do the allegations try to show that Payton and Durant committed acts of fraud in connection with their purchases of SPSS securities?  Judge Rakoff says the following: (1) They knew that Martin was Conradt’s roommate, and that the information about SPSS went from Martin to Conradt to RR1; (2) Conradt told Payton that Martin had been arrested for assault; (3) they never asked Conradt why Martin had given him information about SPSS or how Martin had learned the information; (4) after the IBM/SPSS merger was disclosed to the public, they met with Conradt, RR1 and another Conradt tippee “to discuss what they should do if any of them were contacted by the SEC or other law enforcement,” and they “agreed not to discuss the trading with anyone and to contact a lawyer if questioned”; (5) Payton took steps to hide his transactions; and (6) after receiving an SEC subpoena, they lied to their employer about the origin of their interest in SPSS securities.

These alleged facts simply do not add up to adequate allegations of fraudulent conduct by defendants Payton and Durant, and certainly not under the strict pleading requirements for stating fraud claims under Fed. R. Civ. P. 9(b), which applies to this claim.

Why not?  To put it simply, there is no allegation of any deceptive act by the defendants leading up to, and consummating, their purchases of SPSS securities.  The bulk of Judge Rakoff’s opinion focuses on the relationships and reasons for communications between Dallas, Martin, and Conradt.  Dallas and Martin allegedly had a close confidential relationship, and Martin and Conradt allegedly had “a close, mutually-dependent financial relationship” and “a history of personal favors.”  But Conradt is not alleged to have had any special relationship with RR1 or the defendants, and RR1 is not alleged to have had any special relationship with the defendants.  Nor are there any allegations that the defendants (Payton and Durant) knew about the existence of the source of the information, Dallas, or anything about nature of the relationship between Dallas and Martin, or Martin and Conradt, other than that Martin and Conradt were roommates and Martin had been arrested for assault.

Nothing about any of these facts suggests Payton and Durant defrauded anyone up to, and including, the consummation of their SPSS security purchases.  No facts suggest they owed a duty to disclose anything about what they knew (or, more accurately, were willing to bet on) about a possible IBM/SPSS merger before trading SPSS securities. They were not insiders, and, as alleged, had no knowledge that the information they learned originated with an insider.  As a result, there is no basis for finding a duty of disclosure from them to SPSS shareholders.  And they had no knowledge that the information they learned had been “misappropriated” from its owner – the only possible owner they knew about was Martin (they are not alleged to have known anything about the relationship of Dallas and Martin), and they had no reason to believe that Conradt misappropriated information from Martin.  In fact, the SEC complaint makes it clear that Mr. Conradt did not misappropriate the information from Mr. Martin, since it alleges that Martin intentionally “tipped inside information about the SPSS acquisition to Conradt.”

Judge Rakoff dwells on the alleged fact that neither Payton nor Durant asked Conradt about why Martin gave information to Conradt and how Martin got the information in the first place.  But no fact alleged suggests they were under any duty to ask such questions. To be sure, the “willful blindness” doctrine might preclude them from arguing lack of that knowledge in defending the scienter element, although willful blindness seems a stretch here, but Judge Rakoff provides no reason why they had any legal duty to ask such questions before trading on the information they learned from RR1 and Conradt.

So where is fraud alleged against Payton and Durant?  Whether an insider trading violation is viewed under the classical or misappropriation theory, it must be founded in deceiving someone by failing to disclose material nonpublic information in advance of trading, when such disclosure is required.  That is the fraud.  Under the classical theory, a prior disclosure of the information to the counter-party cures any claim of fraud because the disclosure duty is satisfied, eliminating any insider trading liability (the so-called “disclose or refrain from trading” requirement).  Under the misappropriation theory, a prior disclosure to the owner of the information of the intent to trade on the basis of the information eliminates the fraud, which is the undisclosed use of the information to trade (assuming the relationship with the owner created a duty to disclose).  In each instance, the insider trading liability flows from the deceptive breach of the duty of disclosure.

But no allegation in the complaint identifies any person to whom Payton and Durant owed a duty of disclosure.  There is no disclosure they could have made to allow them to go forward with the trades (to satisfy the “disclose or refrain” mandate) because there is no disclosure they were required to make to anyone, based on the allegations in the complaint.  Not to Dallas, whom they didn’t know existed; not to Martin, with whom they had no relationship, and to whom even Conradt owed no disclosure duty because he had been given the information without any promise of confidentiality; not to RR1 or Conradt, neither of whom is alleged to have had a special relationship with the defendants, and both of whom knew about their trading anyway; and not to any shareholder of SPSS, because the defendants were not insiders, or even “constructive” insiders by virtue of knowing their information was confidential and originated with insiders.

What about all the alleged post-trading conduct that supposedly evidences “guilty knowledge” or the like?  I would argue those allegations could be equally explainable by the defendants’ fear that the authorities or their employer would be concerned about, and would certainly investigate, the trades, even if they were not unlawful.  Does Judge Rakoff really believe that running away from the police is evidence of having committed a crime? Even a former prosecutor should be wary about making that connection.  In any event, no amount of allegedly incriminating post-trading conduct can turn a lawful trade into an unlawful one.  Such conduct would have a bearing on the issue of scienter, but all the scienter in the world doesn’t create a violation where there was none.  “Guilty knowledge” doesn’t count for much if the person is, based on the alleged facts, not guilty.

Judge Rakoff discusses none of this, and that is why the opinion is fundamentally flawed. One gets the sense that his overall objective is to try to make sure that people who he believes “cheated” would be held accountable because, as he says it: “The United States securities markets . . . cannot tolerate such cheating if those markets are to retain the confidence of investors and the public alike.”  But that is a legislative thought, not a judicial one.  He is bound to adjudicate within the strictures of section 10(b), which he does not do.  He is so focused on trying to show that the allegations could support an inference satisfying the Newman intent to benefit standard that he ignores the core meaning and analytical framework of Newman, and of Chiarella v. United States, and Dirks v. SEC as well: that fraud is what section 10(b) is all about, not supposedly unfair informational advantages or even sketchy opportunism by traders.  The whole point of Newman’s intent to benefit requirement is to assure that nonpublic information known to a trader is the result of fraudulent conduct, not something else, before that person can be found liable under section 10(b), criminally or civilly.  A tipper’s unauthorized and undisclosed transmission of information to a tippee simply is not fraudulent unless it is done to obtain some form of tangible benefit that was the object of fraud.

Judge Rakoff’s opinion does nothing to explain how these fourth-level tippees could have section 10(b) liability under the facts alleged.  Because the allegations in the complaint in SEC v. Payton fail to provide plausible inferences that their securities trades were founded on fraudulent conduct, not to mention particularized allegations of the fraud (which at least would require identifying the persons defrauded and how), the complaint fails to state a claim under section 10(b), and should have been dismissed.

Straight Arrow

April 22, 2015

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SEC Wages Desperate Battle To Limit Newman in SEC v. Payton and Durant

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:

  1. 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.
  2. 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:

  1. 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.”
  1. 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.
  2. 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.
  3. 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).

Straight Arrow

March 11, 2015

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First Post-Newman Shoe Drops: Insider Trading Guilty Pleas Vacated in U.S. v. Conradt

We now have the first official judicial reaction to the Second Circuit’s recent opinion in United States v. Newman and Chiasson.  On January 22, 2015, District Judge Andrew Carter of the Southern District of New York vacated previously-accepted guilty pleas in United States v. Conradt, 12 Cr. 887 (ALC) (S.D.N.Y.).

Conradt is an insider trading prosecution based on securities trades by alleged tippees who learned and traded on the basis of nonpublic information about an impending IBM acquisition of a software firm. Briefly, the facts are as follows.  A law firm employee learned about the impending IBM acquisition of SPSS and improperly communicated that information to a friend, Trent Martin.  There apparently is no evidence that the lawyer who leaked the information in the first place received any proceeds or benefits from doing so.  Martin was a roommate and friend of defendant Thomas Conradt, and told Conradt about the SPSS deal.  Conradt told other defendants about the deal.  The defendants bought SPSS options and profited on them when the transaction was announced.  Four defendants pleaded guilty to insider trading charges before Newman was decided. The fifth, Benjamin Durant, pleaded not guilty and is scheduled for trial on February 23.  The four pleading defendants admitted in their plea allocutions that they committed insider trading and knew what they did was illegal.

We previously wrote a post about the Department of Justice’s brief arguing against dismissal of the Durant indictment, explaining that the DOJ’s grounds for distinguishing U.S. v. Newman ­– that Newman involved the “classical” theory of insider trading and the Durant prosecution was based on the “misappropriation” theory – were specious and should be rejected by the court.  You can review that discussion here: U.S. v. Durant: DOJ Argument that Newman Reasoning Does Not Apply to Misappropriation Theory Misses the Mark.

Having reviewed the DOJ position, Judge Carter rejected it in the context of considering the four previously-accepted guilty pleas. His decision is brief and decisive. It can be read here: United States v. Conradt, but this is the core of what he says:

[T]his Court finds that, as indicated in Newman, the controlling rule of law in the Second Circuit is that “the elements of tipping liability are the same, regardless of whether the tipper’s duty arises under the ‘classical’ or the ‘misappropriation’ theory.”. . . Additionally, even if Newman did not specifically resolve the issue, the Court is swayed by the fact that Newman’s unequivocal statement on the point is part of a meticulous and conscientious effort by the Second Circuit to clarify the state of insider-trading law in this Circuit. Accordingly, even assuming arguendo that the Government is correct that the cited language in Newman is dicta, it is not just any dicta, but emphatic dicta which must be given the utmost consideration. . . . Finally, the Court notes that it agrees with Newman’s articulation of the requirements of tipping liability and its statement that such analysis applies equally in misappropriation cases.

Conradt, slip op. at 2-3.  The court also rejected the DOJ argument that previous Second Circuit cases held that a personal benefit to the tipper is not required in misappropriation cases, noting that “Newman construes each one of the authorities the Government cites in this regard to be consonant with its holding.” Id. at 3 n.1.

In other news, today (January 23) the DOJ announced that it would seek en banc review from the Second Circuit of the Newman decision. See Bharara To Appeal 2nd Circ.’s Landmark Newman Decision.

Straight Arrow

January 23,2015

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