On April 6, 2015, a federal district court in Manhattan permitted the U.S. Securities and Exchange Commission to pursue a civil enforcement action against two defendants accused of insider trading, notwithstanding the recently reshaped insider trading rules articulated in U.S. v. Newman. This week’s decision, in S.E.C. v. Payton, represents the first direct effort to apply Newman to a civil insider trading case, and demonstrates that the Newman decision is not as harmful to the S.E.C. as many believe.
A few months ago, in Newman, the U.S. Court of Appeals for the Second Circuit strengthened the standard of liability for insider trading cases. The Second Circuit held that in insider trading cases the plaintiff, which is required to show a personal benefit to the tipper, must establish that the tipper and tippee had a meaningfully close personal relationship that generates an exchange that is objective, consequential and pecuniary (or similarly valuable). The Second Circuit also ruled in Newman that the tippee must have known that the tipper received a personal benefit in exchange for the tipped information, making it more difficult for the government and the S.E.C. to prove insider trading against remote tippees several levels removed from the tipper.
In Payton, the government initially charged Daryl Payton and Benjamin Durant III with criminal insider trading, for illegally trading on confidential information concerning IBM’s impending acquisition of SPSS Inc. In the aftermath of Newman, federal prosecutors dropped the criminal charges against Payton and Durant following the trial court’s conclusion that the tipper did not receive a personal benefit. The S.E.C. proceeded with civil insider trading charges, prompting the defendants to move to dismiss the civil complaint on the basis of Newman. This week, however, the district court denied the defendants’ motion and allowed the case to go forward.
The judge in Payton held that the tipper, Trent Martin, received a personal benefit because Martin and an intermediary tippee, Thomas Conradt, had a close, mutually dependent financial relationship, and because Conradt assisted Martin in resolving a criminal matter that may have threated Martin’s ability to remain in the United States. While there is no allegation that the defendants knew specifically about Conradt’s help to Martin, the S.E.C. alleged that (i) the defendants knew that Martin was the source of the tip to Conradt and that Conradt and Martin were friends and roommates, and they took steps to conceal their trading in SPSS securities, (ii) Durant repeatedly asked Conradt if Martin had given him any additional information, and (iii) Payton knew of Martin’s assault arrest.
Construing all allegations in favor of the S.E.C., as required on a motion to dismiss, the court in Payton ruled that, consistent with Newman, the complaint more than sufficiently alleged that Martin received a personal benefit in exchange for the tipped information, and that the defendants knew that Martin’s relationship with Conradt involved reciprocal benefits or at least recklessly avoided discovering the details. As a result, the case will proceed against the defendants, and in the future a jury probably will decide whether they committed insider trading.
The decision in Payton is significant. This decision highlights the distinction between criminal cases, like Newman, where prosecutors ultimately must establish guilt beyond a reasonable doubt, and civil enforcement actions, like Payton, where the standard of liability is less exacting and the S.E.C. need show only that the defendants knew or should have known of the personal benefit to the tipper. The Payton decision reveals that the S.E.C. can frame insider trading claims to satisfy its high burden of proof and potentially can weather the Newman ruling and its impact, even if criminal actions are unsuccessful. While Newman has made the job of prosecutors and regulators much more difficult under certain circumstances, defendants accused of insider trading still are not out of the woods.