New York Court Upholds Insider-Trading Verdict
U.S. District Judge Jed Rakoff denied motions for judgment as a matter of law or for a new trial after a jury found the defendants civilly liable for insider trading. The decision in SEC v. Payton (S.D.N.Y. Nov. 29, 2016) held that the jury had sufficient evidence to conclude that the initial tipper of inside information had misappropriated it and passed it on in breach of a duty of confidence and in exchange for a personal benefit – and that the defendant remote tippees had consciously avoided learning of the tipper’s breach of duty.
The Payton case involved inside information about a potential corporate acquisition. The information had come from one of the acquiror’s outside attorneys, who allegedly had told a friend named Martin (the initial tipper) in circumstances where the two had allegedly shared a duty of trust and confidence. Martin allegedly tipped his roommate, Conradt, who then allegedly tipped the two defendants. The SEC brought civil proceedings against the two defendants for their trading, and the jury found them liable after a seven-day trial.
Judge Rakoff denied the defendants’ post-trial motions, concluding that sufficient evidence existed to allow the jury to have concluded that (i) the tipper (Martin) had breached his duty of trust and confidence to the source of the inside information, (ii) Martin had received a sufficient personal benefit in exchange for tipping Conradt, and (iii) the defendants (the remote tippees) had known or had had reason to know that Martin had breached his duty in exchange for a personal benefit.
Duty of Trust and Confidence.
The court held that a rational jury could have concluded that a duty of trust and confidence had existed between the insider and the initial tipper (Martin), thereby justifying the insider’s belief that the tipper would not share the confidential information about the upcoming transaction. The insider and the tipper had “enjoyed a close relationship of trust and confidence, including sharing private and sensitive matters about their careers, salaries, friends, and romantic partners.” “Against this background, [the insider] shared details about the . . . transaction with [the tipper] because [the insider], a young associate, was ‘apprehensive’ about being assigned to work on a high-profile deal for a major client under the direction of a ‘fearsome’ partner, and wanted [the tipper’s] support and reassurance.”
Sufficiency of Personal Benefit.
The court next held that a rational jury could have concluded that the tipper had received a personal benefit in exchange for tipping the initial tippee (Conradt). The jury could have found that “[t]he two men considered each other friends and not only lived together as roommates but also engaged in a variety of social activities together, such as dining, hosting parties, playing basketball, and so forth.” In addition, the jury had heard evidence that the tipper had tipped his friend “in order to benefit him, which, under the language of [the Supreme Court’s decision in Dirks v. SEC] at least, would have been a sufficient personal benefit.” The jury could also have found a “quid pro quo” type of benefit sufficient to satisfy the Second Circuit’s decision in United States v. Newman because of several “favors” that the tippee had allegedly given to the tipper.
The tipper “repeatedly testified that he tipped [the tippee, who was an attorney] in exchange for advice about the legality of trading on the information.”
The tippee had helped the tipper when the tipper was arrested on an unrelated matter: the tippee had put the tipper in touch with a law-clerk friend who provided advice; the tippee had assisted the tipper in finding counsel and had suggested legal strategies that the tipper could use; and the tipper “himself linked the . . . tips to [the tippee’s] assistance with his arrest.”
The tippee had provided various household services to the tipper.
Defendants’ Conscious Avoidance of Knowledge.
The court also held that a rational jury could have found that the remote tippees had known or had had reason to know that the initial tipper had disclosed the inside information in breach of a duty of confidentiality and in exchange for a personal benefit.
The tippee-defendants “were sophisticated investment professionals who understood that information about announced corporate transactions was confidential and valuable.”
The tippees also knew that the inside information “would have become ‘worthless’ if [they] had learned that it came from [a corporate insider], because [they] would have been unable to trade on it.”
The direct source of the defendants’ tips (Conradt) was “a green broker whose professional abilities [the defendants] held in small regard.”
The defendants’ direct source (Conradt) had “told them the source of the information was his roommate Trent Martin and warned them not to spread it any further.”
One of the remote tippees “took that warning to heart, concealing the information from another coworker who saw him researching [the target company] on his computer.”
“On a few occasions, [the defendant tippee] asked Conradt if his roommate (Martin) had learned any more [inside] information.”
Even though “neither defendant ever asked Conradt how his roommate came by the information or why his roommate shared it with him,” the court observed that, “without asking any questions, and crediting the inexperienced Conradt’s tips, they nonetheless made risky, speculative investments in [the target’s] securities, and turned handsome profits. . . . These are classic signs of ‘conscious disregard.’” In addition, the defendants’ conduct after the transaction became public further supported “the inference that they generally understood, but had consciously avoided learning, the means by which the confidential [inside] information had been obtained.”
The nature of the “personal benefit” requirement is currently before the Supreme Court in Salman v. United States, which was argued on October 5, 2016. The oral argument in that case suggested that the Court is not likely to make any radical changes to insider-trading law, although the Court could refine the definition of the type of “personal benefit” needed to support a claim for breach of duty. However, Salman involved tips within a family, rather than between or among unrelated individuals, so the Court could choose to focus narrowly on the family context.
Perhaps the more interesting aspect of the Payton decision is the court’s treatment of whether the defendants knew or should have known that the tipper (Martin) had breached his duty of confidentiality in exchange for a personal benefit. The court laid out the evidence supporting the jury’s finding that the defendants had consciously avoided learning the facts: they had believed that they could not trade if the information had come from an insider; they had known that their source (Conradt) had received the information from his roommate and that they were not supposed to share the information; they had concealed their investigations into the target company; and they had sought to disguise their conduct after placing their trades. In these circumstances, the defendants’ failure to ask any questions about the origin of the information, coupled with their reliance on a source (Conradt) whom they apparently viewed as inexperienced, allowed the jury to conclude that the defendants had “generally understood, but had consciously avoided learning, the means by which the confidential . . . information had been obtained.”