Overview
In an opinion yesterday, Judge Rakoff denied a motion to dismiss an SEC complaint against two individuals who traded stocks after learning about an impending acquisition from a co-worker, Thomas Conradt, who, in turn, learned the information from his roommate Trent Martin. The opinion begins by acknowledging the “difficulties” with having insider trading defined by case law instead of by statute:
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 Unites 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. But if unlawful insider trading is to be properly deterred, it must be adequately defined. The appropriate body to do so, one would think, is Congress; but in the absence of Congressional action, such definition has been largely left to the courts. This creates difficulties, because courts must proceed on a case-by-case basis. Sometimes those cases are criminal prosecutions, in which circumstance a court is obliged to define unlawful insider trading narrowly, so as to provide the fair notice that due process requires before a person may be placed in jeopardy of imprisonment. Other times, those cases are civil proceedings, most often brought by the U.S. Securities and Exchange Commission ("SEC"), in which circumstance a court is inclined to define unlawful insider trading broadly, so as to effectuate the remedial purposes behind the prohibition of such trading.The major recent case law development regarding insider trading is United States v. Newman, in which the Second Circuit held (in Judge Rakoff’s words) “that the remote tippee, in order to be criminally liable, had to be aware that the original tipper had received a benefit for disclosing the inside information, for otherwise the remote tippee would not know whether he was participating in a fraud or not.” (See our sister blog's coverage of Newman here.) He ruled that this standard was satisfied as to the defendants, at least based on the minimal pleading standards, because of the defendants allegedly consciously avoided learning about the source of the tip and because they allegedly took steps to conceal their conduct:
Despite their market sophistication and their knowledge that Conradt learned the information from Martin, they did not ask Conradt why Martin shared the inside information or how Martin learned of it in the first place. The Court may draw an adverse inference from their conscious avoidance of details about the source of the inside information and nature of the initial disclosure . . . . As further evidence of defendants' knowledge that the inside information was the product of a breach of duty, defendants took multiple steps to conceal their own trading . . . . Defendant Durant avoided leaving a paper trail at a lunch meeting with Conradt; defendants met with other tippees and agreed not to discuss their trading with anyone else; defendant Payton transferred his holdings . . . that were held with his employer to another brokerage firm and misrepresented himself to be engaged in real estate consulting to avoid any controls the new firm may have had in place for monitoring members of the security industry; and, when questioned, defendants lied to their employer about the origins in their interest in [the target company’s stock].
