The SEC’s administrative proceeding against Jordan Peixoto for insider trading has unraveled following the Second Circuit’s issuance of its decision in United States v. Newman.[1] In our recent post, SEC Looks to Tackle Insider Trading on its Home Field – Defense Bar Claims Unnecessary Roughness,[2] we discussed the outcry in the wake of the SEC’s decision to bring a rare insider-trading case against Peixoto, who was accused of trading in Herbalife stock as a downstream tippee.[3] Many in the defense bar, in addition to expressing skepticism as to whether the underlying allegations even constituted insider trading, assailed the SEC’s decision to proceed in its in-house administrative court on a fact-intensive insider trading case. To many, the SEC’s choice of a friendly forum with self-appointed administrative law judges (“ALJs”), coupled with the frenetic pace of an administrative proceeding—which under SEC rules would yield a decision within 300 days at most—severely hampered Peixoto’s ability to conduct discovery and defend himself from the SEC’s allegations.  

Ironically, the compressed timetable of the administrative proceeding—the supposed “home-field advantage”—may have played a central role in dismantling the SEC’s case against Peixoto. On December 15, the SEC’s Division of Enforcement (“Division”) filed a motion with the Commission to dismiss the administrative case against Peixoto.[4] While Newman immediately springs to mind as the cause, a review of the chronology of the matter reveals that everything else that could have gone wrong, did go wrong. But the SEC may still have salvaged the case were it not for the fact that it had selected to proceed administratively, subjecting itself to an expedited schedule. Without extra time, the SEC had no room to maneuver amidst the fallout from Newman, and the case collapsed like a house of cards.

The SEC’s original decision to bring an insider trading case against Peixoto and his friend Filip Szymik, the alleged downstream tipper, was a gamble from its inception because the Commission was operating under the cloud of the pending Second Circuit decision in United States v. Newman. In Newman, the issue before the Court of Appeals was whether a downstream tippee could be liable for insider trading if the government had failed to prove that he knew of a personal benefit that the tipper gained by disclosing inside information. Oral arguments had taken place in April of this year, and commentators had noted that the Second Circuit panel seemed disfavored to decide in the government’s favor. Yet on September 30, 2014, with a decision from the Second Circuit imminent, the SEC nevertheless chose to file against Peixoto and Szymik alleging similar downstream tipper/tippee activity, without alleging that Peixoto knew of any personal benefit to Szymik, or even to the original upstream tipper.

Szymik settled, but Peixoto battled on, refusing to settle the administrative allegations and instead filing suit in federal district court to enjoin the SEC.[5] In the meantime, the ALJ on November 10 adopted an aggressive schedule for the proceeding, setting summary judgment motions one month away on December 12 and trial for March 16, 2015, less than 6 months from the initiation of the case.[6] A mere two weeks later, fatal cracks began to develop in the foundation of the Commission’s case. On November 25, the SEC informed the ALJ that one of its two “essential” witnesses—Szymik—had left the country, and that the Division would only be able to offer his Fifth Amendment declaration in lieu of live testimony at the March hearing.[7] Another two weeks later, on December 8, the SEC learned that the second of the two witnesses—Mariusz Adamski, the original tipper who allegedly disclosed Pershing Square Capital Management’s confidential information to Szymik—had also left the United States and would be unavailable to testify at trial.[8] What’s more, counsel for Szymik and Adamski both informed the SEC that, even if the SEC could have compelled their clients to appear at trial, they intended to exercise their Fifth Amendment privileges.[9] Without live witnesses, the SEC’s ability to prove its case against Peixoto was significantly hamstrung.

The other shoe dropped two days later, on December 10, with the issuance of the Second Circuit’s decision in Newman. The Court of Appeals overturned the insider trading convictions of two downstream tippees, Todd Newman and Anthony Chiasson, based on the government’s failure to establish that either trader knew of any personal benefit to the tipper from disclosing the inside information at issue.[10] While acknowledging that its prior opinions broadly defined personal benefit “to include not only pecuniary gain, but also, inter alia, any reputational benefit that will translate into future earnings and the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend,” the Newmancourt made it clear that the standard, “although permissive,” was not a “nullity.”[11] The decision cast a shadow over the SEC’s pending case against Peixoto, which had neglected to allege that Peixoto knew of any personal benefit to Szymik or Adamski from disclosing the tip. While the SEC may been able to cure this gap with an amended pleading and/or additional evidence, Szymik and Adamski had already skipped town and were unwilling to talk, tying the SEC’s hands.

With these developments—both factual and legal—the wheels appeared to have fallen off the Division’s case against Peixoto. The SEC had three options at this time: (1) seek a stay of the proceeding, (2) carry on and brief the Newman issue on the ALJ’s schedule, or (3) dismiss the case altogether. Staying the administrative proceeding, however, would do nothing to pause Peixoto’s pending case against the Commission in federal district court. In a worst-case scenario, it may even yield damaging precedent that could limit the SEC’s use of its administrative forum in the future.

On the other hand, to brief the issue would force the SEC to leapfrog the Department of Justice and muddy the DOJ’s appellate strategy in Newman, all so that the Commission could comply with the punishing clock in its own administrative court. The same day that Newman came down, Peixoto filed for a 5-day extension so that he could incorporate the decision into his summary judgment motion, which was otherwise due to the ALJ two days later on December 12.[12] The Commission responded that it, too, wanted an extension for its summary judgment opposition and replies, despite having opposed Peixoto’s request for a stay—also based on the pendency of Newman—earlier in the case.[13][14] The ALJ granted the requests, pushing the deadlines out to December 17 for summary judgment motions and January 14, 2015 for oppositions.[15]

The 5-day extension was simply not enough time for the SEC, who now faced the unenviable prospect of having to commit to the record, in a summary judgment brief, its theory as to why Peixoto was liable for insider trading under Newman. Even if the SEC was content to wait until January 14 to respond to Peixoto’s summary judgment motion, that was far too little time to coordinate a cohesive response with the DOJ, the office actually responsible for responding to the Newman decision. On December 10, Manhattan U.S. Attorney Preet Bharara candidly admitted that Newman “limit[s] the ability to prosecute people who trade on leaked inside information” and that his office was “considering our options for further appellate review.”[16] On December 11, Bharara’s staff filed a letter motion with the district court seeking a 45-day extension (until the end of January) to “consider the effect of the Newman decision” in the case against Newman’s co-defendant Danny Kuo.[17] And on December 12, the government filed a similar affirmation with the Second Circuit seeking an extension until January 23 to “confer[] internally and with the Office of the Solicitor General concerning the issue of petitioning for panel rehearing and/or rehearing en banc,”[18] raising the specter of further appellate review not only before the full panel in the Second Circuit, but also through a writ of certiorari to the U.S. Supreme Court.

While the DOJ is mulling its options, the Newman decision is making an immediate impact on past and pending insider trading cases, not the least being Peixoto. In United States v. Conradt et al.,[19] another insider trading case with near-identical facts to Peixoto, the district court instructed the parties on December 11 to address whether Newman affects the defendants’ guilty pleas entered earlier this year.[20]Szymik has also reportedly requested that the ALJ void his settlement with the SEC and refund his fine.[21] Many other litigants are sure to follow. In light of the import of Newman on the future of insider trading prosecutions, the SEC and the DOJ—close partners in securities fraud enforcement—are likely apprehensive that any position the SEC takes in the interim would reverberate through the DOJ’s nascent appellate strategy. With the clock ticking in Peixoto, however, the SEC had nowhere to turn, and little time to think.

So the SEC’s Division took the only remaining option, and moved the Commission to dismiss the administrative case against Peixoto five days after the issuance of Newman.[22] The ALJ, perhaps illustrating the uncomfortable closeness between the SEC’s adjudicatory and enforcement arms, did not even wait for the Commission to formally grant the Division’s motion before cancelling the trial date and the prehearing schedule, given “the high likelihood that the Commission will dismiss this proceeding.”[23] And in federal court, Peixoto moved to stay his constitutional case against the Commission, acknowledging that if the administrative case against him was dismissed, it “would render the instant action moot.”[24]

The SEC’s capitulation is especially striking in the face of its recent victory in Chau v. Securities and Exchange Commission,[25] where the Commission won dismissal of Chau’s federal complaint that recited many of the same arguments that Peixoto brought in Peixoto v. SEC. Chau and his investment firm had alleged in their complaint that the SEC’s decision to proceed administratively on allegations of securities fraud gave rise to due process and equal protection violations under the Constitution.[26] Judge Lewis A. Kaplan was much less receptive to plaintiffs’ constitutional concerns about the SEC’s administrative proceedings than his colleague in the Southern District of New York Judge Jed Rakoff.[27] Judge Kaplan agreed with the SEC that the district court’s jurisdiction “is not an escape hatch for litigants to delay or derail and administrative action when statutory channels of review are entirely adequate,” and held that the court had no subject matter jurisdiction to hear the merits of Chau’s complaint.[28]

Perhaps Peixoto—who had made a paltry $47,100 out of his Herbalife trades—was never really worth the risk. But it is hard to ignore the fact that the risk was self-inflicted by the SEC when it chose to roll the dice and bring a rapid-fire administrative case against Peixoto while Newman was hanging in the balance. With more time, the SEC possibly could have cultivated its witnesses and mitigated the Fifth Amendment issue, and certainly would have had the luxury of strategizing with the DOJ and crafting a summary judgment response that would take the government’s fully-fleshed appellate strategy into account. But with the clock quickly winding down, and with Murphy’s Law in full force, the SEC appears to have gambled and lost this round.

There is a chance, of course, that the SEC may repeat the performance it gave against Rajat Gupta in 2011, and bring an enforcement action against Peixoto in federal district court after having dismissed the administrative action. Even if the Commission has to wait a couple of years for the DOJ to win a reversal of the Second Circuit in Newman, the statute of limitations should not bar the Commission from trying to reel its fish home. However, with Szymik and Adamski safely ensconced in Poland and determined to remain silent, whether the SEC has a case against Peixoto anymore—under a pre- or post-Newman regime—is very much in doubt. In the meantime, the defense bar will continue to closely watch the SEC and the DOJ for their next move.