Recent cases, particularly in the U.S., have highlighted the challenges regulators face in pursuing individuals for tipping (disclosing material non-public information to third parties) and trading on the basis of a tip. Securing a criminal conviction or even a civil sanction has proved difficult because of evidentiary difficulties and the stringent test that must be met. Despite these challenges, the SEC in the United States is continuing to pursue tippers and tippees, as illustrated by the most recent in a string of tipping decisions, SEC v. Payton et. al.
As we have noted in previous posts:
- The SEC in the United States has faced continuing challenges enforcing insider trading activity.
- Canada is not immune to these challenges. On both sides of the border, prosecutors of insider trading face tough evidentiary hurdles.
- Recently, the OSC has seen success, and partial victory.
- While Canadian regulators have achieved some success, south of the border there has been grave concern about enforcement in the wake of the Second Circuit’s decision in United States v. Newman and Chiasson.
- Newman, a criminal case, overturned the conviction of two portfolio managers.
- The Second Circuit held “a tippee’s knowledge of the insider’s breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit.”
- Proving (1) the tippee knowledge requirement and (2) a personal benefit to the tipper is exceptionally difficult under Newman.
Newman resulted in a significant setback for the SEC, when a New York Federal Court, applying Newman, vacated four guilty pleas for insider trading this past January. In that case (Conradt) a lawyer working as outside counsel on an IBM Corp. deal told a research analyst about IBM’s planned acquisition of SPSS in 2009. Allegedly, the research analyst bought stock and tipped his roommate (a lawyer and broker), who in turn, tipped three other brokers. Four members of the alleged tipping chain pled guilty. Their pleas were vacated because the judge ruled that based on Newman, there was no longer a sufficient factual basis for the plea. The charges were subsequently dropped.
In Payton, two of the four individuals whose guilty pleas were vacated in Conradt moved to have the SEC’s civil claims against them summarily dismissed as well. The Court denied their motion to dismiss. Although Judge Rakoff stated he was “up in the air” about whether or how to apply Newman to this matter, he ultimately drew a distinction between the criminal standard of willful conduct and the civil standard, which can include reckless conduct. He therefore held that the civil claims should not be dismissed on a summary basis. It remains to be seen whether Newman will be a significant impediment for the SEC in securing a judgment on the merits, but the fact that the civil claim survived the pleadings stage is at least a crumb of comfort for SEC staff.
Calls for Legislative Clarity
Regulators in both Canada and the United States continue to face difficult evidentiary hurdles in their attempts to prove tipping. The difference between the criminal and civil standards of proof impact enforcement strategies, which is perhaps why regulators have been accused of attempting to regulate through litigation.
In Payton, Judge Rakoff commented that the appropriate body to define and properly deter insider trading is Congress, but “in the absence of Congressional action, such definition has been largely left to the courts.” Judge Rakoff noted that this creates difficulties because courts proceed on a case-by-case basis—a problem that Canadian regulators are familiar with. Barring legislative clarification on either side of the border, regulators and market participants alike will hope that cases currently working their way through the system will provide much needed clarity.