Insider trading cases are rarely decided on the basis of “smoking gun” evidence or a confession of wrongdoing. Instead, allegations of trading on the basis of material non-public information are built from the ground up, on circumstantial evidence. After disparate facts are proven and circumstances established, the key issue becomes determining the inferences that can be drawn from those facts.
This reality makes insider trading cases hard for the government to prove, and hard for defendants to defend against. It also speaks to the value of top-notch compliance policies and procedures.
Demonstrated adherence to existing compliance policies and procedures can tip the weight of inferences in favor of the defense, as highlighted in the district court decision in SEC v. Rorech, __ F. Supp.2d __ (S.D.N.Y. June 24, 2010). That 122-page decision, issued after a three-week trial, illustrates the complexity and fact-bound focus of insider trading analysis. It also demonstrates the types of evidence and the nature of the defenses that can be mustered to rebut circumstantial evidence of wrongdoing.
Rorech handed a stunning victory to the defendants, despite alleged secretive conversations about an upcoming bond issuance that prompted one defendant to trade. The SEC alleged that a Deutsche Bank high-yield bond salesperson, Jon-Paul Rorech, misappropriated material non-public information and communicated it in two unrecorded cellular telephone calls to a hedge fund portfolio manager, Renato Negrin, and that Mr. Negrin purchased securities-based credit default swaps (“CDS”) on the basis of inside information received from Mr. Rorech. The court ruled that the SEC failed to prove its claims.1
While the two men raised numerous defenses, one critical component of Mr. Rorech’s successful defense was that his employer, Deutsche Bank, had in place a credible “wall” between the private side of the bank that had material non-public information and the public side where Mr. Rorech and other sales personnel worked, and the SEC introduced no evidence that “wall-crossing” procedures had been initiated or that the wall had been breached. The court concluded that the evidence of adherence to the bank’s procedures bolstered Mr. Rorech’s claim that he had no special information to convey to Mr. Negrin. Accordingly, the court rejected the SEC’s inference from the circumstantial evidence of the two unrecorded calls that the two had purposefully gone off-line in those calls so that Mr. Rorech could give Mr. Negrin inside information to use in unlawful trading.
VNU Bond Offering Related To The CDS
Deutsche Bank was the lead underwriter for a bond offering by VNU N.V., a Dutch media conglomerate. The initial plan was for the bonds to be issued by VNU subsidiaries, not the parent company. Contemporaneously, the parent company also planned to retire certain of its outstanding bonds. The value of existing VNU CDS would have been affected by the initial plan, because only parent company bonds were deliverable under the CDS contracts in the event of a credit event. The initial plan would have left VNU CDSholders with a shrinking pool of deliverable bonds. Market participants discussed ways of restructuring the bond offering in order to alleviate this problem, and Deutsche Bank became aware of market demand for bonds issued by the parent company rather than its subsidiaries. Prior to the trading in issue there was much speculation in the market about potential structural changes to the VNU bond offering.
Linchpin Of The SEC’s Case: Unrecorded Calls
The SEC’s case against Mr. Rorech and Mr. Negrin turned on the inferences to be drawn from two unrecorded cellular phone calls between them that took place shortly before Mr. Negrin traded in VNU CDS. The two men had discussed the VNU bond offering in a number of recorded calls over the course of several days, but it was only after the two unrecorded calls that Mr. Negrin made his two purchases of VNU CDS with a notional value of $10 million each. At trial there was no evidence as to what was said in those two calls, but, according to the SEC, the fact of the unrecorded calls and the timing of the trades supported the inference of nefarious conduct.
Evidence Of Adherence To Deutsche Bank Compliance Program Bolstered Defense That Mr. Rorech Had No Access To Material Non-public Information
The district court painstakingly analyzed the evidence at trial in reaching its judgment as to what Mr. Rorech likely knew about VNU that the public would not have known and that would have prompted Mr. Negrin to buy the VNU CDS. That judgment was that Mr. Rorech had no inside information to convey to Mr. Negrin. In support of that judgment, the district court noted that Mr. Rorech’s employer, Deutsche Bank, had in place a credible information barrier or “wall” policy, with attendant “wall-crossing” procedures. The policy and procedures operated to separate the private side of the bank (which had access to price-sensitive information about VNU and other issuers) from its public side (which could trade the public securities of VNU and other issuers because it, by operation of the policy and procedures, had no access to the price-sensitive information the issuers had shared with the private side of the bank). The evidence adduced was that Deutsche Bank’s wall-crossing procedures—by which someone on the private side was brought over the wall to the public side, or the converse—were rarely employed and were not used to give Mr. Rorech access to non-public, pricesensitive information in connection with the VNU transaction. Further, the SEC offered no evidence that Mr. Rorech obtained private-side information through a wall breach.
CONCLUSION AFTER RORECH
While the SEC suffered a loss in Rorech, a loss in one case based on very detailed particular facts does not herald a loss in another case involving different facts. The risk of insider trading enforcement action has not diminished. We anticipate that, even after its Rorech loss, the SEC will continue to look with a skeptical eye on trade-related conversations that appear to be deliberately taken “off-line” and out of reach of compliance monitoring systems (such as recorded lines) designed to detect and prevent insider trading. At the same time, as illustrated by the successful defense in Rorech, credible compliance procedures that are designed to protect against insider trading, and demonstrated adherence to those procedures by a firm’s personnel, can tip the balance against a finding of improper or illegal conduct. Firms that (1) craft and implement credible policies and procedures to protect material non-public information entrusted to them, (2) train their personnel on the operation of the procedures, (3) expect adherence, and (4) monitor whether there is adherence in fact, bolster the ability to defeat insider trading claims against their personnel based on circumstantial evidence. Certainly the Rorech court’s confidence in Deutsche Bank’s compliance program for handling material non-public information contributed to the successful defense in that case.