On March 20, 2017, Judge Juan Sanchez of the U.S. District Court for the Eastern District of Pennsylvania denied Defendant Leon Cooperman’s motion to dismiss an insider trading claim brought by the Securities and Exchange Commission (“SEC”). Memorandum, SEC v. Cooperman, No. 16-cv-05043 (E.D. Pa. Mar. 20, 2017). Judge Sanchez’s opinion may be the first time a court has squarely considered whether, to be liable under the “misappropriation theory” of insider trading, the trader must have a duty of trust and confidence to the source of the “misappropriated” confidential information at the time the source discloses the confidential information to the trader—and not just sometime prior to executing the challenged trade. The Court ruled that as long as the SEC alleged that there was a duty of trust and confidence prior to the challenged trade, using the information in breach of that duty could be an actionable misappropriation.

On September 21, 2016, the SEC filed a complaint alleging that Cooperman, and his firm, Omega Advisors Inc. (“Omega”), violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) by engaging in insider trading and violated Sections 13(d) and 16(a) of the Exchange Act by failing to file reports concerning Cooperman’s beneficial ownership of eight public companies. The SEC alleged that Cooperman and Omega traded in advance of an announcement of a $650 million Atlas Pipe Partners LP (“Atlas”) asset sale on the basis of confidential information that Cooperman, who was one of Atlas’s largest shareholders, obtained directly from an Atlas executive. Specifically, the SEC claimed that Cooperman and Omega were liable under the misappropriation theory of insider trading, which imposes liability on corporate outsiders who trade a company’s securities on the basis of material nonpublic information in breach of a duty of trust and confidence owed to the source of the information. The SEC alleged that after the Atlas executive told him about the upcoming asset sale, Cooperman promised the executive that Cooperman would not trade in Atlas’s stock and then traded anyway. Since Cooperman owed the executive a duty of trust and confidence at the time he traded, the SEC alleged, Cooperman had “misappropriated” the information about the asset sale and engaged in insider trading.

The defense moved to dismiss, however, on the ground that Cooperman could only have misappropriated the confidential information about Atlas if he owed the executive a duty of trust and confidence at the time the executive disclosed the asset sale. The defense argued since Cooperman allegedly promised to not trade in Atlas stock after he received the confidential information, Cooperman did not owe the executive a duty of trust and confidence at the time he received the information.

Judge Sanchez acknowledged that “[w]hether liability under misappropriation theory of insider trading may be premised on a post disclosure agreement is a novel issue,” which no court has “squarely addressed,” but denied Cooperman’s motion to dismiss. First, Judge Sanchez held the plain language of Rule 10b5-2 indicated that a duty of trust and confidence created by an agreement can arise at any time. Second, Judge Sanchez stated that case law considering the misappropriation theory of insider trading has focused on “the deception that occurs at the time the outsider uses material nonpublic information to trade” and generally suggested that an agreement that forms a duty of trust and confidence can be made post-disclosure. Third, Judge Sanchez held that the SEC’s interpretation was consistent with the principle that liability under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder should be construed “broadly, not technically.” Finally, Judge Sanchez held that “accepting Defendants’ interpretation would create a loophole in the SEC’s enforcement scheme for corporations and the outsiders to whom they provide material non-public information, legalizing insider trading by means of sequencing.”

While holding that the SEC had stated a claim for insider trading, Judge Sanchez dismissed the SEC’s 13(d) and 16(a) claims, which alleged that Cooperman failed to file with the SEC required reports regarding his beneficial ownership of securities of eight different public companies. In doing so, Judge Sanchez determined that the SEC could not show that the Pennsylvania court was the proper venue, because Cooperman did not “transact business” in the district (notwithstanding his beneficial ownership of companies based there) and the reports in question are required to be filed with the agency in Washington, D.C.

Although this ruling against Cooperman’s motion to dismiss the complaint is certainly a setback for the defendants, the case has the potential to clarify at what point liability for insider trading under the misappropriation theory attaches, which the parties agreed had not been squarely considered by the courts before. Judge Sanchez has scheduled jury selection for November.