January 04, 2022
Government Investigations & White Collar Alert
Author(s): Mark D. Lytle, Colin T. Missett
In a rare move, a federal judge in the Eastern District of Virginia granted a mid-trial motion to dismiss for an SEC insider trading case, finding the SEC had not met its burden by a preponderance of the evidence.
On December 13, 2021, U.S. District Judge Claude M. Hilton of the U.S. District Court for the Eastern District of Virginia issued a mid-trial dismissal of the U.S. Securities and Exchange Commission’s (SEC’s) insider trading case against a mortgage broker.[1] The defendant mortgage broker, Christopher Clark, was alleged to have been tipped information by his brother-in-law about a potential merger involving the brother-in-law’s employer. In the pre-trial briefing, SEC argued that on the basis of this tipped information, Clark and his son made “highly suspicious” trades, including “nearly $40,000 of well out-of-the-money, short-term call options.”[2] The SEC further alleged that for “most of these options, including all of the most out-of-the-money options they purchased, they were the only investors in the entire world willing to buy such risky options,” and the riskiness of their trading only became more aggressive as the merger approached.
But Judge Hilton looked past the risk of the trading, instead focusing on the lack of evidence of transmission of insider information, finding “there’s just simply no circumstantial evidence here that gives rise to an inference that he received the insider information, as has been alleged here,” and further noting “[w]e talk about highly suspicious trading; that’s not the evidence.”[3] Judge Hilton also discounted the relevance of Clark’s improbable success rate weighed in connection with the lengths he went to find financing for his trades, including opening lines of credit and mortgaging his car, opining that “this wasn’t a man who was desperate for money” and that at all times “during this entire situation and before, his assets far exceeded his liabilities.”
Despite these findings—delivered via a mid-trial oral ruling—the SEC may still feel confident in its chances to prevail on appeal. As the SEC argued pre-trial, courts “have repeatedly ruled that evidence of suspicious trading that coincides with communications between the alleged tippee and tipper should go to the jury, often on facts much weaker than those here.” And, although the SEC did not have the communications Clark exchanged with his brother-in-law—because the SEC alleged he “conveniently” lost “his phone just days before he was supposed to surrender it”—the SEC presented evidence that for eight of Clark’s eleven earning trades for which the SEC has communications records, he spoke with his brother-in-law in advance of trading. In addition to losing his phone, the SEC also alleged that “Clark lied to the FBI about the reasons for his trading, his communications with his son about trading in CEB, and his relationship with Wright.”
Moreover, even if the SEC does not prevail on appeal (or decides not to appeal), the agency will likely view this result as a minor blip on an otherwise extremely strong track record of bringing cases the agency originates using its own data analytical tools to identify suspicious trading patterns. The SEC’s Market Abuse Unit, created in 2010 to focus on identifying “large-scale and organized insider trading and market manipulation schemes,” utilizes “some unique technology to aid in the investigations.”[4] The “Analysis and Detection Center” within the Market Abuse Unit “uses data analysis tools to detect suspicious trading patterns, such as improbably successful trading across different securities over time.”[5] The SEC uses these tools to identify cases on its own without the need for traditional tips, complaints, and referrals from outside sources. Given the success the SEC has had in settling and prevailing in litigation in these cases, the agency is unlikely to change course based on one trial result, especially given its apparent belief in the strength of the evidence in this case.
This trial result should not change anything about how financial firms, companies, and individual investors approach insider trading compliance. In light of the SEC’s high success rate in these cases and the collateral consequences they bring to their subjects in the form of unwanted media attention, significant reputational consequences, and litigation costs, the risks of insider trading are as high as ever. It is, therefore, incumbent on financial firms that trade or companies that maintain material non-public information to have a robust insider trading policy and compliance program.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.
