(Article from Securities Law Alert, June 2015)
For more information, please visit the Securities Law Alert Resource Center On June 8, 2015, the Southern District of New York found that the Second Circuit’s ruling in United States v. Newman, 773 F.3d 438 (2d Cir. 2014)[1] did not warrant reconsideration of its earlier decision declining to dismiss the SEC’s insider trading claims against two alleged tippees. SEC v. Jafar, 2015 WL 3604228 (S.D.N.Y. 2015) (Oetken, J.) (Jafar II). The court found that “Newman did not change the standard” for the SEC to plead an insider trading claim “under Rules 8 and 9 of the Federal Rules of Civil Procedure, and that, under this standard, the SEC ha[d] pleaded a plausible insider trading claim” against the alleged tippees.
Background
In the case before the court, the SEC “[knew] neither the identity of the tipper nor how the tip was relayed to [d]efendants.” However, the SEC did “plead[ ] ‘on information and belief’ that the tip was made in breach of a fiduciary duty, and that . . . [d]efendants knew that the tip was made in breach of a fiduciary duty.” The SEC also alleged “specific facts” detailing “a similar [insider trading] scheme involving three of the same actors.”
Defendants moved to dismiss the SEC’s complaint for failure to state a claim. On September 29, 2014, the Southern District of New York denied defendants’ motion to dismiss. SEC v. One or More Unknown Traders in the Securities of Onyx Pharmaceuticals, 2014 WL 5026153 (S.D.N.Y. 2014) (Oetken, J.) (Jafar I). The court found the allegations “sufficient to state a plausible claim that [defendants] [were] liable for insider trading.”
Following the Second Circuit’s decision in Newman, defendants moved for reconsideration of the court’s decision. Defendants contended that the Newman decision “‘redefine[d] the SEC’s burden of proving tippee liability’ in such a way that ‘compels reconsideration’ of the [court’s] denial of their motion to dismiss.” Jafar II, 2015 WL 3604228.
Southern District of New York Rejects Defendants’ Contention That Newman Heightened the Pleading Requirements for SEC Insider Trading Claims Against Tippees
In considering defendants’ motion for reconsideration, the Southern District of New York rejected defendants’ contention that “Newman established a more burdensome standard for proving tippee liability” in insider trading cases brought by the SEC. The court explained that Newman addressed the Government’s burden of proof with respect to the “personal benefit” requirement of tippee liability. Under Newman, the Government must establish that “‘the tippee [knew] of the personal benefit received by the insider in exchange for the disclosure’” of material nonpublic information (quoting Newman, 773 F.3d 438). Moreover, “the mere fact of a casual or social friendship is not enough; there must be evidence of the relationship between tipper and immediate tippee that ‘suggests a quid pro quo from the [immediate tippee] . . . or an intention to benefit [the immediate tippee]’” (quoting Newman, 773 F.3d 438).
The Jafar II court acknowledged that “the Second Circuit’s holding in Newman may make it more difficult for the SEC to ultimately prevail on its insider trading claims in this action.” However, the court “agree[d] with the SEC that Newman did not change the standard for pleading a claim under Rules 8 and 9 of the Federal Rules of Civil Procedure.”
Southern District of New York Finds Rule 9(b)’s Particularity Requirements Are “Relaxed” for SEC Insider Trading Claims Against Tippees If the Scheme’s Details Are Known Only by the Tippees and the Tipper
Turning to the allegations of the complaint, the court found that “the SEC [had pled] a plausible insider trading claim.” The court noted that the SEC had not pled “specific facts that illuminate[d] whether the tip was part of a quid pro quo relationship and whether . . . [d]efendants knew that the tip was exchanged as part of a quid pro quo relationship.” However, the court found that because “[t]his information [was] peculiarly within the knowledge of [d]efendants and the tipper,” “it would be ‘impractical’ . . . to require the SEC to allege with particularity these details of the alleged insider trading.”
The court determined that in these types of situations, “the standard under Rule 9(b) is relaxed.” The court held that the SEC may satisfy Rule 9(b)’s requirements in cases like this by simply “plead[ing] a belief about the nature of the tip and [d]efendant’s knowledge of the nature of the tip, coupled with particular facts supporting that belief.”
Applying this standard to the complaint before it, the court deemed the SEC’s allegations “sufficient to state a plausible claim that [d]efendants [were] subject to tippee liability as defined in Newman.” The court found it significant that the SEC had alleged “two similar instances in which [d]efendants . . . [had] placed substantial, well-timed, risky bets that two different companies would experience sudden increases in their stock prices.” Both “trades proved highly profitable,” and “both involved a newspaper article written by the same journalist.” The court found it “plausible to infer from the similar nature of the two events that the person who tipped the confidential information received a personal benefit of the quid pro quo variety required by Newman.” Finally, the court found that “the parallel nature of the alleged events, just six months apart, strongly support[ed] an inference that [d]efendants, experienced traders, knew or should have known that the tipper received a personal benefit in exchange for the tip.”
The court therefore denied defendants’ motion for reconsideration of its earlier order denying their motion to dismiss.
[1] Please click here to read our prior discussion of the Newman decision.