This Week In Securities Litigation (Week ending July 21, 2017)

The Commission affirmed by a divided vote an Initial Decision dismissing insider trading charges against Wells Fargo trader Joseph Ruggieri. At a hearing the Division of Enforcement failed to prove that in six instances Mr. Ruggieri traded ahead of announcements by a Wells Fargo analyst. The Initial Decision concluded that the pattern of phone calls and trades relied on by the Division of Enforcement was not sufficient to establish the charges when placed in context, even along with other evidence offered. The Commission affirmed by a divided vote with one Commissioner voting to overturn the findings of the ALJ and one voting to sustain the dismissal.

SEC Enforcement – Litigated Actions

Insider trading: In the Matter of Joseph C. Ruggieri, Adm. Proc. File No. 3-16178 (July 13, 2017). The action initially involved two Wells Fargo employees, Gregory Bolan who settled and Joseph Ruggieri. Mr. Bolan was a research analyst in Nashville, Tennessee focused on three sub-sectors of the health care industry. Mr. Ruggieri was a senior trader of health care stocks in New York City, trading for customers and the firm. The Order Instituting Proceedings alleged that over a two year period beginning in 2010 Mr. Ruggieri traded ahead of six recommendations made by Mr. Bolan. This generated over $117,000 in profits in Mr. Ruggieri’s account. Following a hearing on the merits the ALJ found in favor of Respondent. The staff appealed four of the six instances of alleged insider trading. The Commission affirmed based on a split between the two commissioners. Commissioner Stein would have affirmed as she stated in a brief, one paragraph opinion. Commissioner Piwowar would have affirmed based on the analysis in his opinion. A detailed analysis of the case, including the Initial Decision and the opinion issued by the Commissioners is here.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC did not file a civil injunctive case but did institute 2 administrative proceedings, excluding 12j and tag-along proceedings.

False disclosure: In the Matter of David Lubin, Adm. No. 3-18070 (July 19, 2017) is an action that names as a Respondent, New York attorney David Lubin who also served as secretary to Entertainment Art, Inc., a public company, from 2007 through mid-2011. Mr. Lubin, along with two others, arranged the sale of about 1.2 million shares of the firm. There were also about 610,000 shares sold in private placement. Mr. Lubin, who prepared firm filings, repeatedly failed to include these facts in the filings, creating the appearance that there were about 1.8 million issued shares available. Ultimately about 14 million shares were sold in an illegal distribution which is the subject of another Commission action. The Order alleges violations of Exchange Act Section 10(b). Mr. Lubin partially resolved the matter, consenting to the entry of a cease and desist order based on the Section cited in the Order. He also agreed to the entry of an order prohibiting him from serving as an officer or director of a public company and denying him the privilege of appearing and practicing before the Commission. The question of monetary sanctions will be considered at a later date.

Valuation: In the Matter of Envisco Capital LLC, Adm. Proc. File No. 3-18071 (July 19, 2017) is a proceeding which names as Respondents the firm, formerly a registered investment adviser, Ray Bowers, a Managing Principal and CCO and Jeffrey LaBerge CPA, a Principal. During the period 2012 to 2014 the adviser failed to properly value the primary asset of one private fund by utilizing unreasonable assumptions regarding revenue projections. The adviser also failed to properly value a loan held by another fund. In addition, the adviser made misrepresentations regarding one fund. Mr. LaBerge had a primary role in the improper valuations which were approved by the other Respondents. The Order alleges violations of Advisers Act Sections 206(2), 206(4) and 207. Respondents resolved the proceedings, consenting to the entry of cease and desist orders based on the Sections cited in the Order except the order as to Mr. Bowers does not include Section 207. The firm was censured. An association bar as to the securities business was imposed on each individual Respondent with the right to apply for reinstatement after two years. Respondents will each pay a penalty of $50,000.

Offering fraud: SEC v. TelexFree, Inc., Civil Action No. 14-cv-11858 (D. Mass.) is a previously filed action centered on a pyramid scheme that targeted the Latino community. Defendant Steven Labriola, the international sales director for the firm, settled with the Commission. Mr. Labriola made certain admissions in connection with the settlement and consented to the entry of a conduct based injunction prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). He will also pay about $25,000 in disgorgement and prejudgment interest. Two other defendants in the Commission’s action have been criminally charged, one of whom fled. The SEC’s action continues as to the other defendants. See Lit. Rel. No. 23880 (July 14, 2017).

Court of Appeals

MSRB Rules: Tennessee Republican Party v. SEC, Nos. 16-3360/3732 (6th Cir. July 13, 2017) is an action brought by the Tennessee Republican Party and the New York Republican State Committee challenging certain rule amendments proposed by the MSRB which were deemed approved by the SEC. Specifically, the amendments limit the campaign activities of persons who advise city and state governments on issuing municipal securities. The court concluded that Petitioners lacked standing and thus dismissed the petitions for a lack of jurisdiction. The SEC’s motion to dismiss was denied as moot as was the petition by the MSRB to intervene.

Australia

Misuse of client funds: The Securities and Investment Commission permanently banned Gold Coast based financial adviser Satvir Singh Birk form the industry. The ban follows findings that the former adviser drew checks on client accounts without authorization deceived some client regarding funds withdrawn from their accounts, mislead others regarding the use of their proceeds and with regard to their investments. Parallel criminal charges are pending.

Hong Kong

MOU: The Securities and Futures Commission entered into a memorandum of understading with the U.K. Financial Conduct Authority. It provides for consultation, cooperation and an exchange of information in connection with their respective duties.

U.K.

Report: The Financial Conduct Authority published its monthly round-up – a news letter for recounting important events over the last month (here).

Failure to supervise: The FCA fined David Watters £75,000 (U.S.$98,000) for failing to properly supervise in his role as a compliance officer at two different firms. Specifically, the regulator concluded that Mr. Watters did not give sufficient consideration to whether the advice process was compliance, take reasonable steps to gain a sufficient understanding of the relevant regulatory requirements, failed to obtain the appropriate third party reviews and did not take reasonable steps to ensure that advisers were properly monitored to reduce the risk of unsuitable pension transfer advice being given to clients.

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SEC Sustains Dismissal of Wells Fargo Insider Trading Case

The rash of lawsuits challenging the SEC’s venue selection decisions may ultimately end with the Supreme Court reviewing the propriety of the retention process for Commission ALJs under the Constitution’s Appointments Clause a question that split the DC Circuit and Tenth Circuit. Raymond James Lucia Cos., Inc. v. SEC, No. 15-1345 (D.C. Cir. En banc June 26, 2017); Bandmere v. SEC, 844 F. 3d 1168 (10th Cir. 2016). A driving force behind those cases was an effort to avoid being required to litigate an enforcement action in an administrative forum rather than federal district court.

The Commission’s most recent decision may give those about to be charged additional food for thought. There the agency affirmed by a one to one split an appeal by the Division of Enforcement of the dismissal of an insider trading action against a former Wells Fargo Securities LLC employee by an ALJ. In the Matter of Joseph C. Ruggieri, Adm. Proc. File No. 3-16178 (July 13, 2017).

Factual background

The action initially involved two Wells Fargo employees, Gregory Bolan who settled and Joseph Ruggieri. Mr. Bolan was a research analyst in Nashville, Tennessee focused on three sub-sectors of the health care industry. Mr. Ruggieri was a senior trader of health care stocks i New York City, trading for customers and the firm.

The Order Instituting Proceedings alleged that over a two year period beginning in 2010 Mr. Ruggieri traded ahead of six recommendations made by Mr. Bolan. This generated over $117,000 in profits in Mr. Ruggieri’s account.

Mr. Bolan benefitted from tipping Mr. Ruggieri, according to the Order. Specifically, after resigning from Wells Fargo Mr. Ruggieri gave Mr. Bolan the keys to his apartment so he could use it when interviewing in New York City. In addition, Mr. Ruggieri and his Wells Fargo manager provided positive feedback to Mr. Bolan’s managers at the firm. That helped him obtain a promotion. The Order alleged violations of Exchange Act Section 10(b) and Securities Act Section 17(a).

Initial Decision

ALJ Jason S. Patil dismissed the action following a hearing. The initial question was if Mr. Ruggieris was tipped. The trader disputed the contention that he had been illegally tipped and traded ahead of the research reports. The Division contended that it is “statistically impossible that Ruggieri would have – as a matter of pure change – held profitable positions in the six stocks at issue for which Bolan issued ratings changes.”

After a careful analysis of the circumstantial evidence ALJ Patil concluded that Mr. Ruggieri had traded ahead of four of the six reports alleged in the Order. Furnishing the information alone is, however, not sufficient to sustain an insider trading charge. Citing Dirks and Newman the ALJ held that “the Division must prove, among other elements, that the tipper breached a fiduciary duty by disclosing non-public, material information to the tippee for a personal benefit . . . The personal benefit element applies in both classical and misappropriation cases.” Whether a disclosure is a breach of duty “’depends in large part on the purpose of the disclosure . . . Absent some personal gain, there has been no breach of duty to stockholders,’” quoting Dirks. It is for this reason that disclosure alone, or trading on the basis of confidential information, is insufficient to constitute a breach of duty for insider trading. The personal benefit is “critical to the determination whether there has been a fraudulent breach.”

In assessing the breach of duty question the court must focus on objective criteria, the ALJ concluded. This applies to both forms of insider trading, contrary to the Division’s position. Indeed, court’s cannot simply assume that a breach is for personal benefit, ALJ Patil wrote, citing Newman. Thus, the ALJ rejected the Division’s reading of cases which it claimed supported that proposition.

Both Dirks and Newman defined personal benefit in terms of objective criteria. Under those decisions the insider “receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings. There are objective facts and circumstances that often justify such an inference. For example, there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient . . . [or the] insider makes a gift of confidential information . . . The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient,’” the Initial Decision states, quoting Dirks.

Newman followed the teachings of Dirks, holding that the concept of a personal benefit is “broadly defined” and includes not only “pecuniary gain” but also reputational benefits that “’will translate into future earnings . . .’” While the government’s petition for a writ of certiorari argues that Newman conflicts with Dirks “I do not, however read Newman as conflicting with Dirks, but rather as clarifying the standard where proof of a personal benefit is based on a personal relationship or friendship,” ALJ Patil noted.

Here the Division’s proof was insufficient to establish a DirksNewman personal benefit. Initially, the Division could have had Mr. Bolan, who was under subpoena, testify on this critical point. It chose not to call him. Furthermore, the “friendship” between Messrs. Bolan and Ruggieri “was not a meaningful, close or personal one.” Likewise, the Division’s claims of “career mentorship” and giving “positive feedback” to Mr. Bolan’s superiors are nothing more than standard practice – neither was sufficient to establish a Dirks type personal benefit. While in “an abstract sense, feedback from the trading desk, including Ruggieri, could be viewed as having some potential pecuniary value . . .” here the question was not if it helped Mr. Bolan’s career but rather if Mr. Bolan would have tipped for it. The Division did not establish that point.

Likewise, the claimed friendship – a working relationship between the two men – was not adequate to establish the necessary benefit. That is true even when Mr. Bolan’s motives are considered which seemed to be more about his disregard for the rules. Accordingly, the Division failed to establish the requisite personal benefit.

The Commission

The Commission split evenly, affirming the Initial Decision. Commissioner Stein, in a brief, one paragraph opinion, argued for reversal, finding that the Division had established its case because it “is not required to prove that Ruggieri engaged in insider trading on every possible occasion or on every tip of potential material information, merely that he did so on at least one occasion.” Here the evidence met that standard, according to Commissioner Stein.

Commissioner Piwowar reached the opposite conclusion after analyzing the evidence. First, while evidence of phone calls followed by trades may permit an inference of insider trading, the Commissioner wrote, that inference is not necessarily compelled. This is particularly true under the circumstances here were there is contrary evidence demonstrating that “Bolan and Ruggieri talked almost every day during the year . . . in accordance with Wells Fargo policy that encouraged active communication between traders and analysts. . . Further, on at least some of the relevant days, contemporaneous emails suggest that Bolan and Ruggieri likely talked about matters other than the Ratings Changes.”

Second, the statistical evidence relied on by the Division does not support a contrary conclusion. The Division’s expert analyzed the likelihood that Mr. Ruggieri’s trades in the days preceding the rating changes were coincidence, concluding that such events would only happen 8.78% of the time because the trades took place six out of eight times there was a rating change. When, however, the analysis included each time Mr. Bolan published research with potentially marketing moving information such as a rating change, an earning change or a valuation change – a total of 71 times over a year – the instances when there was a trade were statistically indistinguishable from trading by coincidence.

Finally, the Division’s other circumstantial evidence was “inclusive,” according to the Commissioner. For example, the Division argued that a tip may be inferred from the fact that Mr. Ruggieri’s bonus was tied to the profits he generated. But that “incentive to make profitable trades does not establish that Bolan tipped him.” Equally inconclusive is the Division’s claim that Mr. Bolan furnished the tippes in exchange for positive performance evaluations from Mr. Ruggieri. There is no suggestion that Mr. Bolan tipped other traders who gave him positive evaluations. Likewise, the Division’s assertion that Mr. Ruggieri’s implausible testimony about the transactions supports an inference of insider trading is incorrect since “I do not find Ruggieri’s explanations . . . so implausible. . . .” Overall the Division “has not demonstrated by a preponderance of the evidence that Bolan . . .” tipped Mr. Ruggieri.

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