by T. GormanPosted on Posted in SECActions

The SEC won a significant victory in the Second Circuit, securing a reversal of summary judgment in a closely watched insider trading case. SEC v. Obus, Docket No. 10-4749 (2nd Cir. Decided Sept. 6, 2012). Perhaps even more significant than the SEC victory is the Court’s discussion of insider trading law and its resolution of a key issue regarding tipper liability.

The case centers on the acquisition of SunSource, Inc. by Allied Capital Corporation, announced June 19, 2001. Following the acquisition the SEC brought an insider trading action against Nelson Obus, Peter Black and Thomas Strickland. At the time of the transaction Mr. Strickland was employed as an assistant vice president and underwriter at GE Capital Corporation. His college friend Peter Black worked as an analyst at Wynnefield Capital, Inc. which managed a group of hedge funds. His boss was Nelson Obus.

In May 2001 Allied approached GE Capital about financing its acquisition of SunSource. Mr. Strickland was assigned to perform due diligence on SunSource during which he learned about the proposed deal. Although he understood the information was confidential, SunSource and Allied were not placed on the transaction restricted list until after the GE Capital team had completed its work.

During his review Mr. Strickland also learned that Wynnefield was a large SunSource shareholder. On May 14, 2001 he discussed the company with his friend Peter Black. Both men claim that there was no tip, only a routine due diligence conversation. The SEC claims there was an illegal tip.

Subsequently, Mr. Black suspected that SunSource was considering a transaction that would dilute existing shareholders. He conveyed this suspicion to his boss, Mr. Opus who later called Maurice Andrien, the president of SunSource. Mr. Andrien would subsequently claim he learned during the conversation that Mr. Opus had been tipped. Mr. Opus denied this.

On June 8, 2001 Wynnefield purchased 287,200 shares of SunSource at $4.50 per share. This was about two weeks after the Strickland-Black conversation. The transaction was initiated by Cantor Fitzgerald which called and initially offered a 50,000 share block at $5 per share. The purchase was about the same size as an earlier Wynnefield transaction in the stock. Nine days later the deal was announced and the share price doubled, giving the hedge fund a profit of about $1.3 million.

The district court granted summary judgment in favor of the defendants, concluding that Mr. Strickland had not breached any duty to GE Capital. This ruling was based on the theory that GE Capital’s internal investigation had found no breach of duty and the fact that SunSource had not been on the firm’s transaction restricted list until after the deal was announced. The court also concluded that there were insufficient facts from which the jury could find that Mr. Strickland’s conduct was deceptive.

The SEC appealed the ruling based on the misappropriation theory of insider trading. That theory, the Circuit Court began is premised on a breach of fiduciary to the source of the information rather than the company as with the classic theory. Unlike the classic theory, under which the holder of the information can abstain from trading or disclose, under the misappropriation theory disclosure can only be made to the source or the holder can abstain from trading.

To hold a tipper liable there must be: 1) a tip, 2) material non-public information, 3) in breach of a fiduciary duty 4) for the personal benefit to the tipper The required scienter corresponds to the first three elements. While the tipper is not required to have specific knowledge of the legal nature of a breach of fiduciary duty, he “must understand that tipping the information would be violating a confidence” the court held. The tippee must also know that the information conveyed is material and non-public.

Dirks v. SEC, 463 U.S. 646 (1983) presents a significant question regarding the scienter of a tippee. There the High Court stated that while the tippee is a participant in the tipper’s breach of fiduciary duty, “a tippee has a duty to abstain or disclose only when the insider has breached his fiduciary duty . . . and the tippee knows or should know that there has been a breach.” This statement by the Court suggested a negligence standard in contrast with the requirement of Ernst & Ernst v. Hochfelder425 U.S. 185 (1976) which held that there must be scienter.

The Second Circuit harmonized the apparent inconsistency, holding: “We think the best way to reconcile Dirks and Hochfelder in a tipping situation is to recognize that the two cases were not discussing the same knowledge requirement . .. Dirks’ knows or should know standard pertains to a tippee’s knowledge that the tipper breached a duty, either to his corporation’s shareholders . .. or to his principal . . .Hochfelder’s requirement . . . pertains to the tippee’s eventual use of the tip through trading or further disseminating the information.” Chain tippee liability is built on the same principles.

Following these principles the Court concluded that the SEC had presented sufficient evidence to withstand summary judgment. First, Mr. Strickland breached his fiduciary duty. There is sufficient evidence that he knew he owed GE Capital a duty to keep the information confidential and not to convert it to his own profit. This is sufficient. The findings by the internal investigation and the facts about the restricted list do not change this conclusion. Furthermore, the district court erred in requiring the SEC to make an additional showing of deception as to Mr. Strickland beyond the tip. The tip is sufficient.

Mr. Black’s liability is derivative of Mr. Strickland. The critical point is if he knew or should have known that Mr. Strickland breached his fiduciary duty. He is a sophisticated financial analyst who knew that his friend was involved in developing financing packages for other companies and performing due diligence He also knew that information about an acquisition would be material non-public information. This, the Court held, is sufficient.

Finally, the same question is critical as to Mr. Obus. Here the Court found it sufficient that Mr. Obus deterimined the information he obtained credible and knew that it originated from a person with a duty of confidentiality. Accordingly, the decision of the district court was reversed and the case was remanded for trial.

Tagged with: , ,

by T. GormanPosted on Posted in SECActions

The SEC settled another significant market crisis case at the close of last week when the founder and president of investment advisory firm ICP Asset Management, Thomas C. Priore and his firm, along with the related entities, agreed to settle a fraud action brought over two years ago. SEC v. ICP Asset Management, LLC, Civil action No. 10-cv-4791 (S.D.N.Y. Filed June 21, 2010). The action alleged violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15(c)(1)(a) and Advisers Act Section 206(1), (2), (3) and (4) by the adviser, ICP Holdco, ICP Securities, LLC, a registered broker dealer owned by ICP Holdco, Institutional Credit Partners, LLC and Mr. Priore. .

The Commission’s complaint focused a series of transactions related to four multi-billion dollar collateralized debt obligations know as Triaxx CDOs. ICP Asset Management has managed the Triaxx CDOs since 2006. As the markets declined the adviser and other defendants engaged in repeated fraudulent conduct to the detriment of the clients. For example, in one series of transactions, it caused the Triaxx CDOs to repeatedly overpay for bonds. Frequently, those transactions were undertaken to protect other clients. In one transaction, ICP Asset Management had a CDO purchase about $22 million of mortgage bonds from another client for $75 per bond. Earlier the same day ICP Asset Management had purchased the same bonds for that client at $63.50 per bond. As a result, the CDO lost about $2.5 million. According to the complaint, ICP Asset Management directed more than a billion dollars in fraudulent trades for Triaxx CDOs that were similar and at inflated prices.

Defendant ICP Asset Management also structured trades which benefited its affiliates at the expense of the CDOs. In one purchase of a large portfolio of mortgage bonds, ICP altered the trade so its affiliates could make a $14 million profit at the expense of the CDOs. In other transactions ICP Asset Management and its affiliates benefited from undisclosed mark ups. The defendants also caused the CDOs to enter into prohibited transactions and misrepresented the value of holdings. By early 2010, most of the bonds held by the Triaxx CDOs which had once been AAA rated were downgraded to junk status.

After litigating the case for two years each of the defendants agreed to settle, consenting to the entry of permanent injunctions based on each of the sections cited in the complaint. In addition, Mr. Priore agreed to pay disgorgement of $797,337, prejudgment interest and a penalty of $487,337. ICP and its holding company, Institutional Credit Partners, on a joint and several basis, will pay disgorgement of $13,916,005 along with prejudgment interest. The adviser was also ordered to pay a penalty of $650,000. ICP Securities agreed to pay disgorgement of $1,637,581 along with prejudgment interest and a penalty of $1,939,474. Mr. Priore also agreed to settle an administrative proceeding against him. Under the terms of that settlement he will be barred from the securities business and from participating in any penny stock offering with a right to reapply after five years. As part of the settlement the Commission withdrew certain unjust enrishment and fraudulent conveyance claims, without prejudice, against Mr. Priore, his wife and Bertrand Smyers. See also Lit. Rel. No. 22477 (Sept. 10, 2012).

Tagged with: , , ,