by T. GormanPosted on Posted in SECActions

The Commission filed another offering fraud action tied to the sale of interests in the development of oil and gas wells prior to the recent downturn in the price of oil. Beginning in 2010 the defendants raised about $4.4 million from 60 investors through a nationwide offering. The defendants largely dissipated the investor funds, according to the complaint. SEC v. Mieka Energy Corporation, Civil Action No. 3:15-cv-01097 (N.D. Tx. Filed April 10, 2015). See Lit. Rel. No. 23239 (April 10, 2015).

Named as defendants in the action are: Mieka Energy, a wholly owned subsidiary of another defendant, Vadda Energy Corporation, based in Flower Mound, Texas, which registered its shares under the Exchange Act; Daro Blankenship, the founder and managing director of Mieka and also the President and CEO of Vadda of which he and his wife own 79%; Robert Myers, Jr., Mieka’s vice president of project development; and Stephen Romo, previously a real estate broker, who sold interests in Mieka.

Beginning in September 2010 Mieka Energy marketed what were called joint venture interests nationwide to investors. The offering package contained brochures, newspaper and magazine segments, a Confidential Information Memorandum, a joint venture agreement, a subscription agreement and an investor questionnaire. Investors were told that the funds raised in the offering would be used to drill, test and complete horizontal and vertical gas wells in Westmoreland County, Pennsylvania. The documents also authorized the payment of offering and organizational costs and discussed a fee for Mieka Energy. These were supposed to be turnkey projects undertaken with an affiliate.

The interests were marketed through extensive boiler-room type calls. While investors were told that they would be acquiring joint venture interests, in fact they had little control. Two of the salesmen in this effort were defendants Myers and Romo. Neither was registered with the SEC or associated with a Commission registered broker-dealer.

Contrary to the representations made to investors, Mieka Energy did not drill the horizontal well. It did do work on a vertical well. That well was not functional, however, because it was never connected to a transmission line for the gas. About $850,000 was spent on development activities. Overall the commissions and those development costs constituted a little over 21% of the total funds raised from investors.

When most of the investor funds were gone, Mr. Blankenship furnished investors with a series of update letters. Those letters indicated that the wells would be developed and completed in the near future. Filings made with the Commission by Vadda did not disclose the true nature of the project.

The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a) and 15(a) and control person liability under Section 20(a). The case is pending.

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by T. GormanPosted on Posted in SECActions

The Second Circuit’s decision in U.S. v. Newman, 773 F. 3d 438 (2nd Cir. 2014) regarding the personal benefit test in insider trading either radically altered the law or just reaffirmed the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983) which had been eroded over the years by the SEC and the Government, depending on your point of view. Regardless, under Newman it is not debatable that to establish liability for illegal tipping under either the classic or misappropriation theory of insider trading the following elements must be established: 1) the corporate insider or the person entrusted with the confidential information had a fiduciary or similar duty; 2) the duty to maintain confidentiality was breached by disclosing the confidential information to a tippee in exchange for a personal benefit that is in the nature of a quid pro quo; 3) the tippee knew of the tipper’s breach; and 4) the tippee traded.

While the Newman elements are not difficult to list, their application can be more problematic. The recent decision by Judge Rakoff in SEC v. Payton, Civil Action No. 14 civ 4644 (S.D.N.Y. Opinion issued April 6, 2015) is instructive. There the SEC brought an insider trading action centered on the IBM acquisition of SPSS against two brokers, Daryl Payton and Benjamin Durant. Defendants Payton and Durant moved to dismiss based on Newman.

Background

The claimed tip in Payton traces to attorney Michael Dallas, an associate in a New York law firm assigned to work on the deal. Mr. Dallas was close friends with broker Trent Martin. The two men had a history of sharing confidential information. Beginning in the spring of 2009 Mr. Dallas told his friend about the SPSS deal. Over time he provided updates. Both men understood that the information they shared regarding their work was non-public and confidential. Both expected that confidentiality would be maintained.

Mr. Martin was roommates with Thomas Conradt, an attorney employed at another New York brokerage firm. They had a close, mutually dependent financial relationship with a history of personal favors. Mr. Martin told his roommate about the SSPS deal. Mr. Conradt purchased shares of SPSS prior to the deal announcement on July 28, 2009.

Defendants Payton and Durant were co-works of Mr. Conradt. The three men had discussions about Mr. Conradt’s roommate – Trent Martin. Each knew that Mr. Martin worked at a brokerage firm. Mr. Conradt told his co-workers that he learned about the SPSS acquisition from his roommate. Messrs. Payton and Durant did not ask more about the roommate. They did purchase shares of SPSS just prior to the public announcement of the deal.

The SEC charged Messrs. Payton and Durant with insider trading. The defendants moved to dismiss based on Newman. The Court denied the motion.

The decision

Judge Rakoff began by noting that there is a difference between criminal and civil cases. In the former the “court is obliged to define unlawful insider trading narrowly, so as to provide the fair notice that due process requires . . .” In the latter, typically brought by the SEC, “the court is inclined to define unlawful insider trading broadly, so as to effectuate the remedial purposes behind the prohibition of such trading.”

Nevertheless, to properly plead tippee liability the SEC must set forth facts in its complaint which are sufficient to meet the Newman test. Those facts must be construed in favor of the SEC.

Under Newman the first question is whether the SEC has sufficiently alleged that Mr. Martin, the tipper, received a personal benefit when furnishing the inside information to his friend, Mr. Conradt. That requirement has been met because the SEC alleged that Mr. Conradt had a mutually dependent financial relationship, a history of personal favors and their expenses were “intertwined.” Mr. Conradt “took the lead” in organizing and initially paying for shared expenses. He also assisted his friend with a criminal charge. Later the two men had a conversation in which, according to the complaint, “Martin thanked Conradt for his prior assistance with the criminal legal matter and told Conradt he was happy that Conradt profited from the SPSS trading because Conradt had helped him.” These allegations support an inference of a quid pro quo relationship, the Court found.

The second critical question is whether the defendants knew of the benefit. Here again, the allegations of the complaint are sufficient, the Court concluded, when all inferences are drawn in favor of the SEC. Those allegations demonstrate that the defendants knew Messrs. Conradt and Martin were friends and roommates and that Mr. Conradt assisted with the criminal matter. “This is enough to raise the reasonable inference that the defendants knew that Martin’s relationship with Conradt involved reciprocal benefits,” according to Judge Rakoff. This inference is bolstered by the fact that Mr. Durant repeatedly asked Mr. Conradt if additional information could be obtained from his roommate – and it was.

Finally, the two defendants took steps to conceal their trading activity while avoiding any discovery of the circumstances surrounding the tip between Messrs. Martin and Conradt. The latter is evidence of “conscious avoidance of details about the source of the inside information and nature of the initial disclosure,” according to the Court. Collectively, these allegations are sufficient to survive a motion to dismiss based on Newman.

Comment

The critical question raised by Payton is whether the decision begins the erosion that many claim took place following Dirks and continued until Newman. To be sure the introductory discussion of the difference between criminal and civil cases by Judge Rakoff at least suggests the possibility. While the Court’s discussion of criminal and civil cases is presented as basic, indisputable legal principles it ignores the fact that SEC enforcement actions are a different kind of civil case since they can result in the imposition of severe sanctions and penalties as Gabelli v. SEC, 133 S.Ct. 1216 (2013) acknowledged. Payton does, however, faithfully quotes and analyzes the Newman elements of tipping liability, including the quid pro quo requirement.

In the end, it is difficult to read the analysis of the SEC’s allegations as anything but reaching for every possible inference to avoid dismissal. While the SEC’s claims may support an inference of a quid pro quo between Messrs. Martin and Conradt, the allegations regarding the defendants’ knowledge of the benefit are thin at best. Tested against the fact record in Newman which the Court referencedwhere there was no evidence on the point – which of course is not the test — and viewed in the context of giving the SEC the benefit of each inference on a motion to dismiss, the issue is perhaps debatable.

For those who think Newman is new law cut from whole cloth, the decision is no doubt correct and perhaps a relief. For those who think Newman is the restoration of Dirks there is undoubtedly concern that the erosion has begun. Perhaps the true test is whether Payton can survive dispositive motions and, if so, trial.

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