SEC ALJ Dismisses Insider Trading Claims Based on Dirks-Newman
When the Second Circuit handed down Newman the SEC joined with the Manhattan U.S. Attorney seeking rehearing en banc and arguing that the case would significantly hinder insider trading enforcement. Many wondered if the agency would move all it cases in-house. To date that trend has not developed, perhaps due in part to the number of challenges being brought to the Commission’s forum selection decisions. Now there may be another reason – an ALJ Initial Decision finding against the Division in an insider trading case based on Newman and stating the government’s petition for certiorari is incorrect. In the Matter of Gregory T. Bolan, Jr., Adm. Proc. File No. 3-16178 (Initial Decision Sept. 14, 2015).
Bolan named as Respondents two former Wells Fargo Securities LLC employees. Mr. Bolan was a research analyst in Nashville, Tennessee. His research focused on three sub-sectors of the health care industry. Respondent Joseph Ruggieri was a senior trader of health care stocks in Wels Fargo’s trading department in New York City. In that role he placed customer orders and principal trades for the firm.
The Order alleges 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. Trader A, who passed away in 2013, was a friend of Mr. Bolan’s who also is alleged to have traded ahead of recommendations.
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). Mr. Bolan settled, consenting to the entry of a cease and desist order based on Securities Act Section 17(a)(3). He also agreed to pay a penalty of $75,000. No industry bar was imposed.
Mr. Ruggieri proceeding to hearing. At the conclusion of the hearing ALJ Jason S. Patil dismissed the action based on Dirks and Newman.
The Initial Decision
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. 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 decision 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 Dirks-Newman 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 — 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.