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.