Insider trading cases can be difficult to prove. Few if any are willing to admit they breached their duty and traded, misappropriated or stole inside information or illegally tipped someone. Absent the kind of blue collar tactics seen in the Galleon case and expert network investigation the cases typically turn on the inferences drawn from circumstantial evidence. Assembling such a case takes painstaking work, carefully sifting bits of evidence and assessing trading patterns. Despite these difficulties this task should very familiar to the point of being second nature to the SEC enforcement division.

A recent summary judgment ruling in SEC v. De La Maz, Case No. 09-21977 Civ. (S.D. Fla. Filed July 15, 2009) raises questions about this assumed expertise. Defendants Thomas Borell, an attorney, and Dr. Sebastian de Las Maza both traded in the securities of a take over target. The Commission claimed both men misappropriated inside information to trade. The court granted summary judgment to Mr. Borell, concluding the Commission failed to offer any proof on a key element of its claim. The court denied Dr. de Las Maza’s motion, holding there was a conflict of fact which required a trial while cautioning that the SEC’s evidence is not strong or compelling.

The case centers on the acquisition of Neff Corporation, an equipment rental company, by Odyssey Investment Partners, LLC, a private equity fund. The deal was announced on April 7, 2005 as discussed here. Negotiations for the transaction began in November 2004. In February 2005 Neff and Odyssey executed a letter of intent. Due diligence began in March 2005. When the deal was announced the share price for Neff increased by 51%.

Thomas Borell’s trades: According to the SEC, Mr. Borell is a long time friend of Neff director Jose Mas whose brother was the CEO of the company. Mr. Borell’s relationship with Neff director stems from the friendship of their children. The two sons met in 2001 – 2002 at Epiphany pre-school when they were about three years old. They became good friends. As a result the Borell and the Mas families would see each other periodically at school functions and other events for the children. The two families became part of a circle of friends consisting of parents with children at the school. Typically the social events involved the children but on occasion only the group of parents would socialize.

On some occasions the large group of families would go on vacations together. For several years they would make bi-annual trips to Disney World, as well as annual ski trips. There is no evidence however that the Mas and Borell families ever interacted by themselves outside of the larger group. Messrs. Borell and Mas both stated that they were and are not close friends. There is no history of business dealings between the two men.

From March 13 -15, 2005 both families went on a group trip to Disney World. The group also took a ski trip to Vail, Colorado on March 28, 2005. Two other Mas brothers, CEO Juan and director Jorge, also participated in the ski trip. While Mr. Borell and Jose Mas spoke on the phone during the ski trip both testified that the conversations did not reference the transaction. Jose Mas testified that he did not believe Mr. Borell was in a position to overhear any of his conversations about the deal.

Between March 27, 2005 and April 7 when the deal was announced Mr. Borell purchased $1,084,295 worth of Neff stock. To fund this purchase he sold another block of stock at a loss. This was not Mr. Borell’s first purchase of Neff shares. In 1999 he acquired $89,373 worth of shares which he later sold at a loss. In early January 2005 he purchase a block of Mastec shares for $1.35 million. The next moth he purchased 750,000 shares of Terremark for over $723,000. Mr. Borell sold over $1 million of Terremark shares to pay for his March purchases of Neff shares.

Mr. Borell denied having inside information. Rather, he testified that he is an avid day trader and has multiple sources of information. As to Neff, he regarded the company as a take-over target following the death of the elder Mas who is the former chairman of Mastec. He also claimed it was public knowledge that the Mas family was selling things. He speculation that the company was for sale was bolstered by his observation during the ski trip that Juan Carlos Mas was not skiing despite being on the trip.

Dr. De La Maza’s trades: Dr. De La Maza’s daughter Vivian is married to former Neff CEO Juan Carols Mas. By the time of the takeover the couple had been married for twelve years. The Doctor had a close relationship with his daughter. They spoke on the telephone almost daily and frequently spent time together.

In late 2004 the family planned to take a European cruise in June 2005. Vivian and her family as well as other family members and friends would attend. In early 2005 before putting down the deposit on the cruise Vivian consulted with her husband regarding his availability. During the conversations she learned about the deal negotiations. After that however she did not receive updates and never saw any documents. Vivian testified that she did not tell anyone, including her parents, about the deal.

Subsequently, Vivian told the family and friends that Juan Carlos might not be able to attend the cruise because of business. She did not give any specifics. At about that point in time she overheard her father purchasing Neff shares on the telephone. This concerned her but she did not say anything.

Between March 14 and April 4 Dr. De La Maza made four purchases of Neff securities. He purchased a total of $111,126 worth of stock spread over two accounts in his name and one in his wife’s name. The purchases were paid for largely by liquidating other holdings. The Doctor first purchased Neff shares in May 1998, buying 3,000 shares in the IPO. Later in 1998 he purchased about $90,000 of Neff shares in two transactions. In December 2001 he also made a small purchase which was sold in 2003.

Dr. De La Maza denied having inside information. He testified he purchased the shares on a hunch.

The ruling: In ruling on Mr. Borell’s summary judgment motion, the court agreed with the SEC that the defendant had inside information: “I agree that the SEC has offered sufficient circumstantial evidence that Mr. Borell possessed material, non-public information relating to the Neff-Odyssey deal and traded on that information (i.e. access and contact to Mr. Mas during the Neff-Odyssey due diligence period and unusual trading patterns during that period of time). . . “

The critical question however is whether Mr. Borell had a duty of loyalty and confidentiality to Jose Mas. To prevail on an insider trading claim under the misappropriation theory the SEC must establish that the person who misappropriated the information breached a duty of loyalty and confidence owed to the source of the confidential information. That duty is typically phrased in terms of a “duty of trust and confidence.”

While the courts have not delineated the precise contours of this duty, the SEC did implement Rule 10b5-2. It provides a non-exclusive definition of the circumstances in which a person has a duty of trust or confidence for purposes of the misappropriation theory of insider trading. That rule states in part that such a relation exists when there is “a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality. . “ The rule was promulgated in large part to broaden the definition of “relationship of trust and confidence” developed in cases such as U.S. v. Chestman, 947 F. 2d 551 (2nd Cir. 1991).

Here it is undisputed that Mr. Borell and Mr. Mas ‘never expressly agreed to maintain information pertaining to the Neff-Odyssey deal confidential . . . “ Thus the SEC’s case hinged on the type of relation described in Rule 10b5-2 the court concluded. The Commission however failed to present any facts to establish the key Rule 10b5-2 relation. Likewise, the agency failed to cite any case in which the court found the type of evidence presented here sufficient. Accordingly, summary judgment was granted in favor of Mr. Borell.

In contrast, the court denied the motion of Dr. De La Maza. He clearly had a relationship of trust and confidence with his daughter. Likewise, the circumstantial evidence regarding his proximity to a source of information, lack of reasons for purchasing the stock and unusual trading pattern was more than sufficient to raise an inference supporting the SEC’s claims. The resolution of the conflicting inferences is for the jury, not the court on summary judgment.

The rulings clearly reflect the difficulty of proving an insider trading claim. At the same it also highlights the need to carefully analyze the evidence prior to filing the complaint. A key focus of the recent reorganization of the enforcement division was to put more “boots on the ground,” presumably to more carefully sift the evidence. Yet here the case against Mr. Borell was dismissed for a lack of proof not of some novel legal theory but of the elements in the rule the Commission wrote to ease its proof standards. Even as to Dr. De La Maza the court cautioned that “the evidence brought by the SEC is certainly not strong or compelling. But at summary judgment my roe is not to weight evidence.” No doubt the “new boots” need to spend more time assessing the evidence.

I would like to thank James Sallah of Sallah and Cox LLC, Boca Raton, Florida whose firm is counsel for Dr. De La Maz, for sending me court’s opinion.