The SEC Settles A Long Running And Significant Insider Trading Case

The SEC settled a long running and significant insider trading case. The action was initially dismissed by the district court and was later reinstated by the Ninth Circuit Court of Appeals. With the entry of a final judgment against J. Thomas Talbot, former director of Fidelity National Financial, Inc., on March 9, 2009, the case came to an end about five years after it began. SEC v. Talbot, Case No. CV 04-04556 (C.D. Cal. Filed June 24, 2004). Mr. Talbot agreed to settle the case by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and Rule 10b-5. Mr. Talbot also agreed to the entry of an order requiring him to disgorge $67,881 along with $26,916 in prejudgment interest for a total of $94,797. In addition, he agreed to pay a civil penalty of $135,762. Although the complaint sought an officer and director bar, the settlement did not include this provision.

This case arouse out of the take-over of the LendingTree by USA Interactive in May 2003. Prior to that transaction, according to the Commission’s complaint, LendingTree was in negotiations to be acquired. The CEO of LendingTree, Douglas Libda, told a vice-president of Fidelity, Brent Bickett, about the proposed transaction. The consent of Fidelity would be required, since the company owned about 12% of LendingTree.

Subsequently, Mr. Bickett told William Foley, CEO of Fidelity, about the proposed transaction. Mr. Foley, in turn discussed the matter at a regular board meeting attended by Mr. Talbot. While the board was not told to keep the information confidential, one board member noted at the conclusion of the meeting that the information about LendingTree was inside information.

Two days after the board meeting Mr. Talbot purchased 5,000 shares of LendingTree at about $13.50 per share. Later he purchased an additional 5,000 shares at $14.50 per share. A few days later, on May 5, 2003, the acquisition of LendingTree was announced. Mr. Talbot sold his shares for a profit of over $67,000.

The district court granted summary judgment in favor of Mr. Talbot. The court held that the SEC had failed to establish a breach of duty because it did not demonstrate that there was a continuous chain of fiduciary relationships back from Mr. Talbot to the source of the information. The court read U.S. v. O’Hagan, 512 U.S. 642 (1997), which upheld the misappropriation theory, as requiring a continuous link.

The Ninth Circuit reversed. The circuit court held that under the misappropriation theory as defined by O’Hagan, a breach of duty is required since it supplies the key element of deception. That breach however, need not be to the shareholder involved in the trading. Rather, the breach of duty and deception runs to the source of the inside information. Stated differently, the breach runs to the source of the information who is deceived. Accordingly, a continuous chain back to the source of the information as the district court concluded is not required.

The ruling by the Ninth Circuit is significant for SEC enforcement. A ruling upholding the district court’s conclusion would have significantly narrowed the scope of liability under the misappropriation theory. In contrast, the ruling of the Ninth Circuit gives insider trading a far broader reach than the rejected continuous chain would have permitted.