Does Payton Erode the Newman Tipping Test for Insider Trading Liability?

The 2014 decision by the U.S. Court of Appeals for the Second Circuit in U.S. v. Newman established four essential elements for determining liability for illegal tipping under the classic or misappropriation theory of insider trading:

  1. The person entrusted with confidential information had a fiduciary or similar duty;
  2. That duty was breached by providing confidential information to a tippee as a quid pro quo for a personal benefit;
  3. The tippee was aware that the tipper was breaching his or her duty; and
  4. The tippee traded on the confidential information received.

A recent decision by a New York U.S. District Court in SEC v. Payton demonstrates how insider trading cases can survive Newman even when parallel criminal cases fail, although the Securities and Exchange Commission still faces a high bar for proving the benefits tippers receive for disclosing confidential information.

Payton involved a tip on IBM’s acquisition of software company SPSS that broker Trent Martin received from a close friend, who was an attorney working on the deal. Martin told his roommate, attorney Thomas Conradt, about the deal and Conradt purchased shares in SPSS before the deal was announced. Contradt shared the information with two co-workers, Daryl Payton and Benjamin Durant, who also purchased SPSS shares prior to the announcement.

The SEC charged Payton and Durant with insider trading. Payton and Durant filed a motion to dismiss based on Newman.

In denying defendants’ motion, U.S. District Court Judge Jed S. Rakoff drew a distinction between civil and criminal insider trading liability, saying that to obtain a criminal conviction, the SEC must prove the act was willful. For civil cases, the SEC only needs to show that the act was reckless.

Judge Rakoff found that the SEC had met the pleading standards by showing that Conradt and Martin had a history of trading favors. The SEC complaint noted that Conradt had assisted Martin in dealing with a personal legal matter, and that Martin had thanked Conradt and said he was glad that Conradt had made a profit from the SPSS trades.

Judge Rakoff ruled that the SEC had sufficiently alleged that Payton and Durant either knew or were reckless in not knowing that Conradt and Martin had a quid pro quo relationship for the SPSS trades, or that Martin had breached his duty to his close friend in sharing the confidential information with Conradt. Judge Rakoff noted that the defendants allegedly tried to hide their SPSS trades, leading him to conclude they knew that a breach of confidentiality had occurred.

The Cogdell Law Firm is a full service criminal litigation and appellate law firm. We provide client-focused representation at all stages of the process, whether our clients are seeking to avoid charges, have been charged, or are seeking reversal of a conviction on appeal. When results matter most, contact Dan Cogdell at (713) 426-2244 or info@cogdell-law.com.

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