One of the basic tenants of the new SEC “get tough/omnipresent” policy is winning at trial. Courtroom wins earn the program respect, aiding the overall enforcement effort. Yet the Commission seems to have difficulty doing that. Despite what the agency claims is a good courtroom track record, there is little doubt that in recent major cases the SEC has not done well, losing three of four cases – losses in Primary Reserve Fund, Cuban and Stoker; win in Tourre.
Now the Commission has lost another trial. Following a two day bench trial on insider trading charges in SEC v. Schvacho, Civil Action No. 1:12-cv-02557 (N.D. Ga. Decision on Jan. 7, 2014) the Court found against the agency and in favor of the defendant in findings which suggest the positions of the agency were less than credible.
Schvacho is an action against Ladislav or Larry Schvacho, a retired employee of Cisco Systems. It centers on claims that Mr. Schvacho misappropriated material, non-public information from his long time friend Larry Enterline, CEO of Comsys IT Partners Inc., regarding its then pending acquisition by Manpower, Inc., announced on February 2, 2010. Specifically, in advance of that announcement Mr. Schvacho was alleged to have built a significant position in the shares of Comsys while in possession of inside information he was either told in confidence by, or overheard from, his friend.
The Commission’s claims were based on inferences from repeated communications and contacts between the two men which included numerous telephone calls, several text messages, a dinner, a boat trip and a meeting at the airport. The Commission did not have evidence regarding the content of the communications between the two men. Following the announcement of the deal Mr. Ladislav sold his shares of Comsys, garnering profits of over $500,000.
In support of its claims that Mr. Schvacho violated Exchange Act Sections 10(b) and 14(e) the “SEC offers two evidentiary theories . . . (1) that Enterline confided to Schvacho material, non-public information about Comsys and its business plan . . . or (2) that Schavcho obtained material non-pubic information from Enterline indirectly by, for example, overhearing Enterline’s communications with third parties or by accessing confidential information about the potential acquisition that Enterline may have left in a briefcase . . .” according to the findings of the Court.
Central to the SEC’s claims was a pattern of communications and contacts, events regarding the progress of the transaction and securities purchases described this way by the Court: “The SEC’s evidence at trial largely focused on records of times of telephone calls and text messages between Schvaccho and Enterline . . . The SEC juxtaposes the stock purchases and sales with these phone calls, arguing that a ‘pattern’ exists between conversations and stock transactions . . .” that establishes insider trading such as:
Call: November 7, 2009, after the deal discussions had commenced, Mr. Enterline telephoned Mr. Schvacho for 6 minutes;
Call: November 9, 2009 Mr. Enterline called Mr. Schvacho for eleven minutes;
Purchase: November 10, 2009 Mr. Schvacho purchased 1,900 shares of Comsys stock
Deal event: On November 11, 2009 Comsys’ board held its regular quarterly board meeting and discussed the potential deal;
Purchase: On November 11, 2009 Mr. Schvcho purchased 1,400 shares of Comsys;
Text message: On November 11, 2009 after the market closed Mr. Enterline sent a text message to Mr. Schvacho;
Call: On November 11, 2009 after the text message Mr. Schvacho called Mr. Enterline for 7 minutes;
Deal event: On November 12, 2009 Mr. Enterline called Manpower’s CFO to discuss the deal;
Purchase: On November 12, 2009 Mr. Schvacho purchased 5,500 shares of Comsys stock;
Call: On November 13, 2009 Mr. Enterline called Mr. Schavcho for 6 minutes; and
Purchase: On November 13, 2009 Mr. Schvacho purchased 400 shares of Comsys stock.
This pattern repeated during the term of the negotiations regarding the acquisition, although many of the phone calls cited were for 1 minute which meant that in fact that there was no actual conversation but only a call. In addition, the Commission established that in mid-December the two men drove from Atlanta to St. Petersburg, Florida and then sailed Mr. Enterline’s boat from that city to Fort Myers, Florida. During the trip Mr. Enterline had a brief case with him that he kept in his bunk. Later that month Mr. Schvacho picked up Mr. Enterline at the Atlanta airport.
Analyzing the SEC’s claims, the Court concluded that the claimed pattern was insufficient to establish insider trading. The Court went on to find that while “this timing is interesting it is not persuasive and does not meet the SEC’s burden of proof. . . The evidence was that Enterline and Schvacho spoke with each other with enormous frequently abut matters that Enterline and Schvacho acknowledge concerned mainly their personal relationship and sometimes about the common business venture in which they were involved . . .” Perhaps more importantly the “SEC did not present any evidence, including phone records, to show that the frequency or pattern of communications and the times when Enterline and Schvacho were together was any different during the period when the SEC contends that insider information was misappropriated by Schvacho than it was before the insider trading allegedly began.”
The Court also rejected the Commission’s claims that Mr. Schvacho may have obtained inside information about the deal during either a dinner the two men had or the sailing trip by overhearing conversations Mr. Enterline had with others. To the contrary, the SEC failed to call any witness to support this supposition.
The Court also rejected the Commission’s claims that the inside information may have been obtained from Mr. Enterline’s brief case. Mr. Enterline testified that “the briefcase he had did not have merger business documents in it, that it was stored in his sleeping compartment at the bow end of the boat in a locker, and that there was no evidence anyone had accessed it. To the contrary, the arguments of the agency only illustrate the “overreaching, self-serving interpretation that the SEC imposed on the evidence presented at trial,” according to the Court.
Finally, the Court found the testimony of Messrs. Evterline and Schvacho credible. There was nothing to contradict Mr. Evterline’s statements that he did not furnish Mr. Schvacho inside information or even know that he had purchased shares in the firm during the negotiation period or during an earlier period, both of which caused him concern and ultimately strained the relationship.
While the Commission tried to undermine the credibility of Mr. Schvacho’s denials of insider trading, it failed. Indeed, Mr. Schvacho’s testimony established that in a period prior to the deal negotiations he had purchased company shares and liquidated them. He also testified that he never told his friend about any of the purchases because of concern that it might undermine their friendship.
In the end the Court found that the SEC wholly failed to offer any evidence about the communications between the two men. Quoting SEC v. Rorech, 720 F. Supp. 2nd 367, 410 (S.D.N.Y. 2010)(another bench trial where the Court rejected SEC insider trading charges) the Court concluded that “’Potential access [however] to material, nonpublic information, without more, is insufficient to prove the defendant . . .’” actually did possess it and engaged in inside information.