Another High Profile SEC Trial Loss – More Steps Backward

by Dorsey & Whitney LLP

The SEC continues to struggle with its swagger. The claim that it has returned is, at best, debatable. Clearly prevailing in the SEC v. Wyly, 10 Civ. 5760 (S.D.N.Y. Verdict May 12, 2014) earlier this month was a major and much need courtroom win for an agency. Yet on the same day the Commission lost what may be a more significant case in SEC v. Graham, Case No. 13-1001 (S.D. Fla. Ruling May 12, 2014) when the Court dismissed all of its claims on jurisdictional grounds, citing the five year statute of limitations in 28 U.S. C. Section 2462. If Wyly was one step forward, then Graham was two back (here).

Now the backward trend may be accelerating. On Friday a jury in Manhattan returned a verdict against the SEC and in favor of the three defendants in the long running, and high profile insider trading case, SEC v. Obus, Civil Action No. 06-03150 (S.D.N.Y.).

Obus centered on the acquisition of SunSource, Inc. by Allied Capital Corporation in June 2001. Following the acquisition the SEC brought an insider trading action against Nelson Obus, Peter Black and Thomas Strickland. Mr. Strickland had been employed as an assistant vice president and underwriter at GE Capital Corporation. His college friend, Peter Black ,worked as an analyst at Wynnefield Capital, Inc. which managed a group of hedge funds. His supervisor was Nelson Obus.

In May 2001 Allied approached GE Capital about financing its acquisition of SunSource. Mr. Strickland was assigned to perform due diligence on SunSource. While doing that work he learned about the proposed deal. He also learned that Wynnefield was a large SunSource shareholder. Although he understood the information was confidential, SunSource and Allied were not placed on the restricted list until after the GE Capital team had completed its work.

Later that same month Mr. Strickland discussed SunSource with his friend Peter Black. Both men claim that there was no tip, only a routine due diligence conversation. Mr. Black did, however, come to suspect that SunSource was considering a transaction that would dilute existing shareholders. He conveyed this suspicion to his boss, Mr. Obus who later called Maurice Andrien, the president of SunSource. Mr. Andrien would subsequently claim he learned during the conversation that Mr. Obus had been tipped. Mr. Obus denied this.

On June 8, 2001 Wynnefield purchased 287,200 shares of SunSource at $4.50 per share. This was about two weeks after the Strickland-Black conversation. The transaction was initiated by Cantor Fitzgerald which called and initially offered a 50,000 share block at $5 per share. The purchase was about the same size as an earlier Wynnefield transaction in the stock. Nine days later the deal was announced and the share price doubled, giving the hedge fund a profit of about $1.3 million.

The SEC claimed Mr. Strickland illegally tipped Mr. Black who in turn tipped Mr. Obus. In the District Court the defendants prevailed on summary judgment. The Court found that Mr. Strickland had not breached any duty to GE Capital. The ruling was based on the theory that GE Capital’s internal investigation had found no breach of duty and the fact that SunSource had not been on the firm’s restricted list until after the due diligence was complete. The Court also found that the facts were insufficient for the jury to conclude that Mr. Strickland’s conduct was deceptive.

The Second Circuit reversed. The SEC relied on the misappropriation theory of insider trading. That theory, the Circuit Court noted, is premised on a breach of fiduciary duty to the source of the information rather than the company as with the classic theory. Unlike the classic theory, under which the holder of the information can abstain from trading or disclose, under the misappropriation theory disclosure can only be made to the source or the holder can abstain from trading.

To hold a tipper liable there must be: 1) a tip, 2) material non-public information, 3) in breach of a fiduciary duty 4) for the personal benefit to the tipper. The required scienter corresponds to the first three elements. While the tipper is not required to have specific knowledge of the legal nature of a breach of fiduciary duty, he “must understand that tipping the information would be violating a confidence” the Court held. The tippee must also know that the information conveyed is material and non-public.

After outlining these principles, Second Circuit made two significant rulings, favoring the SEC. First, it resolved a question regarding the application of Dirks v. SEC, 463 U.S. 646 (1983) on the scienter of a tippee. In Dirks the High Court stated that while the tippee is a participant in the tipper’s breach of fiduciary duty, “a tippee has a duty to abstain or disclose only when the insider has breached his fiduciary duty . . . and the tippee knows or should know that there has been a breach.” This statement, expressing a negligence standard, contrasted with the requirement of Ernst & Ernst v. Hochfelder425 U.S. 185 (1976) which held that there must be scienter. The Second Circuit harmonized the apparent inconsistency, holding that Hochfelder scienter applies to the tippee’s use of the information in trading while the Dirks negligence language applied to that person’s knowledge that the tipper breached a duty.

Second, the Court concluded that despite the findings of the internal investigation that there was no breach of duty, and the facts regarding the restricted list, there could still be a breach of duty and liability. Based on these principles the Court concluded that there was sufficient evidence that Mr. Strickland knew he owed GE Capital a duty to keep the information confidential and not to convert it to his own profit. Furthermore, the District Court erred in requiring the SEC to make an additional showing of deception as to Mr. Strickland beyond the tip. The tip is sufficient, the Circuit Court concluded.

Mr. Black’s liability is derivative of Mr. Strickland, the Circuit Court concluded. The critical point is if he knew or should have known that Mr. Strickland breached his fiduciary duty. He is a sophisticated financial analyst who knew that his friend was involved in developing financing packages for other companies and performing due diligence He also knew that information about an acquisition would be material non-public information. This, the Court held, is sufficient.

Finally, the same question is critical as to Mr. Obus. Here the Court found it sufficient that Mr. Obus determined the information he obtained to be credible and knew that it originated from a person with a duty of confidentiality. Accordingly, the Second Circuit remanded the case for trial.

Despite the favorable rulings on duty and the knowledge of tippees, which in some ways tends to eliminate the statutory element of deception (here), the SEC was unable to prevail in this major, high profile trial. The jury rejected its claims, finding in favor of each defendant. The month of May thus came to an end for the Commission with one step forward in Wyly, two back in Graham and even more back with Obus.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dorsey & Whitney LLP | Attorney Advertising

Written by:

Dorsey & Whitney LLP

Dorsey & Whitney LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.