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The SEC brought a big insider trading case against a number of individuals in the Western District of North Carolina yesterday. The complaint alleges $11 million in illicit profits.

The complaint calls it an insider trading “ring,” but it’s more like a tree. At the roots were a 30-year-old investment banker named John Femenia. He worked in Wells Fargo’s Charlotte office until May of this year, when he moved to New York. The SEC alleges that from July 2010 to July 2012, Femenia misused his position at the bank to obtain inside information about four separate merger transactions involving firm clients. He allegedly then tipped his friends Shawn Hegedus, Aaron Wens, and Matthew Musante. Wens kept the information to himself, but Musante allegedly told his dad, Anthony Musante, while Hegedus tipped his girlfriend, Danielle Laurenti, and his friend Roger Williams. That wasn’t the end of the tipping. The SEC claims that Williams was just as prolific a tipper as Femenia, and told his friends Frank Burgess, James Hayes, and Kenneth Raby (the farthest branches on this tree) about the impending mergers.

All of this means that at least six remote tippees are involved here. The Supreme Court established the parameters of tippee liability almost 30 years ago in SEC v. Dirks. The Court held that a tippee assumes a fiduciary duty to shareholders of a public company not to trade on material nonpublic information if (a) the tipper has breached his fiduciary duty to the company and its shareholders by disclosing such information to the tippee in return for some personal benefit and (b) the tippee knows or should have known of the breach.

But what about a tippee of the tippee, or a remote tippee? Tom Sporkin pointed out yesterday in Law360 that liability for remote tippees has been rattled a bit by a recent case in the Southern District of New York. In United States v. Whitman, Judge Rakoff held (as Sporkin noted):

First, the remote tippee must generally know that a fiduciary duty was breached as part of the initial communication from the insider to the intermediate tippee — a point of law consistent with current Southern District and appellate court holdings. Second, the remote tippee must generally know the insider received an associated benefit in exchange for the tip. Courts have previously required this second element to establish liability for direct tippees, but have not precisely stretched it to fact patterns in which the trader was exclusively a remote tippee . . . Finally, in using the information to trade, the remote tippee must have the specific intent to defraud the company to which the confidential information related — another requirement not precisely articulated as a prerequisite for remote tippee liability.

As to the knowledge of the benefit issue, the court noted that “[t]he Government argued that it needed only to show that the defendant knew (or recklessly disregarded) that the information he was obtaining was an unauthorized disclosure by some inside tipper, but not that he also knew of any benefit provided to the tipper.” Disagreeing, the court countered that a “tippee must have knowledge that … self-dealing [in the form of a personal benefit] occurred. … Without such a knowledge requirement, the tippee does not know if there has been an ‘improper’ disclosure of inside information.

Sporkin’s point was that this new approach could create issues for a future prosecution of SAC Capital principal Steven Cohen. But it could also throw a monkey wrench into the SEC’s cases against the Wells Fargo remote tippees. Whitman is obviously a criminal case, while the SEC’s current case against Femenia, et al., is civil, and no parallel criminal charges appear to have been filed.  Still, Judge Rakoff’s second point seems to apply equally to civil cases involving remote tippees. Indeed, he cited both a criminal case and a private civil matter to support the point. Here is the question for me: will the SEC be able to show that Burgess, Hayes, and Raby knew that Femenia received an associated benefit in exchange for his tips to Hegedus? It seems entirely possible that that will be difficult to prove. They might not even have known Femenia’s name or where any information they received from Williams came from.

It will be interesting to see how this case develops.