DC Circuit Upholds Constitutionality of SEC’s Use of Administrative Law Judges in First Appellate Ruling

In the first appellate ruling of its kind, the District of Columbia Circuit upheld the SEC’s use of administrative law judges in administrative proceedings as constitutional. The court in Raymond J. Lucia Cos. v. SEC denied Mr. Lucia’s petition for review in which he claimed that the SEC’s use of administrative law judges was unconstitutional.

Lucia argued that administrative law judges are “Officers of the United States” within the meaning of the Appointments Clause in Article II of the Constitution. Lucia urged the court to rule that the SEC’s use of administrative law judges was unconstitutional because those judges have not been appointed by the President, as the Constitution requires. The three-judge panel disagreed and concluded that the SEC’s administrative law judges are inferior officers/employees who are not governed by the clause. In making this determination, the panel considered the significance of the matters resolved by the administrative law judges, the discretion the administrative law judges exercise in reaching their decisions, and the finality of the administrative law judges’ decisions. The court found the last factor dispositive because the Commission ultimately must act to approve an administrative law judge’s decision. “As the Commission has emphasized, the initial decision becomes final when, and only when, the Commission issues the finality order, and not before then . . . . Thus, the Commission must affirmatively act—by issuing the order—in every case. The Commission’s final action is either in the form of a new decision after de novo review or, by declining to grant or order review, its embrace of the ALJ’s initial decision as its own.” Op. at 13. In that sense, the court concluded, administrative law judges have not been “delegated sovereign authority” such that they would come within the purview of the Appointments Clause.

The DC Circuit’s decision deals a significant blow to litigants bringing similar challenges in other federal courts. As other cases become ripe for substantive consideration after jurisdictional hurdles are cleared, this decision provides the SEC’s with strong ammunition to oppose similar constitutional challenges. While the Second and Eleventh Circuits recently addressed issues relating to the SEC’s use of ALJs, the opinions focused on the district court’s lack of jurisdiction to hear the cases because the plaintiffs had not raised their challenges in the SEC’s in-house court first, not the merits of the issues. Unless and until another circuit court rules the SEC’s use of ALJs unconstitutional, creating a split, the issue will likely not reach the Supreme Court.

U.S. Supreme Court to Take Up Issue of “Personal Benefit” in Insider Trading Context

The U.S. Supreme Court granted certiorari this week in a case that is sure to draw significant attention given its likely implications on insider trading liability. Bassam Salman filed the petition after the Ninth Circuit affirmed his insider trading conviction in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015).

Salman was convicted of conspiracy and insider trading arising out of a trading scheme involving members of his extended family. During the time period at issue, Maher Kara, Salman’s future brother-in-law, had access to insider information regarding mergers and acquisitions of and by his firm’s clients that he provided to his brother, Michael Kara. Michael subsequently traded on the information. Michael then shared the information he learned from Maher with Salman. Salman also traded on the information.

Following his conviction, Salman appealed and argued that there was no evidence that he knew that Maher disclosed information to Michael in exchange for a personal benefit. The personal benefit requirement, first derived from the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983), requires that the insider personally benefit from the disclosure—including through pecuniary gain, a reputational benefit that will translate into future earnings, or where the insider makes a gift of confidential information to a trading relative or friend. Critical to the third manner of conferring a personal benefit, the Second Circuit recently held in United States v. Newman, 773 F.3d 438, 452 (2d Cir. 2014), that to the extent “a personal benefit may be inferred from a personal relationship between the tipper and tippee . . . such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

Salman urged the Ninth Circuit to adopt the Newman court’s interpretation of Dirks to require more than evidence of a friendship or familial relationship between the tipper and the tippee. The Ninth Circuit declined, holding that doing so would require the court to depart from the ruling in Dirks that liability can be established where the insider makes a gift of confidential information to a trading relative or friend. The Supreme Court likely will resolve whether the concept of a personal benefit addressed in Dirks requires proof of an objective, consequential, and potential pecuniary gain—as the Newman court held—or whether it is enough that the insider and tippee shared a close family relationship.

The Newman decision has already resulted in the dismissal of insider trading charges against several individuals. The Supreme Court’s ultimate decision will therefore provide much needed clarity in this area, given the sharp split between the Second and Ninth Circuits on the issue.

SDNY Judge Deals Rejects Constitutional Challenge to SEC’s Use of Administrative Proceedings

A former executive of Standard & Poor’s (S&P) Rating Services has lost an early constitutional challenge to the SEC’s use of administrative proceedings.

Barbara Duka filed suit in federal court in January, following the SEC’s decision to bring charges against her for violating Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibits fraudulent conduct in the offer and sale of securities. Duka, formerly a co-manager of the commercial mortgage backed securities group of S&P’s Rating Services initiated the suit to prevent her from being compelled to submit to allegedly unconstitutional proceedings. Duka sought a preliminary injunction, arguing that administrative law judges (ALJs) who preside over administrative proceedings, are unlawfully insulated from oversight by the President in violation of Article II of the Constitution. Last week, District Judge Richard M. Berman of the Southern District of New York rejected Duka’s request.

Duka presented her claim as a facial challenged to the constitutionality of SEC ALJ proceedings, which aided the court’s determination that it had subject matter jurisdiction to entertain the suit.

Duka’s constitutional challenge was premised on the argument that SEC ALJs are “inferior officers” protected from removal by at least two levels of good-cause tenure protection and therefore the President cannot oversee ALJs in accordance with Article II. In considering the likelihood of success on the merits of Duka’s constitutional claim, the court rejected the argument that the Supreme Court’s decision in Free Enterprise Fund v. Public Accounting Oversight Board, 561 U.S. 477 (2010), supported the conclusion that SEC administrative proceedings are unconstitutional. In Free Enterprise Fund, the Supreme Court decided that the SEC’s Public Company Accounting Oversight Board created by Sarbanes-Oxley violated Article II because the act provided for dual for-cause limitations on the removal of board members. The Supreme Court held that “such multilevel protection from removal is contrary to Article II’s vesting of the executive power in the President” and that the President “cannot ‘take Care that the Laws be faithfully executed’ if he cannot oversee the faithfulness of the officers who execute them. Id. at 484.

Judge Berman noted that the issue of whether ALJs are “inferior officers” is subject to dispute, but he did not need to resolve that question because it concluded that the level of tenure protection afforded to ALJs was permissible. The court reasoned that the Supreme Court in Free Enterprise Fund addressed the narrow issue of whether Congress may deprive the President of adequate control over the board. The court also noted that ALJs were specifically excluded from the reach of the Free Enterprise Fund holding. Id. at 507 n.10 (“For similar reasons, our holding also does not address that subset of independent agency employees who serve as administrative law judges.”). In addition, the court noted, the decision in Free Enterprise Fund “supports the conclusion that restrictions upon the removal of agency adjudicators, as opposed to agency officials with ‘purely executive’ functions, generally do not violate Article II.” Op. at 19. Here, the court concluded, ALJs perform “solely adjudicatory functions, and are not engaged in policymaking or enforcement.” Id. at 20.

The Duka decision is a setback for defense bar challenges to the SEC’s use of administrative proceedings. As we have written in the previous post: “SEC Faces New Constitutional Challenge to Administrative Proceedings Based on Tenure Protection of Administrative Law Judges,” the SEC has faced a flurry of challenges to the use of administrative proceedings, which provide fewer protections to litigants than those provided in cases brought in federal court. Despite the decision, it is likely that the SEC will continue to face such challenges as they make their way through the federal appellate courts.

SEC Files First Antiretaliation Enforcement Case Against Hedge Fund Advisory Firm

In a first of its kind case, the SEC last week charged an investment adviser to a hedge fund with, among other things, retaliating against an employee who reported allegedly illegal trading activity to the agency. The SEC exercised its authority under a Commission rule adopted in 2011 under the Dodd-Frank Act, which permits enforcement actions based on retaliation against whistleblowers.

Under the Exchange Act, employers may not “discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower.” 15 U.S.C. § 78u-6(h)(1)(A). The Act also provides that the Commission “shall pay an award or awards to 1 or more whistleblowers who voluntarily provided original information to the Commission that led to the successful enforcement of the covered judicial or administrative action, or related action, in an aggregate amount equal to (A) not less than 10 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions; and (B) not more than 30 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions.” Id. § 78u-6(b)(1).

The alleged retaliation at issue centered on the investment adviser’s former head trader, who reported allegedly improper principal transactions to the SEC under the SEC’s Bounty Program. According to the SEC, the investment adviser engaged in trades with an affiliated broker-dealer on behalf of one of its hedge fund clients. The SEC alleged that the investment adviser’s owner had a conflicted role as owner of the brokerage firm while subsequently advising the hedge fund client. In an attempt to satisfy written disclosure and consent requirements, the investment adviser formed a conflicts committee to review the transactions, which consisted of the investment adviser’s CFO and chief compliance officer. The SEC alleges that the conflicts committee was also conflicted because the two-person committee reported to the investment adviser’s owner and because the investment adviser’s CFO also served as CFO of the investment adviser’s affiliated broker-dealer. As a result of this conflict, the SEC contended the investment adviser did not provide effective written disclosure to its hedge fund client, and it did not obtain consent to engage in the transactions.

According to the SEC Order, the trader subsequently informed the owner of the investment adviser that he had reported these potential securities law violations to the SEC. After the company learned of the whistleblower’s submission, it allegedly engaged in a series of retaliatory actions to strip the trader of his responsibilities. Approximately one month after doing so, the whistleblower resigned citing constructive discharge. Of note, the former trader filed a lawsuit against the investment adviser, its owner, and its affiliated broker-dealer under § 78u-6(h)(1)(B), which permits whistleblowers to bring enforcement actions, alleging unlawful retaliation, but the lawsuit was voluntarily dismissed in December 2012. It is not clear why the lawsuit was dismissed or whether the dismissal was related to a settlement.

In settling the matter with the SEC, the investment adviser neither admitted nor denied the charges. It agreed to pay $2.2 million, which includes disgorgement of $1.7 million, prejudgment interest of $181,771, and a civil penalty of $300,000. The Order expressly provides that the disgorgement relates to administrative charges relating to the principal transactions. The Order is silent, however, on whether the civil penalty of $300,000 is related to those principal transactions or has something to do with the retaliation claim. The Commission acknowledged in its order that the principal transactions were effected at the prevailing market price and the affiliated broker-dealer did not charge a markup or commission on the transactions. Significantly, the Order does not contain any finding that the funds were harmed by inadequate prices and the fact that the disgorgement relates to administrative charges strongly suggests there was a lack of monetary injury to the funds.

The SEC has authority to award the whistleblower between 10 and 30 percent of the recovery because the tip led to sanctions in excess of $1 million. According to Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, a whistleblower is eligible for a whistleblower award. We have previously pointed out that the SEC intends to vigorously protect whistleblowers by using it authority under Dodd-Frank to bring retaliation claims against employers in a previous post: “Arbitration Agreements and Whistleblower Protections.” This case is proof.

Second Circuit Vacates Judge Rakoff’s Order Refusing to Approve Citigroup “Neither Admit Nor Deny” Settlement

Today, the Second Circuit Court of Appeals vacated Judge Rakoff’s order refusing to approve a settlement between the SEC and Citigroup in which Citigroup neither admitted nor denied the agency’s allegations. See SEC v. Citigroup Global Mkts., Inc., Docket Nos. 11-5227-cv; 11‑5375-cv; 11-5242-cv (2d Cir. June 4, 2014). Judge Rakoff took issue with the consent decree, finding that it was not fair, reasonable, adequate, or in the public interest because the public was denied the opportunity to know the truth underlying the allegations of securities fraud. The Circuit Court disagreed, reasoning that the district court abused its discretion by requiring the SEC to “establish the ‘truth’ of the allegations against a settling party as a condition for approving the consent decrees.” Id., slip op. at 21. The court said, “Trials are primarily about the truth. Consent decrees are primarily about pragmatism.” Id.

The court clarified that the proper standard for reviewing a consent decree requires determinations of whether the decree is fair and reasonable and whether the public interest would be disserved. According to the court, district courts assessing consent decrees for fairness and reasonableness should consider (1) the basic legality of the decree; (2) whether the terms of the decree, including its enforcement mechanism, are clear; (3) whether the consent decree reflects a resolution of the actual claims in the complaint; and (4) whether the consent decree is tainted by improper collusion or corruption of some kind. The court jettisoned the “adequacy” requirement, finding it incompatible with the use of consent decrees. In addition, the court made clear that “[t]he job of determining whether the proposed S.E.C. consent decree best serves the public interest . . . rests squarely with the S.E.C., and its decision merits significant deference . . . .” Id., slip op. at 24-25.

The court remanded the case to the district court for consideration of the factual basis for the consent decree under these standards, noting that “[a]bsent a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements, the district court is required to enter the order.” Id., slip op. at 19.

The court cautioned that the SEC must be “willing to assure the court that the settlement proposed is fair and reasonable” when it seeks the court’s imprimatur of consent decrees. Id., slip op. at 27. The court pointed out, however, that the SEC has the ability to employ its own remedies—like administrative proceedings—that do not require court involvement. It remains to be seen whether the SEC will make more use of administrative proceedings in an effort to avoid judicial scrutiny in settled cases. During the pendency of the Citibank ruling, the SEC did not shy away from filing significant settled cases such as the JP Morgan internal controls matter in federal court. Moreover, in light of the standard articulated by the Second Circuit, it would seem that both the SEC and settling defendants should have less concern about courts second-guessing or questioning whether proposed settlements serve the public interest.

Recent Decision Demonstrates Reach of Lawson; Extends SOX Whistleblower Protections to Employee of a Nonpublic Subsidiary of a Public Issuer

We recently blogged about the U.S. Supreme Court’s decision in Lawson v. FMR LLC, 571 S. Ct. __, 188 L. Ed. 2d 158 (Mar. 4, 2014), which held that the whistleblower protections in section 1514A applied not only to the direct employees of public companies, but also to employees of private contractors and subcontractors serving public companies. See Lawson and Doral Expand Whistleblower Protections,” SECurities Law Perspectives (Apr. 2, 2014). Taking the lead from Lawson and more recent decisions from the Department of Labor’s Administrative Review Board (“ARB”), the U.S. District Court for the Eastern District of Pennsylvania has ruled that an employee of a nonpublic subsidiary of a public issuer could proceed with his retaliation claims against the company. Wiest v. Lynch, __ F. Supp. 2d __, Civil Action No. 10-3288, 2014 WL 1490250, at *18–23 (E.D. Pa. Apr. 16, 2014).

In reaching this conclusion, the court considered Lawson and more recent ARB decisions interpreting the scope of section 1514A’s “agent” language. The court said, “There is no reason to think that the Supreme Court’s holding in Lawson does not also apply, beyond contractors of public companies, to agents of public companies and those agents’ employees.” Id. at *19; see also 18 U.S.C. § 1514A(a) (“No [public] company . . . or any officer, employee, contractor, subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee . . . to provide information, cause information to be provided, or otherwise assist in an investigation regarding any conduct which the employee reasonably believes constitutes a violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders . . . .” (emphasis added)).

Noting “some disagreement among lower courts and the ARB as to the scope or nature of the required agency relationship,” the court rejected the narrower view—i.e., that an agency is created for purposes of section 1514A only when the public-issuer parent is involved in hiring, supervising, or terminating its nonpublic subsidiary’s employees—for more traditional agency principles. The court found persuasive the ARB’s decision in Johnson v. Siemens Building Techs., Inc., ARB No. 08-032, 2011 WL 1247202 (Dep’t of Labor Mar. 31, 2011), which held that section 1514A applied to a subsidiary whose financial information was included in the consolidated financial statements of a public-issuer parent.

In combination with Lawson, the Wiest court found the concurrence in Johnson suggestive of “the direction in which the ARB is headed.” Wiest, 2014 WL 1490250, at *20. Specifically, the concurrence observed that to focus the agency coverage question on whether the public issuer was involved in employment/labor law issues would “fly in the face” of two other bases for finding agency—i.e., apparent authority and respondeat superior. Id. at *20–21 (quoting Johnson, 2011 WL 1247202, at *16). Rather, it explained, “[A]n entity will be held independently liable as a covered agent under [section 1514A] where it is established that the entity engaged in retaliatory conduct was serving as the public company’s agent with respect to securities related matters.” Id. at *21 (quoting Wiest, 2011 WL 1247202, at *17).

In resolving the motion to dismiss before it, the Wiest court concluded that the complaint sufficiently alleged that Wiest’s employer, the nonpublic subsidiary, acted as an agent of its public-issuer parent. For example, the court found Wiest’s allegation that executives of the public-issuer parent had approved certain expenses about which Wiest had complained to be “a strong indicator of an agency relationship regarding accounting and taxes between [the two entities].” 2014 WL 1490250, at *22. The court noted, however, that “[t]his theory will quite likely be tested on the evidence later . . . .” Id. at *23.

While Lawson opened the door for employees of nonpublic companies to bring whistleblower claims, there still will be legal challenges to the scope of such protections. The Wiest decision highlights at least one area about which there may be substantial disagreement and on which companies may fight back on the courts’ expansion of these claims.

Lawson and Doral Expand Whistleblower Protections

Two recent decisions interpreting the Sarbanes-Oxley Act have significantly expanded the protections available for federal whistleblowers and increase the potential liability for public companies and private companies that contract for public companies.

In Lawson v. FMR LLC, 571 S. Ct. __, 188 L. Ed. 2d 158 (Mar. 4, 2014), the U.S. Supreme Court held that SOX protects from retaliation not only the direct employees of public companies, but also employees of private contractors and subcontractors serving public companies.  At issue in Lawson was the scope of the protected class in section 1514A of the statute:

No [public] company … or any officer, employee, contractor, subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee … to provide information, cause information to be provided, or otherwise assist in an investigation regarding any conduct which the employee reasonably believes constitutes a violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders ….

18 U.S.C. § 1514A(a).  The plaintiffs in Lawson were former employees of privately held companies that provide advisory and management services to a mutual fund, a public company.  The mutual fund itself has no employees.  The defendants argued that the plaintiffs could not bring whistleblower claims under SOX because the statute only protects those directly employed by the public company.

In a 6–3 opinion, Justice Ginsburg, writing for the Court, concluded that section 1514A shields employees of privately held contractors and subcontractors, including investment advisors, law firms, and accounting enterprises, that contract for public companies.  The Court reasoned that “nothing in § 1514A’s language confines the class of employees protected to those of a designated employer.”  188 L. Ed. at 175.  In addition to its textual interpretation of the statute, the Court recognized that including employees of contractors and subcontractors would comport with Congress’s goal of encouraging outside professionals to report fraud without fear of retribution.

In Stewart v. Doral Financial Corporation, No. 13-1349, 2014 U.S. Dist. LEXIS 22441 (D.P.R. Feb. 21, 2014), the U.S. District Court for the District of Puerto Rico addressed the standard for pleading protected conduct.  The plaintiff claimed that he was terminated illegally after expressing concerns to the company’s audit committee that certain financial information would not be reported accurately in quarterly filings.  Relying on the Department of Labor’s Administrative Review Board’s (“ARB”) decision in Platone v. FLYi, Inc., 2006 WL 3193772 (Dept’ of Labor Sept. 29, 2006), the company moved to dismiss the plaintiff’s claim for failing to plead that the alleged protected activity “definitively and specifically” implicated the federal laws upon which section 1514A is based.  After Platone, however, the ARB abandoned the “definitively and specifically” standard in favor of a more liberal standard:  that a plaintiff must only plead she had “a reasonable belief” the alleged protected activity that the reported conduct violated applicable federal law.  Sylvester v. Parexel Int’l LLC, ARB Case No. 07-123, 2011 WL 2165854 (Dep’t of Labor May 25, 2011).  Even though the First Circuit already had adopted the “definitively and specifically” standard, see Day v. Staples, Inc., 555 F.3d 42, 56 (1st Cir. 2009), the Doral court ruled that the ARB’s more recent “reasonable belief” standard controlled and that plaintiff’s pleading was sufficient, 2014 U.S. Dist. LEXIS 22441, at *19–24.

Both the Lawson and Doral rulings dramatically broaden the scope of whistleblower liability for public companies and private companies that contract for public companies.  In fact, the dissent in Lawson points out that the Court’s interpretation gives section 1514A a “stunning reach” that will allow babysitters and cleaning staff who work for people employed by a public company to file federal cases claiming retaliation.  And the Doral decision—which echoes the conclusions of the U.S. Courts of Appeals for the Third and Tenth Circuits—allows those claims to survive the pleading stage by demonstrating only that the employee had a reasonable belief that the perceived illegal conduct implicated the federal laws upon which SOX is based.  Lawson and Doral demonstrate that it is vital for public companies and private companies who contract for public companies to have robust reporting policies in place to address employee complaints of misconduct.

Drinker Biddle & Reath LLP filed an amicus curiae brief in the Lawson case on behalf of the National Federation of Independent Business.  That brief advocated that the whistleblower protections of section 1514A not extend to employees of private contractors and subcontractors of public companies.

SEC v. Jacobs May Signal Limit to Duty of Trust or Confidence Required to Prove Insider Trading Based on Misappropriation Theory

To prevail on an insider-trading claim pursuant to Section 10(b) of the Exchange Act and Rule 10b-5 thereunder based on the misappropriation theory, the SEC must prove that the defendant (1) misappropriated material, nonpublic information; (2) had a duty of trust or confidence; (3) breached that duty; (4) purchased or sold securities, or tipped another who purchased or sold securities, on the basis of that information; and (5) knew or should have known that he or she was trading or tipping others on inappropriately obtained information. Dirks v. SEC, 463 U.S. 646, 660 (1983). The SEC has identified three nonexhaustive circumstances that create a duty of trust or confidence; they are (1) when a person agrees to maintain information in confidence; (2) when there is a history, pattern, or practice of sharing confidences and the recipient knows or reasonably should know that the person communicating the information expects the recipient to maintain its confidentiality; and (3) when a person receives material, nonpublic information from his or her spouse, parent, child, or sibling. See 17 C.F.R. § 240.10b5-2(b).

The existence of “a duty of trust or confidence” and the SEC’s attempt to expand that duty beyond the traditional fiduciary relationship have been the subject of many a motion to dismiss. Courts, however, have routinely ruled that a duty of trust or confidence is not limited to traditional fiduciary relationships. For example, in United States v. Corbin, 729 F. Supp. 2d 607 (S.D.N.Y. 2010), the court acknowledged Rule 10b5-2’s presumption of a relationship of trust and confidence between spouses and held that the SEC adequately alleged that a husband and wife had a history of sharing business confidences that the wife obtained about impending acquisitions while working for a communications firm, and that the pair had a “domestic confidentiality policy” of sorts whereby the husband understood he could not share that confidential information. In United States v. McGee, 892 F. Supp. 2d 726 (E.D. Pa. 2012), the court concluded that the complaint adequately alleged a relationship of trust and confidence where the source of the information and the recipient had become friends through Alcoholics Anonymous and also had an agreement of confidentiality through their involvement with that organization. In SEC v. Conradt, 947 F. Supp. 2d 406 (S.D.N.Y. 2013), the Court concluded that the SEC adequately pleaded a relationship of trust and confidence by alleging that two friends over the course of eight months shared confidences regarding family illnesses, personal legal troubles, and work communications describing sensitive client holdings.

But two recent jury verdicts provide some hope to defendants. In SEC v. Jacobs, Case No. 13-cv-1289 (N.D. Ohio), the SEC alleged that Andrew and Leslie Jacobs violated Section 14 of the Exchange Act and Rule 14e-3, which pertains to insider trading specifically in the context of tender offers, and Section 10(b) of the Exchange Act and Rule 10b(5), which pertains to insider trading generally, when Leslie traded on information provided to Andrew by his close friend and brother-in-law, Blair Ramey. According to the complaint, although Ramey did not tell Andrew about the tender offer specifically, he was certain to have understood Ramey’s company was going to be acquired given the nature of the conversation. Ramey requested that Andrew keep their conversation confidential, and Andrew agreed to do so.

Although the jury found Andrew and Leslie liable under Section 14 of the Exchange Act and Rule 14e-3, it did not find them liable under Section 10(b) of the Exchange Act and Rule 10b(5). The distinction between these two claims is crucial—a finding of liability under Section 14 of the Exchange Act and Rule 14e-3 does not require the existence of a duty of trust or confidence while a finding under Section 10(b) of the Exchange Act and Rule 10(b)(5) does.

And, of course, the jury found entrepreneur Mark Cuban not liable for insider trading, even though the Fifth Circuit had concluded that the SEC adequately pleaded Cuban had a relationship of confidence because he agreed to keep confidential material, nonpublic information and also promised not to trade on the information, SEC v. Cuban, 620 F.3d 551 (5th Cir. 2010).

Notwithstanding the expansive interpretation given to the duty of trust or confidence element by the SEC and the courts, the Jacobs and Cuban verdicts serve as a reminder that the jury may not always accept the SEC’s formulation of liability, even when that formulation has been the basis for numerous successful oppositions to motions to dismiss.