On January 7, 2014 the SEC lost an insider trading bench trial before Judge William Duffey of the U.S. District Court for the Northern District of Georgia. In a thorough opinion, Judge Duffey found the SEC’s case to be entirely circumstantial, founded on no more than a pattern of trades that were made in close proximity to communications between the purported tipper and tippee. This case shows how difficult insider trading claims are to prove, especially without wire taps, and may give the Commission pause in bringing cases to trial that rest on such circumstantial evidence.
On trial was Larry Schvacho, a retiree who spent much of his free time investing. The SEC alleged Schvacho had misappropriated material, nonpublic information from Larry Enterline, a long time friend, who was then CEO and director of Comsys IT. Although Schvacho had traded in Comsys stock for many years, the SEC’s case focused on trades Schvacho made during the run-up to an acquisition of Comsys by Manpower in early 2010. As the SEC established at trial, Schvacho and Enterline had repeatedly communicated and socialized together during the period, and there were numerous phone calls, text messages, car rides, sailing trips, and dinners where Enterline could have given Schvacho information about the acquisition. When news of the acquisition was eventually made public to the market, Schvacho made over $500,000 on his trades.
As the court put it, “[w]hile facially interesting, this pattern and the other evidence upon which the SEC relies does not prove, by a preponderance of the evidence, that Schvacho misappropriated insider information.” Indeed, Schvacho and Enterline were close friends and spoke quite frequently about all matters, including their personal lives and business dealings unrelated to Comsys. The SEC did not introduce any evidence, whether expert or otherwise, to show that the frequency of communications between Enterline and Schvacho were any different during the period in question than in prior periods. Nor does it appear to have introduced evidence that Schvacho’s trading pattern in Comsys stock was any more frequent or unusual than in prior periods.
Moreover, the SEC failed to introduce the content of any communications between Enterline and Schvacho. While this is understandable for phone communications, it is not clear why the SEC failed to introduce any text messages.
The court gave serious credit to Enterline’s testimony at trial. Enterline, who by this point was no longer on friendly terms with Schvacho, testified convincingly that he had never divulged information about the transaction and maintained strict practices as CEO to protect inside information. Notably, the SEC did not seek to discredit or attack Enterline at trial.
At bottom, while the SEC’s evidence was sufficient to show that Schvacho could have had access to material, nonpublic information, it was not enough to demonstrate that he had obtained and traded on it. “Potential access,” the court noted, does not lead to liability under the securities laws. Based on the court’s opinion, then, if the SEC is to rely upon a pattern of communications and trading between tipper and tippee, it must do more to prove misappropriation—it must (i) show an unusual degree of communication beyond the established pattern between tipper and tippee, (ii) establish an unusual trading pattern, and (iii) prove up the content of the communications.