Post-Disclosure Agreement Not To Trade May Be A Basis For Liability Under The Misappropriation Theory

The SEC is locked in an insider trading battle against Leon Cooperman (“Cooperman”), a well-funded and shrewd financier. Mr. Cooperman heads Omega, a registered investment advisory firm that provides investment advice to Omega’s hedge funds, institutional clients, family accounts, and his off-shore tax deferral account. The SEC alleges that Cooperman committed insider trading under the misappropriation theory in connection with the purchase of Atlas Pipeline Partners, LP (“APL”) stock.

Background

Cooperman held a $46 million stock position in APL throughout most of 2009. His stake amounted to approximately 9%. Cooperman reduced his APL holdings during the first half of 2010 because APL had underperformed in 2009. Cooperman developed a close relationship with senior executives at APL (“Executive”) while he was one of the company’s largest shareholders. 

The SEC’s complaint alleges that on July 7, 19, and 20 of 2010, an APL executive told Cooperman that APL was negotiating the sale of its Elk City operating facility for approximately $650 million. The contemplated sale was material nonpublic information (“MNPI”). During one of the phone calls, the SEC alleges that Cooperman expressly agreed “that he would not and could not use the confidential information to trade APL securities.” Nevertheless, several accounts associated with Cooperman and Omega purchased APL stock between July 7 and July 19, 2010, and between July 21 – 27 after Cooperman learned that APL’s board would meet on July 27, 2010 to approve the transaction. The Cooperman accounts netted profits in the aggregate amount of $4.09 million after APL announced the transaction on July 27, 2010. 

Both sides agree that under the misappropriation theory, a corporate outsider is civilly liable when he trades a company’s securities on the basis of MNPI in breach of a duty of trust and confidence owed to the source of the information. The SEC contends that Cooperman is liable under the misappropriation theory of insider trading because after the APL executive told Cooperman about the Elk City transaction, Cooperman promised the Executive that he would not trade in APL stock. Cooperman’s promise created a duty of trust and confidence when he made the promise. As such, Cooperman “misappropriated” the information about the Elk City transaction and engaged in insider trading before one or more purchases of APL stock.

Cooperman moved to dismiss the SEC’s complaint, pursuant to Rule 12(b)(6), for failure to plead Section 10(b) and Rule 10b-5 claims with particularity. Cooperman contends that the SEC did not state when he agreed to avoid trading on the confidential information that the APL Executive provided. Cooperman argued that since he allegedly promised not trade APL stock after he received the confidential information, he did not owe the Executive a duty of trust and confidence at the time he received the information. 

The Court concluded that the agreement did not need to precede the disclosure, and found support for its finding in the regulation, case law, and legislative intent. First, the Court noted that under Rule 10b-5 a “duty of trust or confidence exists . . . whenever a person agrees to maintain information in confidence” (emphasis added). 17 C.F.R. § 240.10b5-2(b)(1). Rule 10b-5 places no limit on when the parties create the agreement. 

Second, the Court sided with the SEC that the case law applying the misappropriation theory does not require an agreement not to trade precede the disclosure of confidential information.¹ The Court rejected Defendant’s suggestion, gleaned from the same cases as the SEC and others, that a duty of trust and confidence must precede disclosure.² The Court concluded that the cases Defendant cited “frame the issue as one involving reliance, but they do not mandate that where a relationship of trust and confidence is based on an agreement rather than a pre-existing relationship of trust, the exchange of information must be made in reliance on that agreement.” Each of the cases cited by the parties, however, arguably involved instances where the insider and outsider had a pre-existing relationship of trust and confidence, and an agreement was made simultaneous with or proximate to the disclosure. Thus, neither side presented compelling judicial support regarding whether an agreement not to trade must precede receipt of MNPI. 

Third, the Court supported the SEC’s interpretation that “Section 10(b) and Rule 10b-5 are to be construed broadly, not technically,” and that the securities laws are intended, in part, to eradicate deception from the securities markets. The Court found that misappropriation theory may encompass post-disclosure agreements, and concluded that its finding is not inconsistent with the congressional intent for securities laws to target exactly the type of deception in which Cooperman engaged. The Court also highlighted that Defendant’s position would enable participants to get a “free pass for a well-timed deception” by obtaining MNPI before entering into an agreement and trading on this information without the prospect of being culpable for the misuse of MNPI.³ 

For these reasons, the court concluded that the SEC’s allegation that Cooperman traded APL securities following one of the three calls in which an APL executive disclosed MNPI about the $650 million transaction, and Cooperman at some point agreed not to trade on that information, sufficiently pled the “who, what, when, where, and how” concerning Defendants’ insider trading, giving rise to a plausible misappropriation claim. 

Practical Considerations

This case was decided at the motion to dismiss stage and the SEC merely had to present evidence that its complaint pled a plausible claim. The ruling raises concerns, however, about when liability attaches in a misappropriation case. The Court concluded there is no time limit after disclosure when the agreement needs to be made. However, the Court’s reasoning and discussion of any nuances regarding the timing of the agreement is thin. For example, the Court did not articulate whether Cooperman has exposure for all of the trades or only the trades made after the purported agreement not to trade.⁴ 

Regulators review the circumstances around trades with 20/20 hindsight. It is possible that a regulator will seek to impose liability on an insider with whom a trader has a history, pattern, or practice of sharing confidences, and, to avoid tipper/tippee liability, the insider will manufacture an agreement not to trade to avoid liability. Until this case is decided on the merits, the Court’s conclusion that post-disclosure agreements may create liability under the misappropriation theory provides incentives for recipients of confidential information to have objective evidence, such as a memorandum to file or a confirming e-mail, that the insider did not limit the trader’s use of the information. 

¹ See SEC v. Yun, 327 F.3d 1267 (11th Cir. 2003); SEC v Sargent, 229 F.3d 68 (1st Cir. 2000); SEC v Lyon, 605 F. Supp. 2d 531 (S.D.N.Y. 2009). 
² See Untied States v. Willis, 737 F. Supp. 269 (S.D.N.Y. 1990); United States v. Reed, 601 F. Supp. 685 (S.D.N.Y. 1985); SEC v. Talbot, 430 F. Supp. 2d 1029 (C.D. 2006). 
³ See the attached chart: 

⁴ The SEC’s pleading in this case is in stark contrast to its pleading in SEC v. Cuban, in which the SEC identified when the call between Mr. Cuban and the CEO occurred, and there were memoranda that referenced Mr. Cuban’s agreement not trade on the company’s security. The jury acquitted Cuban, in part, because the CEO refused to appear at trial. Like Mr. Cuban, Cooperman is a well-funded opponent. Practitioners will be watching closely to see how this case is resolved on the merits.