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SEC's Circumstantial Evidence of Insider Trading Fails to Survive Summary Judgment

Friday, January 6, 2012

Susan M. Greenwood | Bloomberg Law SEC v. Garcia, No. 10-CV-05268, 2011 BL 327296 (N.D. Ill. Dec. 28, 2011)

  • Spoliation of evidence requires the bad faith destruction of adverse evidence.
  • Circumstantial evidence of insider trading must rise above mere speculation.
The U.S. District Court for the Northern District of Illinois granted summary judgment to Luis Martin Caro Sanchez and dismissed insider trading claims brought by the Securities and Exchange Commission (SEC) under Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder. Unlike the much-publicized criminal insider trading case against Galleon Group founder Raj Rajaratnam, the SEC had no wiretap evidence to present against Sanchez. Relying on only circumstantial evidence, the SEC could not convince the Court that Sanchez had traded on non-public information.

Call Options Provide Huge Profit

Sanchez, the Court explained, is a Spanish citizen who resides in Madrid. Over two days in August 2010, he purchased call options contacts of Potash Corporation of Saskatchewan, Inc. (Potash), a Canadian company that produces potash, nitrogen, and phosphate for use in fertilizer. Only days after Sanchez's purchases, Potash announced that BHP Billiton Plc made an unsolicited acquisition offer. Potash's stock price increased by approximately 27 percent, and Sanchez sold his options for a profit of almost $500,000.

Was Evidence Lurking on a Destroyed Computer?

Before addressing the substance of the insider trading claims, the Court discussed whether Sanchez's alleged "failure to produce all of his electronically stored information should prohibit summary judgment." In particular, Sanchez "threw away" his laptop computer in December 2010, even though he was directed by court order to preserve all documents and information related to the case. He further installed a software cleaning program on his desktop computer in April 2010 that deleted temporary files, files in the recycle bin, and temporary internet files. According to the Court, if the alleged destruction of evidence was committed in bad faith, it "'may infer from this state of mind that the contents of the evidence would be unfavorable to the party if introduced in court.'" Under Seventh Circuit precedent, bad faith exists when documents are destroyed "'for the purpose of hiding adverse information.'" The SEC, however, failed to produce evidence to permit even an inference that the laptop contained relevant information. "The trashed laptop," the Court said, "is at best tangentially relevant to the SEC's case." While the Court "agree[d] that Sanchez should not have thrown out the laptop after the SEC had requested access to all his hard drives," it could not find bad faith based on "mere speculation that the documents contained adverse information." The deletion of files from Sanchez's desktop computer also did not evidence bad faith, the Court held. Again, there was no indication that Sanchez intentionally deleted files that were relevant to the insider trading case.

When Does Circumstantial Evidence Fail?

Turning to the crux of the SEC's arguments, the Court noted that "it is possible to establish insider trading through circumstantial evidence." After all, the Court reasoned, "you cannot expect a tipper or tippee to voluntarily confess to passing or receiving non-public information. . . ." Because Sanchez's destruction of his laptop and deletion of other files did not support an inference that the computers contained adverse information, the SEC's case rested on (1) Sanchez's allegedly suspicious trades that were a departure from his previous trading history, and (2) his purportedly "'implausible reasons for such trades.'" According to the SEC, Sanchez's trades were suspicious because he made a $500,000 profit even though he had never invested in fertilizer companies, had never traded in options, and had to get authorization to make the trades through his internet brokerage account. The SEC's expert witness also described the trades as "consistent with the trading of an insider who sought to maximize profits based upon non-public knowledge of the takeover target, the announcement month, and the takeover bid." Lastly, the SEC did not credit Sanchez's explanation that he tracked and researched Potash and relied on "technical signals, confirmation of technical signals, and intuition." The SEC's circumstantial evidence, the Court said, fell short when compared to other insider trading cases. In particular, missing from the SEC's case was any indication of where Sanchez could have acquired inside information. Sanchez's source, the Court continued, can be identified only through "impermissible speculation." In addition to its failure to name a source, the SEC also could not "identify any actual information on which Sanchez relied." Although the Court observed that the SEC "raise[d] significant questions about the likelihood of Sanchez's explanations" for his trades, it still was left with a theory "that Sanchez was informed of some unidentified information, related to the proposed acquisition, at an unidentified time, by an unidentified insider, and traded on this unidentified information." Such a "'chain of speculation'" the Court concluded, "'does not raise a material issue of fact for consideration by a jury.'" DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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