SEC Insider Trade Investigations Buoyed in Appeals Court Ruling

An appeals court decision reviving an SEC insider trading case removes what targets of such probes saw as a strike against investigations based on data analysis and other circumstantial evidence.

A Virginia federal district court had abruptly ended the trial of Christopher Clark, a mortgage broker accused of trading on illicit tips ahead of Gartner Inc.’s 2017 acquisition of CEB Inc. The court said the US Securities and Exchange Commission’s case was based on too much speculation.

The US Court of Appeals for the Fourth Circuit reversed that decision in a precedential ruling and said a jury should’ve decided the case.

Some defense lawyers interpreted the trial court’s decision as requiring the SEC to have direct evidence of insider trading before bringing an action. The Fourth Circuit removed that newly erected hurdle—and attorneys say that’s likely to encourage the agency.

“The SEC will push this a lot more,” Washington and Lee University law professor Karen Woody said. After the ruling, the scales “still tip in the SEC’s favor in what they’re able to at least try to infer and implicate by circumstantial evidence they can find.”

The case highlights the role that the agency’s surveillance tools have in insider trading investigations. Analyzing volumes of trade records, the agency uses computer software to look for certain patterns that may indicate suspicious trading, as a jumping off point for an investigation.

The SEC didn’t immediately respond to a request for comment.

Data-Driven Cases

Clark’s trades were investigated by the SEC’s Market Abuse Unit (MAU). The SEC alleges Clark learned of the merger from his brother-in-law, who was an accounting officer at CEB.

The unit, which was created in 2010, has broadened the net of insider trading investigations. The unit uses data analysis tools that allow the SEC to identify patterns and connections among traders. It’s a potent tool, said Daniel Hawke, who led the MAU for five years until 2015.

“It gives you leads concerning trades to look at,” Hawke, now a partner at Arnold & Porter, said. And during the investigation, it can be used to “run down leads on other people who may be acting in concert.”

The MAU has been involved in an increasing number of insider trading cases, including one recently against a former FBI trainee who’s alleged to have stolen inside information from his then-girlfriend about a Merck & Co. deal.

The MAU also discovered suspicious patterns that led to SEC charges against former Netflix Inc. engineers, and investigated cousins accused of trading on inside information about companies’ planned Covid-19 partnerships with the government.

Regulators traditionally investigate insider trading by looking for individuals who traded suspiciously around an earnings announcement or other event.

The MAU’s technology combines billions of trade records and analyzes them with various metrics. It considers traders’ patterns and can find people who may be acting together.

Regulators then look for other evidence, such as documents from a trader’s broker and evidence that connects the trader to insider information.

“The SEC’s data analytics are just the starting point for an investigation,” said Tami Stark, a White & Case LLP partner and former SEC attorney. “The SEC first identifies highly suspicious trading and then they start a full-fledged investigation.”

‘Gatekeeper Function’

At trial, an SEC attorney said Clark’s success rate with the trades was “extraordinary,” defying any rational explanation except that he had inside information. But there was no signed confession, wiretap recording, or other direct evidence of insider trading, the attorney told jurors.

Tossing the case mid-way through a December 2021 trial, Judge Claude Hilton in the US District Court for the Eastern District of Virginia said the government was speculating because Clark had been “more successful than he ought to be.”

Defense attorneys had zeroed in on the decision.

“I must admit that, after the Clark decision, I was further emboldened in waving that Clark decision in front of the SEC as to why they would most certainly lose at trial if not beforehand as in Clark,” Perrie Weiner, chair of Baker & McKenzie LLP’s North America Securities Litigation Group, wrote in an email.

After the Fourth Circuit’s ruling, “we’ve lost that gatekeeper function,” said Weiner, who represents hedge funds.

The appeals court didn’t decide whether Clark actually engaged in insider trading, sending the case back to the district court for additional proceedings. The court’s opinion, issued Feb. 23, said that Hilton should’ve let the jury decide, rather than cut off the trial.

Clark’s attorney, Mark Cummings of Sher Cummings & Ellis PLLC, said in a statement that they were disappointed with the court’s ruling.

“After over 5 years and a declination by the DOJ, the SEC brought this case merely on suspicious trading,” Cummings said. “The witnesses who testified at the trial overwhelmingly demonstrated Mr. Clark’s innocence and we look forward to the re-trial because the evidence will not change.”

Return to Normal

Hilton’s decision was unusual.

Courts generally have been receptive to the SEC’s use of data analytics and circumstantial evidence, attorneys said. The Fifth Circuit in August rejected arguments that the agency needed to introduce direct evidence of cherry-picking to prove a case against a Louisiana investment advisory firm.

Statistical evidence “can be useful in securities cases, and its admission is no novelty,” the appeals court said.

The SEC argued to the Fourth Circuit that ruling for Clark would require the court to adopt a “new evidentiary standard contrary to the well-recognized principle that the ‘government may meet its burden’ in an insider trading case through ‘circumstantial evidence alone.’”

The SEC said there was compelling evidence that Clark traded on confidential information. It alleged that Clark emptied his wife’s retirement account, borrowed money, and took out a loan to finance his investments. And he bought call options on CEB stock, the agency alleged, a type of option that becomes more valuable when a stock rises but is also risky.

Such behavior raises red flags among regulators. Woody said it was a “classic case” the SEC would bring.

“The Fourth Circuit opinion is kind of taking us back to where we thought the world was before as far as what the SEC has to show,” said Jeremiah Williams, a Ropes & Gray LLP partner and former SEC attorney.

Pattern Evidence

Without the help of someone who participated in a scheme, insider trading cases can be difficult to prove without direct evidence, attorneys said. But most cases don’t go to trial.

Statistical evidence of trading patterns is sometimes overwhelming, driving defendants to settlements, attorneys said.

“Pattern evidence strengthens the SEC’s hand,” Hawke said.

Some defense lawyers argue the SEC can at times be too aggressive in bringing insider trading cases when algorithms pick up unusual trading activity. Weiner said the threat of suspensions or bars, in particular, can push some funds and traders into settlements.

Others suggested Clark’s case might present a learning opportunity for the commission.

If regulators are too focused on data when presenting their case in court, it can come at the expense of other facts, attorneys said. The agency appears to have refined its approach on appeal, directing the Fourth Circuit’s attention to emails and other evidence. Now, regulators have a chance to shore up their presentation and address weaknesses in a retrial.

“This is almost a gift to the commission,” said O’Melveny & Myers LLP partner and former SEC attorney Jorge deNeve, adding that the “defense will have a harder job than they did the first time around.”

The case is SEC v. Christopher Clark, 4th Cir., No. 22-1157, 2/23/23.