Knowledge, Willfulness, Intent and Motive: Prosecuting and
Defending Mens Rea in Federal Criminal Insider Trading Cases
Brian F. McEvoy
bmcevoy@polsinelli.com
Emma R. Cecil
ececil@polsinelli.com
Since the establishment in 2009 of the Financial Fraud Enforcement Task
Force (FFETF), the DOJ has continued to investigate and prosecute economic crimes
with unprecedented frequency. The federal government’s campaign against
financial fraud has been particularly evident in the area of insider trading, against
which both the SEC and DOJ have taken a historically aggressive stance. In 2014,
the SEC charged 80 people in insider trading cases, while DOJ brought criminal
charges involving insider trading against 20 individuals or entities.1 The U.S.
Attorney’s Office in the Southern District of New York alone has charged 56
individuals with insider trading, and has won convictions in 51 of those cases, since
2009.2 Despite the government’s ardent pursuit of insider trading, cases involving
illegal tipping – which historically have been based on circumstantial evidence,
particularly to establish mens rea – remain difficult to prove.
In order to be establish a violation § 10(b) of the Exchange Act and Rule 10b-5
– in either a criminal or civil insider trading case – the government must prove that
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2
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543184660
http://www.justice.gov/usao/priority-areas/financial-fraud/securities-fraud
Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
the defendant acted with scienter, defined as “a mental state embracing intent to
deceive, manipulate, or defraud.” Aaron v. SEC, 446 U.S. 680, 695-96 (1980). In
insider trading cases based on alleged illegal tipping, scienter requires that the
tippee possess material nonpublic information at the time of the trade, and that the
material nonpublic information be used in the trade. SEC v. Ginsburg, 362 F.3d 1292,
1297 (11th Cir. 2004); SEC v. Adler, 137 F.3d 1325, 1340 (11th Cir. 1998).3
Although possession and use of material non-public information may be
proved through direct evidence – such as testimony from a witness or co-defendant
– that the tipper communicated inside information to the tippee, or that the tippee
received information from the tipper, the government rarely has such evidence.
Instead, the government must rely on circumstantial evidence, which in tipping
The Eleventh Circuit has held that a rebuttable inference of use arises where the
government can show that the defendant possessed knowledge of such inside
information at the time of the trade. Ginsberg, 362 F.3d at 1297. While the court did not
indicate whether such a presumption would apply in a criminal case, the Ninth Circuit
has held that the government in a criminal prosecution has the burden to prove that the
defendant actually used the material non-public information in formulating and
executing a trade. United States v. Smith, 155 F.3d 1051, 1067-69 (9th Cir. 1998) (“Rule
10b-5 requires that the government (or the SEC, as the case may be) demonstrate that
the suspected inside trader actually used material nonpublic information in
consummating his transaction.”); see also SEC v. Truoung, 98 F. Supp. 2d 1086, 1100
(N.D. Cal. 2000) (assuming, without deciding, that the higher evidentiary burden in
Smith applies to a civil enforcement proceeding). The Second Circuit has endorsed, in
dicta, a “knowing possession” standard, noting that “a requirement of a causal
connection between the information and the trade could frustrate attempts to
distinguish between legitimate trades and those conducted in connection with inside
information.” United States v. Teicher, 987 F.2d 112, 119-20 (2d Cir. 1993).
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
cases often comes down to evidence of suspicious timing between tipper/tippee
contacts and profitable trades in the securities at issue.
Numerous cases have addressed the sufficiency of such evidence to prove
violations of § 10(b) and Rule 10b-5 and have held that there must be additional
evidence – something more than mere temporal proximity between contacts and
trades – to support an inference of illegal tipping. This additional evidence is
referred to as a “plus factor,” which, when combined with contacts/trades evidence,
will strengthen the inference of guilt. Thus, while “trading in suspicious amounts or
at suspicious times is probative of bad faith and scienter,” SEC v. Dunn, 2:09-CV2213 (D. Nev. 2011) (citing In re Apple Computer Securities Litigation, 886 F.2d
1109, 1117 (9th Cir. 1989)), “evidence of mere contact with an insider followed by a
trade is not enough to support an inference of liability,” SEC v. Carroll, 9 F.Supp.3d
761 (W.D. Ky. 2014) (citing SEC v. Rorech, 720 F.Supp.2d 367, 410 (S.D.N.Y. 2010)).
See also SEC v. Happ, 392 F.3d 12, 25 (1st Cir. 2004) (“Suspicious trading by itself
cannot suffice to warrant an inference that a trader traded on the basis of material
non-public information.” (quotation marks, alterations, and citation omitted)).
Additional evidence upon which an inference of illegal tipping may be drawn
includes false or inconsistent explanations for the trading, efforts to conceal the
relationship between the tipper and tippee, efforts to conceal the trades, and
uncharacteristic trading activity. See, e.g., United States v. Larrabee, 240 F.3d 18, 21-
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
22 (1st Cir. 2001) (in addition to evidence that tippee traded shortly after receiving a
call from the tipper, there was evidence that tippee’s purchase was nearly twice as
large as any of his previous trades and that tipper and tippee attempted to conceal
their relationship and purchases); Smith, 155 F.3d at 1069 (government may show
use of material non-public information where, for example, “an individual who has
never before invested comes into possession of material nonpublic information and
the very next day invests a significant sum of money in substantially out-of-themoney call options,” or “in other situations in which unique trading patterns or
unusually large trading quantities suggest that an investor had used inside
information”); SEC v. Warde, 151 F.3d 42 (2d Cir. 1998) (while tipper and tippee’s
parallel trading in close proximity to their contacts was not sufficient alone to prove
insider trading, additional evidence implying guilt included that their trading was
“uncharacteristic, substantial and exceedingly risky;” that tipper had attempted to
conceal his trading by using offshore accounts and accounts of others; and that
defendants’ claims that they made investments on the basis of market rumors had
been discredited); Carroll, 9 F.Supp.3d 761 (evidence sufficient from which jury
could infer tipping of material, nonpublic information where, in addition to close
temporal proximity between tippee’s contacts with tipper and his purchase of stock,
tippee was self-described “infrequent trader” with no investment strategy and spent
over 40% of his annual salary on a $60,000 purchase of securities, his largest stock
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
purchase ever); SEC v. Hollier, 6:09-CV-0928 (W.D. La. 2011) (defendant’s
inconsistent statements regarding his trading activity was plus factor that, when
combined with circumstantial evidence of contacts and trades, was sufficient to
preclude summary judgment).
Where this “plus factor” is missing, however, the inference drawn from
contacts/trades evidence amounts to mere speculation, especially where the
defendant provides uncontested innocent explanations for the transactions. In a
recent case out of the Northern District of Georgia, Judge William Duffy found
against the SEC following a two day bench trial on insider trading charges alleging
that the defendant, a former Cisco Systems employee, had traded in Comsys IT
Partners, Inc. (“Comsys IT”) based on material, nonpublic information about the
acquisition of Comsys IT by a competitor, Manpower, Inc. SEC v. Schvacho, 991
F.Supp.2d 1284 (N.D. Ga. 2014). The SEC alleged that the inside information had
been disclosed to Schvacho by the then-CEO of Comsys IT, Larry Enterline, who
was a long-time close personal friend and business associate of Schvacho.
Lacking any direct evidence that Enterline had communicated inside
information to Schvacho, the SEC relied solely on evidence of various telephone
calls that Schvacho had with Enterline, text messages sent between them, and
evidence that they were in the presence of each other at a dinner, during a drive to
Florida and to the airport, and on a sailing trip. The SEC further relied on trades
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
Schvacho made in Comsys stock in close temporal proximity to the time periods
when Schvacho and Enterline communicated or were together, and evidence of the
timing of, and Enterline’s participation in, discussions between Comsys and
Manpower.
The court found that the circumstantial evidence the SEC had offered was
insufficient to prove, even under a preponderance of the evidence standard, that
Schvacho possessed material, nonpublic information about Comsys and used such
information to trade in Comsys stock with scienter. Significantly, the court found
that the SEC’s interpretation of the evidence was contradicted by the credible and
uncontested testimony of Enterline, “a business professional with an unblemished
history of leadership in the private sector,” that he did not and would not disclose
proprietary, inside information to Schvacho. The court also found Schvacho’s
testimony to be believable, despite the SEC’s attempts to discredit it. Also
significant was the court’s emphasis on the complete absence of any direct evidence,
noting that the SEC offered no testimony of the content of any conversation or
communication between Enterline and Schvacho to support any exchange of inside
information to Schvacho, nor did it present any evidence of any text message upon
which it relied at trial. The court found this particularly telling, since text message
content often is available from providers of text messaging services.
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
The court concluded that, in the complete absence of any proof that Enterline
disclosed confidential information to Schvacho, circumstantial evidence of
Schvacho’s contacts with Enterline and subsequent trades was insufficient to prove
liability. To find based on such evidence that Enterline communicated inside
information to Schvacho would, according to the court, require improper
speculation.
The Ninth Circuit similarly held in favor of the defendants in a tipping case
based solely on circumstantial contacts/trades evidence. In SEC v. Goldinger, 1997
WL 21221 (9th Cir. Jan. 14, 1997), a shareholder of Thrifty Corporation received
confidential information from Thrifty’s chairman regarding a potential merger with
Pacific Lighting. The shareholder called Goldinger, her financial advisor, and told
him about the potential merger so that he could give her financial advice when they
met later that day. Shortly after the call, Goldinger stopped a coworker, Cohen, in
the hallway and asked Cohen if he “knew anything about Thrifty,” saying he “had a
client coming in.” Although Cohen replied that he did not, Cohen immediately
researched the company and learned that Thrifty had had heavy trading the week
before. A mere twenty-four minutes later, Cohen placed an order to purchase
Thrifty stock, and made additional purchases after Goldinger told him that Thrifty
stock was underpriced. Cohen told others in the office about Thrifty, who also made
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
purchases. When the merger was announced, the buyers unloaded their stock for a
substantial profit.
The SEC brought suit against Goldinger, Cohen, and the remaining buyers,
alleging that Goldinger had tipped Cohen about the impending merger in their
hallway conversation. On appeal from the district court’s grant of summary
judgment for the defendants, the SEC argued that Goldinger and Cohen’s hallway
conversation created a reasonable inference that more direct tipping about the
merger had taken place.
The Ninth Circuit affirmed, concluding that the circumstantial evidence
offered by the SEC was insufficient to show that Goldinger actually disclosed to
Cohen, and agreeing with the district court that “there is a vast difference between
circumstantial evidence and pure speculation.” Although Cohen had spoken with
an insider who had information about a merger and had engaged in substantial
trading accounting for 7% of the total market volume of the stock immediately
thereafter, there were no other facts in the record showing illegal conduct by the
defendants. Furthermore, in light of Cohen’s unchallenged innocent explanation for
his trading, the fact that he traded in close proximity to his conversation with
Goldinger was merey suspicious, at best.
Finally, in SEC v. Yang, Case No. 12 C 2473 (N.D. Ill. 2014), a jury, following a
six day trial, found the defendant not liable on insider trading charges based solely
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
on circumstantial evidence.4 Having no direct evidence that Yang ever spoke to a
tipper who gave him material nonpublic information about an impending corporate
takeover, the SEC argued at trial that Yang “must have had” inside information
based on the timing and nature of his profitable trades in advance the takeover. This
circumstantial evidence was insufficient for the jury to find that insider trading had
occurred.
As Schvacho, Goldinger, Yang, and other cases make clear, circumstantial
evidence of suspiciously timed trades is often insufficient to prove insider trading,
even in civil enforcement cases where the burden of proving a purely circumstantial
case is less onerous, and particularly where the defendant’s assertions of innocence
are found to be credible. Although the law makes no distinction between the weight
to be given to either direct or circumstantial evidence, these cases suggest that, as a
practical matter, factfinders are less likely to infer insider trading in the absence of
direct evidence, and especially in the absence of a “plus factor” in a circumstantial
case. In criminal cases, where the burden of proof is much higher, juries may be
even more reluctant to find illegal activity based on circumstantial evidence alone.
Given the difficulty of proving insider trading, especially where a “plus factor” is
required, one can expect to see the continued proliferation of court-ordered wiretaps
See http://www.law360.com/articles/501262/jury-clears-chinese-adviser-on-secinsider-trading-claims
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Prosecuting and Defending Mens Rea in Federal Criminal Insider Trading Cases
2015
as powerful, direct evidence of a defendant’s receipt of and intent to trade on
material non-public information.
Brian F. McEvoy is a former Assistant United States Attorney and Health Care Fraud
Coordinator for the Southern District of Georgia. Brian is now a Shareholder at
Polsinelli in Atlanta, Georgia.
Emma R. Cecil is a Health Care Attorney and Litigator practicing at Polsinelli in
Atlanta, Georgia.
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