A federal court granted an SEC Motion for Summary Judgment against a former law firm clerk charged with participating in an insider trading scheme.

In a Complaint filed in the U.S. District Court for the District of New Jersey, the SEC alleged that a managing clerk at a law firm in New York obtained confidential documents from the firm's computer system concerning pending deals of corporate clients (see previous coverage). The SEC alleged that the clerk gave confidential information to a middleman who then passed the information to a stockbroker. According to the SEC, the middleman, who wrote the illicit tips on post-it notes or napkins, would meet the broker at Grand Central station to pass on the information. To destroy the evidence, the middleman later "chewed up," and sometimes ate, the post-it notes or napkins. The broker pled guilty to two counts of fraud and one count of conspiracy, and paid a $1.4 million penalty to the SEC.

In issuing the Summary Judgment, the Court found that the clerk violated Securities Act Section 17(a) and Exchange Act Sections 10(b) and 14(e), and Rules 10b-5 and 14e-3. He was ordered to pay a civil penalty of $25,000.

In a criminal case brought by the DOJ, the clerk pled guilty to securities fraud and conspiracy to commit securities and tender offer fraud. He was sentenced by the court to 46 months in prison and three years of supervised release, and fined $10,000. The sentence was later vacated by the Third Circuit Court of Appeals. The case was remanded for resentencing.

Commentary / Stephen Weiss

This case is an example of insider trading under the misappropriation theory. Fundamentally, insider trading laws prohibit anyone from trading a security on the basis of material, nonpublic information where there has been a breach of a duty of trust or confidence owed to an issuer of a security, and the trader acted on the basis of the inside information. The Supreme Court has long recognized several theories of insider trading, including the classical theory, the tipper-tippee theory, and the misappropriation theory. The misappropriation theory, as evidenced in this case, occurs when a person, who is not an insider and does not obtain information from the issuer of the security, trades on inside information or conveys that information to a third party to execute a trade. The law firm clerk, although not an insider, had access to material, nonpublic information while working at the firm and breached his obligation of trust to his firm and to the client when he disclosed confidential information. The actions of the clerk, as well as the actions of others involved in the scheme, made for a slam-dunk case.

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