Decision to Charge Golfer Phil Mickelson as a “Relief Defendant” in Recent Insider Trading Action Highlights the Impact of United States v. Newman on Insider Trading Enforcement
05/31/2016When a Second Circuit panel in December 2014 reversed the convictions of two portfolio managers in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), many believed that the decision, which held that to be liable for insider trading a tippee must know that a tipper made a gift of inside information or disclosed it in exchange for a personal benefit, would make it more difficult to convict “remote tippees,” or tippees multiple steps removed from the source of the tip, of insider trading. Criminal and civil actions brought last week against former Dean Foods CEO Thomas Davis and gambler William Walters, which included a civil claim against golfer Phil Mickelson as a “relief defendant,” suggest that the DOJ and SEC are reluctant to charge a remote tippee absent concrete evidence that the tippee knew the circumstances of the tip, but that the SEC may be pursuing a new enforcement strategy that nevertheless aims to force remote tippees to disgorge their profits.
Insider trading cases brought in the wake of Newman have generally involved charges against closely connected tippers and tippees who trade in advance of earnings or transaction announcements. The DOJ and SEC’s cases against Davis and Walters are consistent with this trend. Indictment, United States v. Walters, Complaint, SEC v. Walters, Civil Action No. 1:16-cv-03722 (S.D.N.Y. May 19, 2016). According to the indictment and the complaint, from 2008 through 2012, Davis repeatedly disclosed inside information to Walters before multiple Dean Foods corporate announcements, including quarterly earnings releases and the spin-off of a subsidiary. Walters allegedly gave Davis a benefit in exchange for the tips by loaning Davis $1 million, and reaped approximately $40 million from the illicit trades. These allegations describe an almost cut-and-dried case of insider trading; indeed, Davis has already pled guilty and is cooperating against Walters.
The treatment of Mickelson, however, suggests changes in enforcement, perhaps spurred by Newman. Both the indictment and complaint allege that in July 2012, Walters and Mickelson repeatedly spoke by phone and exchanged text messages shortly before Mickelson (who had never bought shares of Dean Foods before) bought, partially on margin, 200,240 Dean Foods shares, a $2.4 million position, using three different brokerage accounts. Dean Foods announced the spin-off less than a week after Mickelson’s purchase, and Mickelson, who allegedly owed approximately $1 million in gambling debts to Walters, reportedly sold the shares the day after the announcement and reaped $931,000 in profits. But Mickelson was not charged criminally or civilly with any wrongdoing. Under Newman, to prove that Mickelson engaged in insider trading, the DOJ or SEC would need to show that Walters passed to Mickelson inside information he received from Davis and that Mickelson traded on that information while knowing, or consciously avoiding knowing, that Davis received a benefit for disclosing it. The decision not to pursue these allegations suggests that the government had concerns about whether it could show what was required by Newman, and decided to make a more conservative charging decision as a result.
Instead, the SEC named Mickelson in its complaint against Davis and Walters as a “relief defendant.” A “relief defendant” is a person named in a civil litigation who is not accused of wrongdoing, but who allegedly received property that was originally obtained illegally and to which that person has no legitimate claim. A complaint against a relief defendant generally asks a court use its equitable powers to order the relief defendant to disgorge the property in question, either under the law of constructive trusts or unjust enrichment. In general, to obtain an order of disgorgement under such a theory, the moving party must establish by a preponderance of the evidence that the relief defendant was enriched and that “the circumstances dictate that, in equity and good conscience, the [relief] defendant should be required to turn over its money to the plaintiff.” SEC v. Antar, 831 F. Supp. 380, 402 (D.N.J. 1993).
The SEC’s decision not to bring an insider trading claim against Mickelson is especially interesting because while the DOJ would have been required to show that Mickelson committed insider trading “‘willfully,’ i.e., knowingly and purposely,” the SEC would only have had to show that Mickelson “committed the offense recklessly, that is, in heedless disregard of the probable consequences.” S.E.C. v. Payton, 97 F. Supp. 3d 558, 559 (S.D.N.Y. 2015). Indeed, in February 2015, an SEC insider trading complaint against two traders survived a motion to dismiss after the judge focused on that very issue. If charged, Mickelson would have had to argue that he was not recklessly disregarding potential insider trading when he made a $2.4 million investment at a moment’s notice in a company in which he had never invested before (and an investment that he immediately sold) solely on the advice of a friend.
By naming Mickelson as a relief defendant only, the SEC was able to seek the bulk of the remedies it would have sought had it brought a claim against him for insider trading, with a still lower burden; it could seek disgorgement and pre-judgment interest, but bypassed penalties. Whether the SEC would have been able to meet its lowered burden against Mickelson as a relief defendant will not be tested because Mickelson agreed to a settlement with the SEC, and the decision to charge Mickelson in this way may well have been the result of extended negotiations. Nevertheless, it could also reflect a blueprint for how future SEC charges against remote tippees are brought or settled.CATEGORY: Criminal Enforcement Matters