2d Circuit: Insider trading conviction based on NDA upheld - 07 April 2021

While the defendant and the company in which he traded dealt at arm’s length, his agreement to keep information confidential was enough to establish the fiduciary duties that in turn supported a guilty verdict for insider trading.

The Second Circuit Court of Appeals upheld the conviction of a defendant who tipped information about a company that his fund was acquiring. Despite an arm’s-length relationship between the defendant and the company his fund was in talks to acquire, there was a basis for insider trading liability because the defendant signed nondisclosure agreements that created a duty not to trade on information he learned in the negotiations. The court also found that there was sufficient evidence that the defendant tipped an associate and did so with the intent to benefit the tippee (U.S. v. Chow, April 6, 2021, Kearse, A.).

Negotiations and tipping. The defendant founded Canyon Bridge Capital Partners, Inc., which in 2016 negotiated to acquire Lattice Semiconductor Corporation. During the merger negotiations, the defendant executed nondisclosure agreements on behalf of his firms, with his counterpart at Lattice signing on behalf of that company. The defendant thus agreed "not to disclose, commercialize, or use any Proprietary Information of the other Party for any purpose, except to evaluate and/or engage in discussions regarding the potential business transaction." The company representatives also used code names for themselves, met in hotel conference rooms rather than at Lattice’s offices, and included reminders of the nondisclosure agreements in their correspondence and presentations to each other. (The merger never took place; the Committee on Foreign Investment in the United States informed Lattice that it would not approve the deal because it believed Canyon Bridge was still a Chinese entity and would have too much control and influence over Lattice’s intellectual property).

In connection with the merger announcement, FINRA flagged a list of people for suspicious trading activity, including one person eventually discovered to have amassed more than seven million shares of Lattice in the four months prior to the merger announcement. The accounts sold half their shares immediately after the announcement, profiting by about $5 million. Canyon Bridge informed FINRA that this individual was a social acquaintance and former business colleague of the defendant. An investigation eventually found a number of emails, meetings and phone calls between the two, along with share purchases that corresponded to the dates of those communications. After a trial, a jury convicted the defendant of one count of conspiracy, one count of securities fraud, and six counts of insider trading; the court sentenced him to three months in prison and two years of supervised release.

Appeal. The defendant argued on appeal that the government failed to prove a duty he owed to Lattice and that the district court erred in instructing the jury that the nondisclosure agreements created such a duty as a matter of law. The court disagreed, however, citing the misappropriation theory of insider trading under which Exchange Act Rule 10b5-2 finds a duty of trust or confidence whenever a person agrees to maintain information in confidence. Under Second Circuit precedent, individuals who enter into such agreements are "temporary insiders" subject to liability when the other elements of insider trading are established. The appeals court therefore rejected the defendant’s assertion that the misappropriation theory cannot be applied when the individual and company have an arm’s-length relationship.

As for the personal benefit element of insider trading, the court noted its holding in Martoma that this element is present when there is evidence that the tipper intended to benefit the tippee, a low evidentiary bar. In the record here, Canyon Bridge’s response to FINRA’s inquiry disclosed that the defendant had asked the tippee to provide him with analyst reports on the semiconductor industry and to recommend possible limited partners for the venture. The tippee provided information on manufacturers, connected the defendant with investment bankers and an analyst, and sent gifts of wine and cigars. "The repeated confluence of the communications and large purchases of Lattice stock the first of which followed contact initiated by [defendant] after a months-long period of no communication between the two men—also permitted the inference that [defendant] intended that [tippee] would make purchases of Lattice shares based on the information he received," the court reasoned.

The case is No. 19-0325.

Attorneys: Won S. Shin, United States Attorney's Office, for the U.S. Paul D. Clement (Kirkland & Ellis LLP) for Benjamin Chow.

Companies: Lattice Semiconductor Corporation; Canyon Bridge Capital Partners, Inc.; China Reform Fund Management Co., Ltd.

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