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The Wages of Sloppy Thinking: Re-Litigation

July 23, 2013

shutterstock_10584919On Monday, the Seventh Circuit Court of Appeals reminded the SEC to thoroughly think through issues before presenting novel theories of liability. As the SEC learned, the consequence of failing to do so is re-litigation.

In one of the few instances in which the SEC has brought insider trading claims in connection with a mutual fund redemption, the Commission claimed that a mutual fund executive redeemed fund shares while in possession of material non-public information. According to the SEC, Jilaine Bauer, the former general counsel, chief compliance officer, and chair of the pricing committee of Heartland Group, Inc., an investment company, and Heartland Advisors, Inc., an investment adviser, redeemed shares in a Heartland Group bond fund while being aware of liquidity and pricing issues relevant to the fund. View the SEC’s press release announcing its charges against Bauer and others here.

The district court entered summary judgment in favor of the SEC based on the parties’ stipulation that Bauer was an insider who possessed nonpublic information at the time she sold the shares at issue, and its findings that no genuine issue of fact existed regarding the materiality of the information in Bauer’s possession and her scienter.

On appeal, the Seventh Circuit notes that the SEC’s case against Bauer fails to fall neatly in to either of the two theories of insider trading: the classical theory and the misappropriation theory. As Bauer argued, and the SEC apparently conceded, the classical theory of insider trading cannot apply here. Because her counterparty, the bond fund, had access to the same information Bauer had, it could not be duped. The SEC then took refuge in the misappropriation theory of insider trading. But as the Seventh Circuit noted, that theory was never argued before the district court. It chastised both the SEC and Bauer for failing to alert the district court to the novelty of the issues involved; no federal court has opined on the applicability of insider trading prohibitions to the trading of mutual fund shares.

In fairness to both Bauer and the district court, the Seventh Circuit concluded that the matter must be remanded. In doing so the Seventh Circuit made one last cautionary observation to the SEC. How, the Court asks, can Bauer be considered an outsider under the misappropriation theory of insider trading given the investment adviser’s deeply entwined role as sponsor and external manager of the fund?

Indeed, since the parties stipulated that Bauer was an insider it could be argued that the SEC cannot assert its misappropriation theory at all. And since the Seventh Circuit considered the SEC’s failure to brief the classical theory of insider trading on appeal as a waiver of that issue, how will the SEC be able to proceed at all?

View the Seventh Circuit’s opinion here.


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