SEC Gets a Split Decision in an Insider Trading Case

SEC Gets a Split Decision in an Insider Trading Case

 SEC v. All Know Holdings, Ltd., 11 C 8605 (N.D. Ill. Opinion issued June 10, 2013) is one of the SEC's aggressive insider trading actions, filed initially based largely on "suspicious trading" and information and belief. The case centers on the November 2011 announcement by Pearson plc that it would acquire China based Global Education & Technology Group, Ltd. The SEC filed suit within days of the announcement, charging the company and others with insider trading in violation of Exchange Act Section 10(b).

Clearly missing from the complaint was a key element - a source of the inside information. After litigating the case since it was filed in late December 2011 the SEC faced the same difficulty in responding to summary judgment motions. On one it prevailed. On the other it did not.

Defendant Youghui Zhang, U.S. citizen born in China, and the company, its principal and her friend moved for summary judgment. Mr. Zhang, who did postdoctoral research at Albert Einstein College of Medicine and Columbia, returned to China in October 2010 to start a gene diagnostics company. During the process he again was employed by Global Education, a company founded by his younger brother Yongqi "David" Zahng and his wife, Xiadong "Veronica Zhang. The day before the take-over announcement he purchased 7,900 American Depository Shares of the company on the NASDAQ. Nevertheless, he argued that summary judgment should be granted in his favor since he had no knowledge of the take-over and the SEC failed to identify a source of the inside information.

In opposing the motion the SEC cited five key points:

1) Mr. Zhang's office at the firm is on the same floor as that of his brother and sister-in-law;

2) He had numerous communications during the period with his brother and sister-in-law as well as others at the firm;

3) Defendant Zhang previously had not purchased shares of the company;

4) Mr. Zhang purchased his shares the day before the deal announcement;

5) The share purchase price was more than three times his annual salary.

These points were bolstered by two others. During discovery Mr. Zhang failed to produce any evidence about the "numerous" discussions he had with his brother and sister-in-law during the period despite a request by the SEC. Furthermore, he offered different explanations for his purchase of the shares during the case when questioned under oath.

The court rejected the motion for summary judgment, ruling in favor of the Commission. While the court did not draw an adverse inference against Mr. Zhang for his discovery failures, his access to inside information, failure to provide responses in discovery and differing explanations for his purchases were the key factors.

In contrast, the motion of the "All Know defendants" - the company along with Sha Chen and Zhi Yao - was granted. All Known Holdings is a British Virgin Islands company that is wholly owned by defendant Sha Chen. She is a citizen of the PRC. The company engages in stock trading, frequently taking large positions in select company shares according to the defendants. Zhi Yao is a life long friend of Defendant Chen.

In the days immediately preceding the deal announcement, the firm purchase about $950,000 worth of Global Education shares. While the position was large, after making the purchases the firm had a substantial amount of cash remaining. Those purchases were based on a trading philosophy which focused on acquiring shares of China based U.S. companies which the defendants viewed as undervalued and there research about the company. At the same time Defendant Yao also purchased shares.

In granting the All Knowing Defendants' motion the court pointed to the failure of the SEC to cite any evidence demonstrating that the All Know Defendants knew or had contact with an insider. While the failure to identify an insider was not dispositive, the court termed it "troubling." That failure contrasts with the detailed explanations offered by the Defendants for their purchases.

The court went on to conclude that while the SEC offered substantial evidence, it "fails to address whether the information purportedly procured by the All Know Defendants was disclosed in breach of a fiduciary duty and whether the All Know Defendants knew or should have known of the breach." Absent evidence on this critical point the Commission cannot prevail.

Finally, the court rejected the SEC's claim that what it viewed as obstructive conduct during discovery by the All Know defendants supported it opposition. The SEC never filed a motion bringing this conduct to the attention of the court. If it was an issue, the Commission should have moved for an order compelling discovery and later sanctions if the defendants failed to comply rather than raising this point here. Accordingly, this claim failed to support the Commission's opposition and summary judgment was granted in favor of the All Know defendants.

ABA Seminar: Fifth Annual FCPA Update: Protecting Your Business in the Future: Lessons from the New DOJ-SEC FCPA Guide, June 19, 2013 from 1:00 -2:30 p.m. EST. The discussion will focus on building effective compliance systems and conducting M&A due diligence. Co-moderators: Thomas Gorman and Frank Razzano. Panel: John Buretta, Principal Deputy to the Assistant AG, DOJ; Charles Cain, Assistant Director, FCPA Unit, SEC Division of Enforcement; Catherine Razzano, Assistant General Counsel, General Dynamics Corporation; Steve Siegel, Senior Counsel, Northrop Grumman Corporation; Ryan Ong, Director of Business Advisory Services, U.S. China Business Counsel. Live in Washington, D.C at 600 14th St. N.W., Penthouse (no charge for ASECA members attending live in Washington who pre-register by sending an e-mail to cvitko.diane@dorsey.com). Webcast nationally by the ABA and available in other Dorsey & Whitney offices. For further information please click here.

For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

For more information about LexisNexis products and solutions connect with us through our corporate site.