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From Securities Regulation Daily, July 11, 2014

Wylys cleared of insider trading charges

By Anne Sherry, J.D.

The Wyly brothers’ agreement between themselves to sell the company they had cofounded, Sterling Software, was not material information subjecting them to insider trading liability for subsequent swap transactions. While the Wylys would have controlled the sell side of any deal, they had not reached out to a buyer, and the court had to draw a line “between inchoate desire and something more material” (SEC v. Wyly, July 10, 2014, Scheindlin, S.).

Insider trading claim. In May, the SEC secured a jury verdict against the Wylys on nine of ten claims. The remaining claim, alleging insider trading regarding several 1999 equity swaps, was not tried to the jury because the SEC was time-barred from seeking civil penalties. The court yesterday dismissed this claim with prejudice because the alleged inside information was not material.

Specifically, that information was both brothers’ knowledge that Samuel Wyly wanted to sell Sterling Software. Although Samuel Wyly decided to sell the company in the summer of 1999, the Wylys did not take any affirmative steps towards pursuing a sale until November 1999, the month after the equity swaps that the SEC challenged. The brothers’ agreement, as chairman and vice-chairman of the company, to sell Sterling Software was not material as a matter of law, the court concluded.

Materiality. The SEC bore the burden of proving that the Wylys’ desire to sell Sterling Software constituted material nonpublic information on the dates they made their trades, but the record was insufficient to justify that conclusion. The court cited cases establishing that a buyout is an important event for a small company and may become material earlier than would otherwise be the case, and that information about a merger that originates from an insider “takes on an added charge.” Nevertheless, Second Circuit precedent also established that information that is so general that its recipient “is still undertaking a substantial economic risk that his tempting target will prove to be a white elephant is not material.”

While investors would probably want to know if a company’s chairman and vice chairman had agreed to sell the company, a fact is not material merely because an investor would like to know it, the court noted. Furthermore, while the Wylys controlled a majority of the board, there was no evidence that they acted to exert that control to pursue a sale prior to November 1999. Critically, there was no evidence that the Wylys approached an investment firm, potential buyer, or other necessary third party about selling the company. Contact with a third party is not requisite to materiality, the court stressed, but the facts in the case were thin without it.

Finally, the court noted that accepting the SEC’s theory in this case “would mean extending the definition of materiality to cover the thought process and personal desires of any director or shareholder with substantial control over a company. While it is difficult to draw the line between inchoate desire and something more material, that line must be drawn somewhere.”

The case is No. 10-cv-5760.

Attorneys: David J. Gottesman for the SEC. Donald P. Lan , Jr. (Kroney Morse Lan PC) for Samuel E. Wyly.

Companies: Sterling Software; Sterling Commerce

MainStory: TopStory Enforcement FraudManipulation NewYorkNews

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