SEC Loses Insider Trading Claim: Not Material/No Personal Benefit

In SEC v. Anton, III, Civil Action No. 06-2274 (E.D. Pa. Decided April 23, 2009), the court concluded that the SEC failed to prove its claim that defendant Frederick W. Anton, III, as Chairman of PMA Capital Corporation’s board of directors illegally tipped outsider and former company employee David L. Johnson. Specifically, the court concluded that the Commission failed to establish that Mr. Anton knew information regarding a reserve increase and dividend elimination the SEC claimed he told to Mr. Johnson, that the information about the reserves was not material and that the “personal benefit” test had not been met. Mr. Johnson had previously settled with the Commission. SEC v. Johnson, Civil Action No. 05-CV-4780 (E.D.Pa. Sept. 7, 2005) (settled with consent injunction and agreement to pay disgorgement, prejudgment interest and penalty of over $786,000, see Lit. Rel. 19363, Sept. 7, 2005).

In 2003, PMA Capital was an insurance holding company. Mr. Johnson, as a retired former employee, was a sophisticated investor who closely followed the stock of the company. In April 2003, David Johnson realized that the company would have to add to its reserves. Earlier in the year, Best had reduced the rating on the company from A to A-minus. By the summer of that year, Mr. Johnson began to diversify his stock holdings.

In late October 2003, Credit Suisse First Boston issued an analyst report on the company reducing its from “neutral” to “underperform.” The report explained that the company’s recent performance had been disappointing and that it would likely have to add to its reserves. Shortly after the Credit Suisse report was issued, Mr. Johnson telephoned John W. Smithson, President and CEO of PMA to verify its facts. Mr. Johnson confirmed that the report was factually accurate. Mr. Johnson then called Frederick Anton at his office. Following that telephone conversation Mr. Johnson sold a portion of his company stock and advised his son and daughter to sell their shares. Overall, Mr. Johnson avoided a loss of about $325,305 when the company announced that significantly more reserves were required and that the dividend would be eliminated. His son avoided a loss of $56,028 while Mr. Johnson’s daughter chose not sell her shares.

In its findings of fact, the court determined that there was no credible evidence regarding what Messrs. Johnson and Anton discussed in their telephone conversation. Although Mr. Johnson testified three times about the matter and at one point said he and Mr. Anton were friends and that during the conversation he learned the dividend would be reduced this testimony, the court refused to credit his testimony, finding it not credible. In fact the record demonstrated that Mr. Anton did not know about the dividend reduction. The record also established that while Mr. Johnson had known Mr. Anton for about 35 years, that their relationship was at best a business one rather than friends.

The court also concluded that Mr. Anton’s testimony was also not credible. In his SEC testimony, he largely stated he did not remember the events about the conversation. The court thus concluded it was unlikely that he would later recall the conversations despite what Mr. Anton claimed in testimony.

The circumstantial evidence regarding the increase in the reserves suggests that Mr. Anton was not aware of the amount of the increase at the time of the conversation, according to the court. Earlier in 2003, the company had made initial determinations regarding a possible increase. No final decision had been made at that time. After those reports, Mr. Anton began preparing for retirement. Although he remained in his position, there was no evidence that he was aware of subsequent internal reports demonstrating the amount of the necessary increase. Accordingly, the court found that Mr. Anton did not know the amount of the increase or if in fact the company made a final determination on the point.

The court went on to conclude that the SEC failed to establish that the information known to Mr. Anton was material. The SEC established that information about the dividend and the increase in the reserve together would be material. The Commission failed however, to establish that information about the reserve alone would be material. Citing Elkind v Liggett & Myers Inc., 635 F.2d 156, 166 (2nd Cir. 1980), the court concluded that “information PMA RE would be increasing its loss reserves, unaccompanied by any quantification, and in the context of the information publicly available, cannot be considered material information.” In this regard, there is no allegation by the SEC that Mr. Anton furnished information regarding the extent of the reserve increase.

Finally, the SEC failed to establish that Mr. Anton benefited from the alleged disclosure. While the Commission conceded that Mr. Anton did not share in the results of the trading, it claims he received a gift and that this is sufficient. The court rejected this contention finding: “Considering the nature of their relationship, it is unlikely Anton would have provided Johnson inside information as a gift. The testimonies of both Anton and Johnson support the conclusion they were not friends. To Anton, Johnson was no different from any other former employee shareholder and Anton did not consider Johnson a friend. Both also testified they had no social or personal relationship . . . ”