SEC v. Khan: Insider Trading and the Need for Specificity

In September 2010, the SEC brought an insider trading case against Dr. Bobby Khan (“Dr. Khan”).  See  SEC v. Khan, No. 10-cv-02865 (N.D. Ga. Oct. 10, 2010).  The defendant filed a Motion to Dismiss both claims brought by the Securities and Exchange Commission (“SEC”).  Dr. Khan alleged an assortment of pleading deficiencies and sought dismissal under F.R.C.P.12(b)(6).

According to the SEC's complaint, Dr. Khan has a "personal and business relationship" with an officer at Sciele Pharma, Inc. (“Sciele Officer”). The two men "had a history and practice of sharing confidential information with one another, with the expectation that each would maintain the confidentiality of the information received and not misuse it." 

On May 14, 2008, the Sciele Officer allegedly learned of interest by Shionogi & Co., Ltd. (“Shionogi”), a Japanese pharmaceutical company, in acquiring Sciele.   On May 16, Dr. Khan and the Sciele Officer had dinner together and the complaint asserts that Dr. Khan learned that Shionogi had a “strong interest in acquiring Sciele.”  Dr. Khan sent the Sciele Officer an email on May 18 that stated: “[h]ad a great dinner with you on Friday[,] and I wish you all the best with the potential buyout of Sciele.” 

Sometime after the dinner (Defendant asserts that the sales occurred three months later), Dr. Khan purchased 4,000 shares of Sciele Pharma.  Shionogi announced a tender offer for Sciele on September 1.  On October 14, Dr. Khan sold his Sciele shares for a profit.  Thereafter, the SEC alleged violations of Rule 10b-5 and Rule 14e-3 of the Securities Exchange Act of 1934. 

Dr. Khan argued the facts alleged by the SEC failed to establish any theory of insider trading.  Under Ashcroft v. Iqbal, to survive a motion to dismiss, a plaintiff “must plead sufficient factual matter” that is plausible and allows for a reasonable inference that the defendant violated the law.  Rule 9(b), furthermore, requires a party to “state with particularity the circumstances constituting the fraud.”  Here, Dr. Khan argued the complaint only alleges insider trading in “conclusory fashion” and does not provide specific facts allowing an inference of insider trading. 

The Defendant asserts that the facts do not give rise to an inference of insider trading.  The only facts alleged to show insider trading were a dinner, a 13 minute phone call, and an email sent by Dr. Khan after the dinner.  As the brief asserted:

• the SEC has attempted to skate on inference.  That inference -- that two friends and business associates must have engaged in illegal conduct because they had dinner together -- is far outweighed by opposing inferences that they discussed other subjects since they were friends, and since the announced purpose of the dinners was to discuss a business other than the one that is the subject of the Complaint.

Defendant asserts that the complaint does not identify whether the claim for insider trading is based upon the "classical theory" or misappropriation.  With respect to the classical theory, insider trading can occur when an outside investor inherits an obligation to shareholders because the information was received from an insider. 

Under Dirks v. SEC, however, this theory is applicable “only when the insider has breached his fiduciary duty to shareholders by disclosing information to the [outsider] and [the outsider] knows or should know that there has been a breach.”  Here, Dr. Khan argued the complaint contained no allegations that Sciele Officer breached a duty to shareholders by providing information to Dr. Khan; therefore, an essential element to prove insider trading is missing and this theory fails.   

With respect to the misappropriation theory of insider trading, U.S. v. O’Hagan imposed liability when an outsider “misappropriates confidential information . . . in breach of a duty owed to the source of the information.”  Such a duty can arise from a fiduciary relationship or a similar relationship of trust and confidence.  Here, the only relationship alleged is friendship.  Dr. Khan argued this relationship does not indicate a fiduciary duty, and therefore the misappropriation theory must fail.  See Brief, at 30-31 ("in the absence of a fiduciary relationship, Dr. Khan cannot be charged with insider trading under the misappropriation theory based upon information he received from the Sciele Officer.").

Dr. Khan, therefore, moved to dismiss the Rule 10b-5 and Rule 14c-3 claim for failure to state a claim because of pleading deficiencies within the complaint. 

The primary materials for this case may be found on the DU Corporate Governance website.