SEC Loses Four More High-Profile Trials Where it Relied on Circumstantial Evidence and Questionable Materiality Arguments to Prove Insider Trading and Fraud


The illusion that the SEC always wins in Court has been shattered by four high-profile SEC trial losses in the last two months:  SEC v. Steffes, 10-cv-6266 (N.D. Ill., Jan. 27, 2014), SEC v. Schvacho, 12-cv-2557 (N.D. Ga. Jan 7, 2014), SEC v. Jensen, 11-cv-5316 (C.D. Cal. Dec. 10, 2013), and SEC v. Kovzan, 11-cv-2017 (D. Kan., Dec. 4, 2013).  These losses - after the notorious Mark Cuban trial loss on October 16, 2013 - show the SEC is struggling to enforce at trial its more aggressive approach of seeking severe sanctions and industry bars for circumstantial cases.  We hope these setbacks will cause the SEC to take a step back from its more aggressive approach.  But if not, clients should be aware of the significant possibility of beating the SEC at trial.


A.    SEC v. Steffes, 10-cv-6266 (N.D. Ill., January 27, 2014):  Jury Rejects SEC Claim that High Number of Rail Yard Tours by People in Business Attire is "Material" Inside Information that Railroad Company Was About to Be Acquired


The Steffes insider trading case is the poster-child for SEC aggressiveness.  The allegedly material inside information was primarily that a railway company had been giving an unusually high number of rail yard tours to "people dressed in business attire."[1]   Two railroad company employees inferred from this that the railroad company (FECI) was in the process of being acquired. They told four family members and three business associates about this, and the group bought $1.6 million of FECI securities, from which they received a $1 million profit three months later, when the acquisition was announced. 


The SEC was unable to persuade the jury that the Defendants' knowledge of the unusual amount of rail yard tours by people dressed in business attire was material inside information.[2]    Indeed, it appears that the SEC's fatal flaw in bringing the Steffes case was believing a jury would accept the SEC's general position that virtually any private information advantage that results in a trading profit is material inside information. The presence of strange "people dressed in business attire" touring a corporation could mean all sorts of things - and it was a stretch for the SEC to claim it was material information that an acquisition would occur.

This verdict should serve to draw a line between material and immaterial inside information.  Further, it shows that juries will not automatically infer insider trading from the SEC's circumstantial evidence of unusual or suspicious trading activity.

B.     SEC v. Schvacho, 12-cv-2557 (N.D. Ga.): Court Faults the "Overreaching, Self-Serving Interpretation that the SEC Imposed on the Evidence Presented at Trial"


In Schvacho, the Court rejected the SEC's exclusive reliance on circumstantial evidence in charging the close friend of the then-CEO of Comsys IT Partners Inc. ("Comsys") with insider trading prior to the announcement of an acquisition that resulted $500,000 in profits.  The Court noted that "The SEC acknowledges that it does not have any direct evidence of misappropriation of insider information," and "admits that its proof of the insider trading is based on circumstantial evidence based on Schvacho's trading activity, phone and text message records," and meetings at social occasions.[3]  The SEC focused on the "suspicious" pattern of close timing between the stock trades and the defendants' conversations with Comsys's CEO.


Notably, the Court appeared to give the SEC a stinging rebuke, by faulting "the overreaching, self-serving interpretation that the SEC imposed on the evidence presented a trial."  The Court held that the SEC's circumstantial evidence was insufficient to prove insider trading, because "[w]hile facially interesting, this pattern...does not prove, by a preponderance of the evidence, that Schvacho misappropriated insider information." Further, the Court criticized the SEC's circumstantial case for "ignor[ing] other interpretations that discredit the SEC's misappropriation theory," including that the defendant and the CEO were close friends who spoke with, and met, each other frequently, and that the defendant had a plausible investment strategy to explain his pattern of trading.[4]  


 C.     SEC v. Jensen, 11-cv-5316 (C.D. Cal., Dec. 10, 2014):  SEC Loses Bench Trial Where Judge Rejects Circumstantial Evidence of Insider Trading, and Rejects Accounting Fraud Based on Reasonable Reliance on Accountants


Jensen was a bench trial where the Court rejected the SEC's circumstantial evidence that the former CEO of Basin Water, Inc. engaged in insider trading, and also rejected claims of accounting fraud against Basin's CFO and former CEO.  As in Steffes, the Jensen Court refused to find insider trading based solely on circumstantial evidence that the former CEO's trades were suspiciously timed to make a large profit - just four days before the company announced it would restate earnings. The Court relied on a stockbroker's testimony that the former CEO's sales were actually solicited by the buyer and were part of the broker's pre-existing (and disclosed) strategy to slowly sell off the former CEO's holdings to avoid harming the stock price.[5]


As to the accounting fraud charges, the Court found that the defendants did not violate the securities laws (even negligently under § 17(a)(2), (3) of the '33 Act) because their revenue recognition decisions were consistent with GAAP, and based on reasonable reliance on outside accountants and attorneys.[6]   The Court rejected the testimony of the SEC's accounting expert, and instead adopted the analysis of the defendants' expert regarding GAAP compliance.


Jensen is another example of the SEC failing to prove its case where it aggressively relied on circumstantial evidence to prove insider trading.  As the Court noted, the SEC was not able to directly prove that the former C.E.O. had knowledge of the upcoming restatement.  He had resigned months before the restatement was announced, and there was no evidence he was told about it.  Further, Jensen shows that the SEC is less likely to prevail where a case comes down to a battle of the experts, particularly on the issue of materiality.


D.     SEC v. Kovzan, 11-CV-2017 (D. Kan. Dec. 4, 2013):  Jury Verdict Form Shows SEC Loses on Scienter, Materiality, and All Claims of Securities Fraud in Disclosing Founder & Former CEO's Compensation and Receipt of Perquisites


In Kovzan, the SEC lost a jury trial in which it alleged that the CFO and former Chief Accounting Officer of NIC Corporation ("NIC") fraudulently misrepresented that NIC's founder & CEO worked for little or no compensation, when in fact he received $1.2 million in benefits and reimbursed expenses over four years.[7]   The SEC claimed that this was material because NIC disclosed that the CEO received only $11,000 in compensation from 2002-05.  Yet the CEO had received over $1.2 million in reimbursement for personal expenses, such as buying two homes, which the CFO improperly classified as business expenses.[8]   

The detailed jury verdict form from Kovzan shows not only that the SEC lost on all of its claims, but also that it lost every major issue disputed in the case.[9]  In particular, the jury found that the CFO did not act with intent to defraud.[10]  Further, it appears defendants were able to persuade the jury that the compensation disclosures were not material, based on an event-study by the defendants' expert showing that NIC's stock price did not react to the false disclosures.[11]  Kovzan is thus another example of the SEC losing a case where it sought to stretch the legal definition of materiality and being vulnerable in a battle of experts. 


E.    The SEC's Failure to Prove Liability in Steffes and Kovzan Raises Questions About the Reasonableness of the Severe Sanctions It Imposed on the Defendants Who Settled Instead of Going to Trial


The Steffes and Kovzan cases are also notable because the SEC imposed severe penalties on the defendants who settled before trial, while the defendants who went to trial emerged scot-free.  In Kovzan, the former CEO who received the undisclosed perquisites settled when the case began for over $2 million in disgorgement, penalties and interest, plus an order barring him from ever serving as an officer or director of a public company.[12]  The predecessor of the CFO who went to trial in Kovzan settled for a $75,000 penalty and a one-year bar from serving as an accountant before the SEC - which triggers an automatic suspension of his CPA licenses.[13]  And NIC and its then-current CEO settled for $700,000 in penalties and an agreement to hire an independent consultant to monitor its treatment of expenses.   


Similarly, in Steffes, two of the six defendants settled before trial with no-admit-no-deny settlements. One, a brother of a railroad employee, settled at the beginning of the case for over $225,000 in disgorgement, penalties and prejudgment interest and a permanent injunction against securities law violations.[14]   The other, an employee, settled before trial for $120,000 in penalties and a permanent injunction.[15] 


Although hindsight is 20-20 - and the record may not reveal all the evidence against particular defendants - the SEC's clear risk of losing the Steffes and Kovzan cases raises serious questions as to why it imposed such severe sanctions on the defendants who settled.  Indeed, the severe sanctions show that the SEC took little, if any, consideration of litigation risk into account in its settlement demands.  This would not be surprising, as the SEC has increasingly demanded severe sanctions such as industry bars in settlement discussions before a case is filed, as part of its efforts to appear more aggressive. .   

We hope that the SEC's string of losses in Steffes, Schvacho, Jensen, Kovzan, and Cuban will make it reassess its recent practice of demanding severe sanctions to settle cases based on circumstantial evidence or questionable materiality arguments.  But if it does not do so, clients should keep in mind the significant possibility of beating the SEC at trial in deciding how to handle an SEC investigation.   




The SEC's recent high-profile trial losses in Steffes, Schvacho, Jensen, Kovzan, and Cuban show that it is having serious trouble enforcing its more aggressive approach in Court.  Courts and juries are willing to reject SEC claims based on circumstantial evidence and questionable legal arguments.      


Sadis & Goldberg has extensive experience successfully handling SEC investigations and litigation against the SEC in Court.  If you have any questions about dealing with the SEC, or would like to discuss this article further, please contact Litigation partners Sam Lieberman at 212.573.8164 or Douglas Hirsch at 212.573.6670.     




[1] SEC v. Steffes, No. 10-cv-6266, Compl. 37(a), docket no. 1 (filed Sept. 30, 2010).

[2] SEC v. Steffes, Litigation Release dated February 4, 2014, available at  

[3] SEC v. Schvacho, --- F. Supp. 2d ---, 2014 WL at 5481, at *12-*13 (N.D. Ga., Jan. 7, 2014)

[4]  Id. at *14-*16    

[5] Findings of Fact and Conclusions of Law at 32-34, SEC v. Jensen, 11-cv-5316 (C.D. Cal. Dec. 10, 2013) docket no. 225.

[6] Id. at 39-41.

[7] Jury Finds Stephen Kovzan Not Liable for Securities Violations," SEC Lit. Rel. No. 22918 (Feb. 4, 2014).

[8] SEC v. Kovzan, Complaint 1-4, 33-34, 47, 54 (Jan 12, 2011), available at

[9] SEC v. Kovzan, Jury Verdict Form at 2-15, docket no. 408 (Dec. 2, 2013).

[10 Id. at 2-3. 

[11] NERA Press Release QuotingKovzan Trial Counsel

[12] SEC v. Kovzan, Press Release (Jan. 12, 2011),

[13] Id.

[14] SEC v. Steffes Press Release (Sept. 30, 2010),

[15] SEC v. Steffes, 10-cv-6266 (N.D. Ill.), docket no. 131-2.



Cheryl Spratt