Securities and Exchange Commission v. Rorech

Case information

• Court: United States District Court for the Southern District of New York
• Judges: Opinion by the Court (bench trial findings of fact and conclusions of law)

Majority opinion

Findings of Fact (continued)

1. Approximately 20% of the trading profits Mr. Negrin and his group generated for Millennium accrued to Mr. Negrin personally. (Tr. 126:7-13.)

2. Both of the VNU CDS trades at issue in this case were made by Mr. Negrin for a Millennium portfolio that he managed. Mr. Negrin did not trade any VNU CDSs for any personal account.

3. Mr. Negrin and Mr. Rorech have a purely professional relationship; they are not friends. (Tr. 172:3-8.)

4. Mr. Negrin was not one of Mr. Rorech’s most important customers and Mr. Rorech was not one of the most important salespeople to Mr. Negrin. (Tr. 171:9-172:2.)

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A. Mr. Negrin’s Practice of Trading VNU CDSs

1. Prior to July 2006, Mr. Negrin and Mr. Masel had researched and traded VNU CDSs, and were familiar with the company. (Tr. 233:4-7, Tr. 234:9-235:4; DX 287; DX289.)

2. Mr. Negrin, on behalf of Millennium, traded VNU CDSs prior to the trades at issue in July 2006 (Stipulated Facts ¶ 62):

a. On November 18, 2005, Mr. Negrin purchased Q10 million worth of VNU CDS from UBS AG, at a price of 90 basis points. He subsequently sold a portion of the VNU CDS on December 9, 2005, at 141 basis points and a portion on January 5, 2006, at 178 basis points. Millennium realized a profit of Q113,397 on the trades. (Stipulated Facts ¶ 63.)

b. On January 12, 2006, Mr. Negrin purchased Q5 million of VNU CDS from the Royal Bank of Scotland at 222 basis points. Mr. Negrin purchased another Q5 million of VNU CDS from BNP Paribas on January 31, 2006, at 215 basis points. He sold both VNU CDS to Lehman Brothers on February 21, 2006, at 213 basis points, incurring a loss of Q27,662 for Millennium. (Stipulated Facts ¶ 64.)

1. The two VNU CDS trades at issue in this case were small relative to the sizes of Mr. Negrin’s other CDS trades and particularly as compared to the size of his total CDS portfolio:

a. In June and July 2006, Negrin regularly purchased CDSs with notional values ranging from $50 million to $250 million. (DX 328.)

b. On June 13, 2006, Negrin purchased a total of $40 million of CDSs in Limited Brands, Inc., through four separate $10 million CDS trades, from HSBC, Morgan Stanley, Deutsche Bank, and Goldman Sachs. (DX 328; Tr. 176:18-177:6, 177:10-12.) Additionally, from June 13 to June 15, Mr. Negrin purchased $45 million of CDS protection in Pactiv Corporation by way of five CDS transactions with four different counterparties. (DX 328; Tr. 177:7-9, 177:13-178:5.) Similarly, on July 21, 2006, Mr. Negrin purchased $60 million of CDS protection in CBS Corporation through three separate $20 million trades with Citigroup, UBS, and Goldman Sachs. (DX 328; Tr. 180:6-25.)

1. The VNU CDS trades at issue in this case did not diverge from Negrin’s historical trading patterns. The size of the VNU CDS trades was not inconsistent with the size of Negrin’s other CDS investments at the time.

B. Mr. Negrin’s Reasons for Purchasing the VNU CDSs

1. Mr. Negrin, as a result of his experience in the finance industry, assumed that because salespeople were on the public side of an investment bank’s “wall,” any information they had was public. (Tr. 185:15-18.)

2. During the period in which he discussed VNU with Mr. Rorech, Mr. Negrin remained interested in buying VNU bonds. (Tr. 184:9-18.) Mr. Masel also spoke to Mr. Rorech because he, too, was evaluating whether Millennium should participate in the VNU bond offering. (Tr. 235:21-236:7.)

3. Mr. Negrin does not recall why he bought VNU CDSs in July 2006. However, he testified that based on a review of the facts surrounding VNU’s July 2006 bond offering, he likely bought the VNU CDSs because he believed that the price of the VNU CDSs was low relative to the high risk of the debt the CDSs referenced and because he believed the company would solve the deliverability issue and

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provide deliverable obligations to the market. (Tr. 123:1-19.)

1. These views were shared by many in the market in July 2006. (Tr. 237:7-13, 398:9-400:14; DX 98; DX 110; DEX 108.)

2. In July 2006, many market participants, including Mr. Masel, believed that the price of VNU CDS was likely to increase regardless of whether the deliverability issue was resolved. (Tr. 236:15-237:13, 813:10-13; DX 41; PX 30.)

3. Indeed, Mr. Masel believed that VNU CDSs were a good buy and, while he cannot recall whether he recommended them to Mr. Negrin, he testified that his usual practice was to recommend good trades to Mr. Negrin. (Tr. 236:8-14;

see also

DX 493.) Furthermore, on July 18, 2006, Mr. Masel told Eddie Oppedisano, a research analyst at the hedge fund Sigma Capital, that he and Mr. Negrin bought VNU CDSs not because of the likelihood that a holding company tranche would be issued, but based on their view that the CDSs were underpriced relative to the expected price of the new operating company bonds. (DX 166; Tr. 218:6-8, 239:3-10, 241:22-242:24.)

VI. Deutsche Bank’s Conñdentiality Policies

A. Deutsche Bank’s Confidentiality Policy, Its Engagement Letter with VNU, and Expected Uses of Indications of Interest

1. Deutsche Bank’s Confidential and Inside Information policy defines “confidential information” as “information provided by or obtained from a third party with the expectation or contractual agreement that it will remain confidential.” Deutsche Bank’s policy permits employees to use confidential information for the “business purpose” for which it was communicated and to disclose information to anyone who has a “legitimate need to know the information.” (DX 285 at 4.)

2. John Cartaina — a lawyer and a compliance officer at Deutsche Bank — confirmed that information is not “confidential” under the Bank’s policy unless there is an “expectation or contractual agreement that we keep it confidential.” (Tr. 716:02-8.)

3. Here, there was no expectation on the part of the sponsors — Deutsche Bank’s issuer client — to keep information regarding the VNU bond offering confidential from prospective purchasers such as Millennium.

4. Deutsche Bank’s Engagement Letter with the sponsors explicitly authorized Deutsche Bank employees to disclose information regarding the potential VNU bond offering, including a potential restructuring, to prospective buyers. Indeed, the Engagement Letter expressly provides that even nonpublic information can be disclosed “to purchasers or prospective purchasers of Securities in connection with an Offering of such Securities, to the extent appropriate in the context of such Offering____” (DX 301 at 7.)

5. It is undisputed that Millennium was a prospective purchaser and, therefore, came within the purview of the Engagement Letter. (Stipulated Facts ¶ 49.)

6. This express grant of authority to discuss information related to the VNU bond offering, including potential structural changes, meant that there was no expectation or agreement that such information be kept confidential.

7. In fact, the sponsors and Deutsche Bank had the expectation that information would be shared with prospective customers to sell the bond deal. Not only is this expectation clear from the language of the Engagement Letter, but, as the testimony confirmed, sharing informa

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tion about potential structural changes in a bond offering — including information related to a potential recommendation related to such changes — is consistent with the custom and practice of marketing a high yield bond deal. (Tr. 444:23^46:7, 539:1-10,1242:13-1243:8,1516:16-1518:10.)

1. It is also consistent with the custom and practice in the high yield bond industry for customers’ indications of interest in placing an order, especially so-called “anchor orders” that allow a deal to take place, such as that placed by Mr. Barnum, to be shared with other potential investors during the process of marketing a new issuance. (Tr. 541:1-9, 830:15-20, 1243:22-1244:23,1500:10-21,1501:14-23.)

2. Mr. Barnum testified specifically that he did not view his indication of interest in the VNU holding company bonds to be confidential. (Tr. 830:15-20.) Rather, he expected that his order would be used as the so-called “anchor order” to obtain other orders:

The Court: But you spoke to Mr. Fedorcik, and Mr. Fedorcik said he was putting together an interest of hundreds of millions of dollars; he was talking to you about $100,000,000. Did you have any expectation that when he went to the next person that he was trying to put together the deal with, he would not be talking, at least in general terms, in the same way about what he was putting together?

Barnum: No. If anything, it’s the contrary. ... I thought I was the so-called anchor orderer. So the narrative in my head was I was the anchor orderer. I did this thing. They were going to use that order to build the rest of the book with a few other guys.... But in fact, what I was trying to achieve very specifically was for the company to agree to do this. And for them to do that, it was going to take more than [$]100,000,000. So what I was hoping to do was jump-start the process and sort of my definition that meant that my order was going to contribute to that.

(Tr. 833:11-834:12.)

1. Mr. Fedorcik believed it was appropriate to share his thoughts on recommending a holding company tranche to the sponsors with potential investors in order to obtain feedback on the potential issuance for the sponsors. Mr. Fedorcik also believed it would be appropriate for a salesperson to do the same. (Tr. 383:6-17, 433:19-434:13.)

2. Mr. Fedorcik’s practice, in the course of exploring potential structural changes to a publicly announced bond offering, was to explore the viability of the possible change with a few investors. He preferred not to broadcast the possibility of the change to the whole market prior to the change’s announcement because he did not want to raise investors’ expectations in the event that the change did not happen. (Tr. 319:25-321:16.)

3. Both Mr. Fedorcik and Mr. Ross, the two senior capital market professionals at Deutsche Bank responsible for marketing the VNU bond offering, expressly asked various salespeople to discuss the possibility of a holding company issuance with their customers in order to obtain market feedback and to gauge investor interest in the change.

4. On July 14, Mr. Fedorcik asked Mr. Rorech to get “color,” that is, to assess investor demand, for a potential holding company issuance. (DX 462.)

5. On July 12, Mr. Ross asked Sean Hunt, the head of the high yield sales group at Deutsche Bank in London, to see if customers had any interest in deliverable bonds. (DX 445.)

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1. Similarly, on July 20, Mr. Ross asked Rachel Bobillier, the head of the hedge fund sales group at Deutsche Bank in London, to raise the potential holding company tranche issuance with CQS, a hedge fund that Ross thought likely traded in VNU CDS. (DX 460.)

2. Furthermore, Mr. Fedorcik spoke, with Mr. Rorech on the line, to Jeremy Barnum, the head of Blue Mountain’s London office, about the possibility of a holding company issuance, and about Mr. Fedorcik’s plans to speak to the financial sponsors and about other customers’ interest in deliverable bonds. (PX 51A; PX 8A; DX 335; PX 55A.) Mr. Fedorcik provided the same information to Geoffrey Sherry at Caxton, also while Mr. Rorech was on the line. (DX 381.)

3. Mr. Fedorcik believed that the information discussed on these calls was not confidential. (Tr. 427:1-10.)

4. Capital markets professionals like Mr. Fedorcik relied on salespeople like Mr. Rorech to know their customers’ needs and to bring customers who might be interested in deliverable bonds to capital markets’ attention. (Tr. 1046:11-19.) Mr. Rorech believed that in order to provide this information to Mr. Fedorcik, he was authorized to discuss the possibility of a potential holding company issuance with his customers in order to ascertain if any of his customers were interested. (Tr. 1069:20-1070:15.)

5. Mr. Rorech spoke with several customers he believed might be interested in a basis trade, that is, purchasing both VNU CDSs and deliverable bonds, including Blue Mountain, Caxton, Claren Road, Millennium, and Gracie Capital. (Tr. 1333:17-1334:7.)

6. Some of these investors gave indications of interest for holding company bonds only after being provided with information about the transaction by Mr. Fedorcik and Mr. Rorech:

a. For example, on the afternoon of July 17, Mr. Fedorcik told Geoffrey Sherry that he was trying to gauge investor demand for a holding company tranche before going to the sponsors with a proposal. Mr. Sherry had not expressed any interest in or given an order for deliverable bonds prior to this recorded conversation. (Tr. 1370:6-1371:17.) After being told about the possibility of a holding company issuance, however, Mr. Sherry gave an indication of interest of Q50 million of VNU bonds. (DX 381.)

b. On July 18, 2006, Mr. Rorech discussed with Sean Fahey, a portfolio manager at Claren Road, the possibility that bonds would be issued out of the VNU holding company. After receiving this information, Mr. Fahey and Bill Green, an analyst at Claren Road, indicated that they may be interested in the potential holding company bonds. (PX 38A.) Later, Claren Road put in a Q15 million order for deliverable bonds. (DX 325.)

B. Deutsche Bank’s Wall-Crossing Procedures

1. According to Deutsche Bank’s Confidentiality Policy, Deutsche Bank maintains a separation between its public side and its private side. (DX 285.) The public side includes the bank’s sales, trading, and research employees, and the private side includes the bank’s investment banking employees. The public side primarily interacts with other public market participants including investors, while the private side primarily interacts with issuers and financial sponsors. (Stipulated Facts ¶ 47.)

2. Deutsche Bank has a “wall” in place to prevent nonpublic information possessed by private-side employees from

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reaching employees on the public side. (DX 285.)

1. Members of Deutsche Bank’s sales force, including high yield salespeople, are on the public side of the wall. (Tr. 725:2-4.)

2. Deutsche Bank’s capital markets professionals, including Mr. Fedorcik, are often thought of as straddling the wall, working on both the public and private sides of the bank. (Tr. 1179:4-11.)

3. Capital markets professionals control the flow of information from the private side of the bank to their sales and trading colleagues on the public side of the bank and to potential investors. As a result, capital markets professionals are responsible for determining whether and when it is appropriate to share information with public-side employees and with investors in the course of marketing bond issuances. (Tr. 300:3-21, 378:9-14, 664:10-20.)

4. Pursuant to Deutsche Bank’s policy, private-side employees, such as investment bankers, are required to initiate a set of formalized “wall-crossing” procedures before providing any material nonpublic information to public-side employees. (DX 285.) These procedures require the private-side employees to notify Deutsche Bank’s compliance department and to notify the public-side, “wall-crossed” employee’s supervisor to obtain approval for the wall-crossing. Upon obtaining approval, the public-side employee is then notified in writing that he or she has been wall-crossed, and a record of the wall-crossing is kept by compliance employees. All of these steps are to be completed before a public-side employee is provided with any material nonpublic information by a private-side employee. (Tr. 725:20-727:8.)

5. Salespeople are not provided with, nor do they have access to, material nonpublic information about Deutsche Bank’s investment banking issuer clients in the ordinary course of business. (Tr. 725:5-10.)

6. Salespeople are infrequently wall-crossed or provided with material nonpublic information. This is especially so during the marketing period for a new issuance, because a wall-crossed salesperson would be prevented from speaking to that person’s clients about an issuance on which the salesperson was wall-crossed. (Tr. 727:22-728:4, 728:19-25, 1234:6-14, 1491:7-13.)

7. Neither Mr. Rorech nor any other Deutsche Bank sales or trading employee was wall-crossed during the period of July 7, 2006, through August 8, 2006, in connection with the VNU bond offering. (Tr. 726:23-727:1, 736:7-18; DX 317; DX 319; PX 22.)

8. In fact, Mr. Fedorcik testified that he personally did not initiate any wall-crossing procedures in connection with the VNU bond offering, because he did not believe that he was in possession of any material nonpublic information that could not be shared with salespeople or customers:

Question: Now, Mr. Fedorcik, is it fair to say that you didn’t initiate any wall-crossing procedures with respect to VNU? Correct?

Fedorcik: That’s correct.

Question: And that’s because you didn’t believe that during the course of the events involved with the marketing of the deal, from the time the marketing began in July 11th of 2006 until the decision was made by the sponsors to make a change on the 21st of July, 2006, that you were in possession of confidential information that was being shared with any salesman?

Fedorcik: That’s correct.

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Question: And likewise, you didn’t believe you were in possession of confidential information that you were sharing with any customer, right?

Fedorcik: That’s correct.

(Tr. 379:7-21.)

C. Deutsche Bank’s View Whether Their Confidentiality Policies Were Breached

1. Deutsche Bank is a registered broker-dealer with the Securities and Exchange Commission. As a result of being so registered, Deutsche Bank has a statutory duty to maintain and to enforce policies designed to comply with the securities laws. (Tr. 721:12-19.)

2. Prior to the institution of this lawsuit, Deutsche Bank was aware that both the Financial Services Agency, which regulates the financial services industry in the United Kingdom, and the SEC, were investigating the conduct of Deutsche Bank employees in connection with the VNU bond offering. (Tr. 489:4-14; DX 277.)

3. Attorneys acting on behalf of Deutsche Bank conducted an internal investigation of its employees’ conduct in connection with the VNU bond offering. Attorneys for Deutsche Bank and Deutsche Bank’s compliance personnel interviewed Mr. Fedorcik and Mr. Rorech about the VNU transaction. (Tr. 489:4-491:3, 492:17-23, 1358:22-1360:2.)

4. Deutsche Bank’s attorneys who conducted the internal review and responded to the SEC’s requests for documents were aware of the evidence that the SEC requested and obtained in connection with this case, including the contents of the audio recordings that were produced and the fact that Mr. Rorech and Mr. Negrin had two cellular phone calls. (DX 277.)

5. In the face of this knowledge, and after its own internal review, neither Mr. Rorech nor Mr. Fedorcik was ever told by their supervisors, by compliance, or by other Deutsche Bank officials to alter their conduct in sharing information with clients. (Tr. 482:22-484:10, 1363:24-1364:2,1528:19-22.)

6. Following Deutsche Bank’s internal investigation, Mr. Fedorcik was promoted twice. He was first promoted to global head of high yield capital markets, and subsequently to global head of leveraged debt capital markets. Today, in that capacity, Mr. Fedorcik oversees a group of approximately 100 capital markets professionals for Deutsche Bank worldwide. (Tr. 493:9-494:14.)

7. After the SEC issued a Wells notice to Mr. Rorech in 2009, Deutsche Bank placed Mr. Rorech on paid administrative leave. (Tr. 1364:12-17.) Mr. Rorech remains a Deutsche Bank employee. (Tr. 1364:18-19.)

D. VNU on Deutsche Bank’s Restricted List

1. VNU was on Deutsche Bank’s internal “restricted list” from March 2006 through August 2006. (DX 316; Tr. 735:3-13, 738:24-739:2.)

2. VNU was placed on Deutsche Bank’s restricted list during the course of the leveraged buyout of VNU and the VNU bond offering in order to prevent conflicts of interest between Deutsche Bank and its issuer client. (Tr. 722:3-723:3.) The restrictions prevented individual trading by Deutsche Bank employees and prevented Deutsche Bank from building proprietary positions in VNU securities and derivatives. (DX 530.)

3. The restricted list governs how the Bank could trade VNU securities and derivatives. VNU’s presence on the re

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stricted list is not relevant to whether information about VNU was confidential, or whether Deutsche Bank possessed material nonpublic information about VNU.

1. Deutsche Bank’s Confidential and Inside Information Policy states that the restricted list is “based on federal securities laws, regulatory rules, and/or Firm policy.” (DX 285 at 8.)

2. Mr. Cartaina testified that an issuer can be placed on the restricted list for a variety of different reasons. He also stated that, in the context of a leveraged buyout transaction where Deutsche Bank was advising the acquirer, one of the reasons an issuer might be on the restricted list would be to avoid Deutsche Bank taking a proprietary position in the issuer and creating a potential conflict of interest with its client. (Tr. 721:20-722:16.)

3. In addition, there are different types of restrictions that Deutsche Bank imposed. Mr. Martindale noted that in some circumstances, salespeople are allowed to solicit trades, but traders are restricted from trading. (Tr. 1496:11-13.)

4. During most of the marketing period for the VNU bond offering, members of Deutsche Bank’s high yield sales group in New York, including Mr. Rorech and Mr. Martindale, did not believe that they were restricted, from speaking to their customers about VNU securities or VNU CDSs. (Tr. 1023:2-12, 1497:24-1499:20.) Indeed, Mr. Martindale did not think it was possible to market the VNU bond offering without being able to discuss the preexisting VNU securities or derivatives. (Tr. 1497:7-23,1499:24-1500:7.)

5. On July 17, 2006, at 10:36 a.m., Mr. Rorech explicitly asked Mr. Aylward “are you still trading VNU? Allowed to trade it?” Mr. Aylward replied that he was. (PX 181A; PX 181T.)

6. Throughout the relevant time period between July 11 and July 24, 2006, Deutsche Bank traders sent runs on VNU to the salespeople. John Olvany, the defendants’ industry expert in the high yield market, testified that his experience at Morgan Stanley was that “[i]f I received a trader run, I would not imagine that we were restricted in the company.” If the salespeople were restricted from soliciting, then “the trader would not be sending out any runs.” (Tr. 1231:16-25.)

7. Mr. Martindale testified that there was a great deal of confusion surrounding VNU’s presence on the restricted list during this time: “So because there were three different traders and it was coming out of London, which is a different time zone, there was indeed some confusion about if we were restricted in the existing securities, that being the CDS and the euro and Sterling bonds for a period of time, as I recall during the marketing.” (Tr. 1498:4-22.) Mr. Martindale testified that Deutsche Bank salespeople were always able to talk to customers about getting orders for the new deal, but were restricted for a couple of days from trading in the existing capital structure. (Tr. 1499:4-1500:7.)

8. A number of Deutsche Bank high yield salespeople, including Mr. Martin-dale, recommended to their customers to buy VNU CDS throughout the marketing period. (DX 346; DX 347; DX 506; DX 512; Tr. 1447:21-1448:19.)

9. Deutsche Bank represents that it did not take proprietary positions in VNU CDSs during the period that VNU was on its restricted list and all trading in VNU CDSs was within Deutsche Bank’s restricted policy. (DX 530.)

Information About the VNU Bond Issuance in the Market

1. VNU’s financial sponsors heard about the deliverability issue and investor

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demands for potential structural changes first-hand during the roadshow presentations. (DX 110; Ross Dep. 114:7-17.)

1. The fact that potential investors had interest in deliverable bonds was “obvious to everyone who was participating in the market.” (Tr. 829:10-830:2, 834:19-21; DX 97; DX 110.)

2. During the time of the VNU bond offering, it was widely known in the market that Deutsche Bank was working with the financial sponsors to resolve the deliverability issues. (Tr. 396:21-397:13, 640:2-16; DX 44; Ross Dep. 124:8-125:4.)

3. Despite this knowledge, and after speaking with Mr. Rorech on July 19, 2006, and learning that the potential holding company issuance was “moving in the right direction,” Mr. Barnum sold VNU CDSs. Mr. Barnum sold the CDSs before the holding company tranche was announced on July 24, 2006, and the price of VNU CDSs increased. (DX 394; Tr. 785:18-20, 789:17-790:16.)

4. Further, Mr. Barnum testified that the fact that there were outstanding orders for deliverable bonds would not have affected his thinking in deciding whether to buy VNU CDSs. (Tr. 830:8-11.)

5. No investor who received information about the potential structural changes, including information about other customers’ indications of interest and about Deutsche Bank’s discussions with the financial sponsors, was asked to sign a confidentiality agreement restricting the potential investor’s ability to trade in VNU CDSs or securities. Nor was any investor who received information about potential structural changes asked to keep the information confidential.

6. Sophisticated institutional investors, who are the participants in the high yield bond market, understand that discussions about reverse inquiries and potential structural changes are tentative and uncertain until the final decision as to whether to implement the changes is made by the issuer. (Tr. 536:14-20, 760:19-761:5, 377:20-378:1, 539:11-16, 810:1-7.) Market participants know that it is common for reverse inquiries, even those that seem like great ideas, to be rejected by issuers. (Tr. 378:2-5, 539:17-22.)

7. In the case of the VNU bond offering, the final decision whether to agree to the investor-proposed structural changes was made by the financial sponsors. (Stipulated Facts ¶ 39.) The fact that the final decision was to be made by a group of highly-sophisticated private equity sponsors in the VNU case was viewed by some investors as increasing the uncertainties involved in the negotiation process for structural changes in the VNU bond offering. (Tr. 783:21-784:12.)

8. The SEC relies on Ms. Tournier’s statement that she became “tainted” and restricted from trading merely “from her discussions about [possible] recommendations” to argue that information about the restructuring was confidential and not available in the market.

9. However, Ms. Tournier’s testimony reveals that her belief that she was “tainted” was not grounded in Deutsche Bank’s Confidentiality Policy. Rather, as she explained, her view was based on her personal opinion that she should not trade because of her conversations with others in capital markets. (Tournier Dep. 105:9-16, 182:10-15.)

10. The SEC also focuses on the fact that, during one of Mr. Fedorcik’s calls with Mr. Ross, he asked Mr. Ross whether Ms. Tournier was “restricted” before Ms. Tournier joined the call. (PX 53A; PX 53T.) However, Mr. Fedorcik explained that he asked this question merely because he wanted to know what Ms. Tournier’s

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status was as a precautionary measure and not because he planned necessarily to share any confidential, material nonpublic information with her. (Tr. 346:19-347:14.) Indeed, Mr. Fedorcik testified that he had no confidential information in his possession with respect to the potential holding company tranche that could not be shared with a public side employee such as Ms. Tournier.

1. Notably, Mr. Ross testified that Ms. Tournier was restricted out of an abundance of caution, in case he ended up sharing confidential, material nonpublic information with her in light of her position as an expert in derivatives. But, as he explained, Mr. Ross did not believe that Ms. Tournier ever received material nonpublic information.

(See

Ross Dep. 165:11-20, 169:22-170:9.)

VIII. Facts Relevant to the Court’s Jurisdiction

1. CDSs that reference single corporate entities are viewed by market participants as synthetic bond positions in those entities, with the purchase of CDS protection being the equivalent of shorting a corporate bond, and the selling of protection being the equivalent of buying a bond. (Tr. 118:19-119:15 (Mr. Negrin discussing using CDSs to short bonds); Tournier Dep. 15:17-16:17 (explaining that buying a CDS has same effect as taking a short position in a bond); DEX 36 at 2 (“[D]e-fault swaps helped investors create outright short and long/short positions much more easily than by using bonds and the repo markets.”).)

The Relationship Between VNU Bond Pnces and Yields and CDS Pnces

1. The price, or the spread, of a CDS is the annual premium that the buyer must pay to the seller, expressed in basis points.

2. The spread of a bond, on the other hand, is the portion of the bond’s yield, or amount of expected return, above the risk-free rate of return. A bond’s price, usually expressed as a dollar value or percentage of the par value of the bond, has an inverse relationship to the bond’s spread or yield. For example, as a bond’s price decreases, the bond’s spread or yield increases. (Tr. 1560:6-22.)

3. Mr. Negrin and Mr. Rorech each testified to, or discussed contemporaneously with the VNU CDS transactions at issue in this case, the fact that CDS prices were based on the spread or yield, and therefore, inversely, on the price, of VNU bonds:

a. At his deposition, Mr. Negrin testified-that if the coupon rate of the new VNU bonds was going to increase, that would be a “piece for the puzzle” in his determination of what the price of the VNU CDSs should be. (Tr. 128:5-130:12;

see also

PX 175.)

b. Mr. Negrin also testified that during a recorded phone call with Mr. Rorech on July 24, 2006, after discussing the expected pricing of the new VNU bonds, including the new holding company bonds, Mr. Negrin asked Mr. Rorech to give his opinion on what the VNU CDS price should be based on the expected spread of the VNU bonds. Mr. Rorech then calculated the expected price of VNU CDSs based on the expected spread of the VNU bonds. (Tr. 149:21-151:22; PX 178.)

c. During a recorded telephone conversation on July 31, 2006, Mr. Rorech and Mr. Negrin again calculated the proper price for VNU CDSs based on the expected spread of the new VNU bonds. (DX 490T.)

1. This understanding was widely shared by fact witnesses who were market participants and by the market more widely. These witnesses and market participants testified or demonstrated in con

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temporaneous communications that they understood that CDS prices were based on the price, spread, or yield of deliverable bonds. For example:

a. Mr. Sherry, in discussing a blast email from a trader at Citigroup dated July 13, 2006, which noted that the existing VNU bonds that served as the VNU CDSs’ reference obligation were always going to be “cheapest to deliver” under the CDS contract, acknowledged that the “cheapest to deliver” bond is in theory reflected in the price of a CDS. (Tr. 564:16-565:13.) The email Mr. Sherry discussed noted that the five-year VNU CDS price is “still determined by a sub bond.” (DX 115.)

b. Mr. Sherry also discussed his own email of July 11, 2006, in which he stated that VNU CDSs would go higher as the new bonds’ pricing “becomes clear.” (Tr. 565:14-566:5; DX42.)

c. Mr. Masel testified as to his recollection of why the VNU CDS price increased after Mr. Negrin bought the CDSs in July 2006: “I think the interest rates on the bond deal were probably higher and the ratings lower than maybe anticipated or they were pretty low. So that had an influence on the CDS spreads. And I think the other thing that had influence was this HoldCo bond deal.” (Tr. 216:20-217:21.)

d. At her deposition, Ms. Tournier testified that “in general, if there’s no corporate action, the bonds and the CDS would tend to move in tandem,” and that the price of a CDS and the price of the issuer’s bonds would be “sometimes, but not always” “correlated.” (Tournier Dep. 11:16— 12:9.) She explained that “in general, if a credit improves, [the bond] price would go up and its spreads would tighten,” but that “each security ... may have its own events that drive the price.” (Tournier Dep. 11:20-12:4.)

e. In discussing the new operating company bond deal that was just announced, on July 11, 2006, Mr. Wagner and Mr. Fedorcik discussed the relationship between the price of VNU CDSs and the expected yield of the VNU bonds. Mr. Wagner said, “CDS contracts should therefore take the pricing from the new bonds.” (DX 51 IT.)

f. Mr. Fedorcik testified that at the time of the bond offering announcement, he believed VNU CDSs should be priced higher because “these three other tranches of debt — the bank debt, the senior unsecureds, the senior subordinated notes— were all going to price at much wider levels.” (Tr. 399:24-400:2.)

1. Contemporaneous analyst reports reflect that market participants in general understood that the price of VNU CDSs was based on the price of VNU bonds, and most closely based on the reference obligation of the VNU CDSs in the market.

(See

PX 213 (“CDS contracts should therefore take their pricing from the new bonds. We note that even if the tender process for the existing VNU bonds is not completely successful, the new Nielsen bonds would still be deliverable. CDS will then be priced from whichever bonds are the cheapest to deliver.”); PX 216 (“At current 5-year CDS levels (mid price is 475 basis points) we believe spreads could continue to widen to 550 + basis points, particularly if the VNU NV notes are priced on the higher end of the 10 to 11% coupon range. Again, 10% would imply a 5-year spread of + 495 basis points; 11% would imply +595 basis points.”).)

1. The relationship between CDS prices and the price or yield of bonds has been demonstrated theoretically and empirically. (PX 232 at ¶¶ 23-60; Tr. 872:12-874:24.)

*402

1. A statistical analysis of the available data on VNU bonds and CDSs referencing VNU bonds demonstrates that the relationship between VNU bond spreads and VNU CDS spreads is consistent with the relationship predicted by academic theory and found in empirical academic papers. The data evidence a long-term equilibrium relationship between VNU CDS spreads and bond spreads, because valid statistical analysis demonstrates that the two spreads are cointegrated. This means that any fluctuation between the two spreads returns to a stable equilibrium value, which, in the context of comparing VNU bond spreads and CDS spreads, means a statistically stable, constant basis. Cointegration also implies that the observed high degree of correlation between VNU CDS and bond spreads is not spurious. Finally, further statistical analysis reveals that both VNU CDS and bond spreads contribute to price discovery of each other. (PX 232 at ¶¶ 61-93; Tr. 878:23-880:1, 881:15-884:11, 885:24-886:17, 887:9-889:25, 891:10-894:18, 896:24-902:2.)

2. This view of CDS prices as based on the spread or value of the referenced entity’s bonds was also shared by market analysts outside of the context of the VNU offering.

(See

DEX 36 at 12 (“Conceptually, the CDS premium should equate to spread over LIBOR for the issuer’s floating rate note trading at par, and represents the compensation for the default risk.”).)

B. The Relationship Between the Value of VNU Bonds and CDS Pnces

1. The “value” of a bond or group of bonds is calculated by multiplying the notional amount of the outstanding bonds by their price. (Tr. 1637:15-1638:1.)

2. The value of VNU bonds that were deliverable into VNU CDSs increased when VNU issued the holding company tranche of bonds in July 2006.

3. Mr. Negrin testified that part of the bet he made in purchasing the VNU CDSs was that the issuance of the holding company bonds would cause the price of the VNU CDSs to increase. (Tr. 147:3-148:14.)

4. He also testified that part of the reason he bought the VNU CDSs was that the fact that the price of the CDSs increased slightly before he bought it, showed him that the market believed the deliverability issue would be resolved: “The price moving itself gave me a signal that that’s what was going to happen.” (Tr. 123:18-19.)

5. On July 24, 2006, Mr. Rorech discussed with Mr. Negrin the fact that the announcement of the issuance of the additional holding company bonds, and the accompanying increase in value of deliverable VNU bonds, would cause an increase in the price of the VNU CDSs. (PX 188.)

6. Other witnesses and market participants agreed that the value of the VNU holding company bonds would affect the price of the VNU CDSs. In a discussion among Mr. Fedorcik, Mr. Ross, and Ms. Tournier on July 17, 2006, Mr. Ross told Mr. Fedorcik to be “extremely careful” when speaking to investors, because if Mr. Fedorcik went out “right now and [had] a conversation with a guy ... the CDS [would] ... blow way out immediately because ... if you say, for instance, I’m going to do this trade at 11, you know, 600 over, and the CDS is at 375, I mean that’s going to sort of immediately — CDS should blow out, right?” (PX 53-A; PX 53 at DBL 1242-42,1246.)

7. An email that a Citigroup employee sent to his clients on July 13, 2006, offered the view that VNU CDSs should

*403

“trade even wider” if additional deliverable bonds were issued by VNU. (DX 98.)

1. A Merrill Lynch report dated July 20, 2006, noted that its evaluation of the target price of VNU CDSs was “impaired” by 100 basis points because of “deliverability and liquidity issues,” an impairment that could be rectified by an issuance of deliverable bonds. (PX 30.)

C. Section 9.9 of the ISDA Definitions

1. In completing the purchase of the two VNU CDSs at issue in this case, Mr. Negrin, on behalf of Millennium, and Deutsche Bank and RBS, the CDS-sellers, memorialized a number of transaction-specific terms in two Trade Confirmations. The Trade Confirmations identified the reference entity or obligation, the notional amount, the expiration date of the CDS, the price of the premium, the frequency of premium payments, and the triggering credit events. (Tr. 1556:15-1558:14; DX 148; DX 161.)

2. The parties agreed that the VNU CDS contracts were to be physically settled, that is, the CDS-buyer would actually deliver a deliverable obligation to the CDS-seller upon settlement. (PX 227; PX 229.)

3. The CDS sales at issue were governed by Master Confirmation Agreements that incorporated by reference the standardized definitions and terms found in the 2003 ISDA Credit Derivatives Definitions and the May 2003 Supplement to the 2003 Definitions (collectively, the “ISDA Definitions”). (PX 227; PX 229; PX 224.)

4. Section 9.9 of the ISDA Definitions allows for the CDS-seller to invoke an option to settle the CDS in cash under certain circumstances. This provision is triggered in the event that a CDS-buyer fails to physically provide to the CDS-seller a deliverable obligation under the contracts within the specified time after a credit event. (Tr. 1633:1-20.)

5. Section 9.9 allows the CDS-seller to “buy-in” to bonds not delivered by buying deliverable obligations and then deducting the price of the undelivered obligations from the final settlement payment owed by the CDS-seller to the CDS-buyer.

6. Dr. Andrew B. Miller, who holds a Ph.D. in economics and testified as the defendants’ expert on financial economics, indicated in his expert report that the “key terms of the VNU-related CDSs are primarily those specified in the Confirmation Agreements as supplemented by the Transaction Supplements and the supporting ISDA documentation.” (DEX 1 ¶ 33.)

7. Dr. Miller also testified that “settlement terms,” including Section 9.9, are among the “key terms” in a CDS contract, but he clarified that he used “key terms” to mean terms he wanted to examine in analyzing the CDS contracts for purposes of this case. (Tr. 1631:21-1633:9.)

Conclusions of Law

1. The single claim in this case alleges insider trading in CDSs in violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5,
   17 C.F.R. § 240
   .10b-5, promulgated thereunder. (Stipulated Law ¶ 1.) The SEC brings this action under the misappropriation theory of insider trading. (Stipulated Law ¶ 2.)

2. To prevail, the SEC first must prove by a preponderance of the evidence that the Court has subject matter jurisdiction over this action.

3. To establish liability as to Mr. Rorech, the SEC must prove that Mr. Rorech, in connection with the purchase or sale of a security or “securities-based swap agreement,” misappropriated material

*404

nonpublic information in breach of a fiduciary duty to Deutsche Bank, and that Mr. Rorech acted with scienter.

See United States v. Falcone,

257 F.3d 226, 232
(2d Cir.2001) (citing

United States v. O'Hagan,

521 U.S. 642, 652
,
117 S.Ct. 2199
,
138 L.Ed.2d 724
(1997));

United States v. Chestman,

947 F.2d 551, 566
(2d Cir.1991) (in banc);

see also Aaron v. SEC,

446 U.S. 680, 691
,
100 S.Ct. 1945
,
64 L.Ed.2d 611
(1980) (finding that scienter is a necessary element of every section 10(b) and Rule 10b-5 claim). (Stipulated Law ¶ 3.)

1. To establish liability as to Mr. Negrin, the SEC must first prove that Mr. Rorech is liable. The SEC must also prove that Mr. Negrin knew that Mr. Rorech provided him with material nonpublic information in breach of a fiduciary duty to Deutsche Bank, and that Mr. Negrin purchased VNU CDSs while in possession of that material nonpublic information.

See Falcone,

257 F.3d at 234
;

Chestman,

947 F.2d at 571
.

1. The SEC bears the burden of proof and must prove every element of its claim by a preponderance of the evidence.

Herman & MacLean v. Huddleston,

459 U.S. 375, 389-91
,
103 S.Ct. 683
,
74 L.Ed.2d 548
(1983);

SEC v. Willis,

825 F.Supp. 617, 622
(S.D.N.Y.1993).

I. Subject Matter Jurisdiction

A. Statutory Provisions

6.In 2000, Congress passed the Commodity Futures Modernization Act (“CFMA”),
Pub.L. No. 106-554, 114
Stat. 2763 (2000), which amended section 10(b) to extend the rules promulgated by the SEC under that section to prohibit fraud, manipulation, and insider trading, and judicial precedents decided under section 10(b), to “securities-based swap agreement[s] (as defined in section 206B of the Gramm-Leach-Bliley Act).”

1. Section 206B of the Gramm-Leach-Bliley Act, in turn, defines a “security-based swap agreement” as “a swap agreement (as defined in section 206A ...) of which a material term is based on the price, yield, value, or volatility of any security or any group or index of securities, or any interest therein.” Gramm-Leach-Bliley Act,
   Pub.L. No. 106-102, §
   206B,
   113 Stat. 1138
   (1999) (set out as a note under 15 U.S.C. § 78c). (Stipulated Law ¶ 8.)

2. A “non-security-based swap agreement” is defined by the Gramm-Leach-Bliley Act as “any swap agreement (as defined in section 206A) that is not a security-based swap agreement (as defined in section 206B).” Gramm-Leach-Bliley Act § 206C (set out as a note under 15 U.S.C. § 78c).

3. A “swap agreement” is defined in section 206A of the Gramm-Leach-Bliley Act as

any agreement, contract, or transaction ... the material terms of which (other than price and quantity) are subject to individual negotiation, and that ... (2) provides ... for the exchange ... of one or more payments based on the value or level of one or more interest or other rates, currencies, commodities, securities, instruments of indebtedness, indices, quantitative measures, or other financial or economic interests or property of any kind ... including any such agreement, contract, or transaction commonly known as an interest rate swap, including a rate floor, rate cap, rate collar, cross-currency rate swap, basis swap, currency swap, equity index swap, equity swap, debt index swap, debt swap, credit spread, credit default swap, credit swap, weather swap, or commodity swap.

Gramm-Leach-Bliley Act § 206A (set out as a note under 15 U.S.C. § 78c).

*405

B. The Meaning of “Based On”

1. The SEC argues that section 10(b) and Rule 10b-5’s proscription of insider trading applies to the CDSs sold in this case because, among other reasons, the price term (or spread) of the two CDSs was based on the price, yield, value, or volatility of VNU bonds.

2. The defendants respond that the price of the two CDSs may have been related to the price, yield, value, or volatility of VNU bonds, but argue that the price of the CDSs was not “based on” those characteristics of the bonds. The defendants argue that “based on” should be interpreted to require a direct, or exclusive dependence, and that, in this case, the price of the VNU CDSs was negotiated between the buyer and seller and was affected by many factors, including the strength of the overall economy and the market’s assessment of the referenced company’s credit risk.

3. The defendants contend that the Court should determine whether the material terms of the CDSs were “based on” the price, yield, value, or volatility of the bonds by looking solely at the terms of the CDSs contracts. They argue that because the price of the CDSs is stated in basis points and does not explicitly refer to the price or value of any security, the price of the CDSs could not be “based on” the price, yield, value, or volatility of the VNU bonds.

4. The Court is not aware of any case that has addressed the question whether CDS agreements that reference a corporate debt security are “security-based swap agreements” for purposes of 15 U.S.C. § 78j, as amended by the CFMA.

5. Because the Gramm-Leach-Bliley Act does not itself define “based on,” “the ordinary meaning of the words chosen by Congress provides the starting point for interpreting the statute.”

Cuomo v. Clearing House Ass'n, L.L.C.,

— U.S. -,
129 S.Ct. 2710, 2723
,
174 L.Ed.2d 464
(2009).

Webster’s Third New International Dictionary

180 (1993) states that the verb “base” or “based,” sometimes used with “on or upon,” means “to use as a base or basis for.” The noun “base,” in turn, is defined as “the fundamental part of something” or a “basic principle.”

“[B]asis” is defined as “the principle component of anything” or a “fundamental ingredient.”

1. The plain meaning of “based on,” therefore, does not imply an exclusive relationship, as the defendants urge. Rather, it means to use as the fundamental part or ingredient of, or principal component of, something.

2. It is possible that “based on” can have different meanings, depending on the context in which the phrase is used. In deciding whether a consumer was subjected to an adverse action “based in whole or in part on any information contained in a consumer report” for purposes of the Fair Credit Reporting Act, 15 U.S.C. § 1681m(a), the Supreme Court stated that “ ‘based on’ indicates a but-for causal relationship and thus a necessary logical condition.”

Safeco Ins. Co. v. Burr,

551 U.S. 47, 63
,
127 S.Ct. 2201
,
167 L.Ed.2d 1045
(2007).

1. However, there is no reason to believe that this interpretation of “based on” applies to all statutory uses of the phrase. Indeed, in other contexts, courts have interpreted “based on” to mean something closer to its dictionary definition.

See, e.g., Environmental Defense v. EPA

369 F.3d 193
, 203-05 (2d Cir.2004) (interpreting “based on photochemical grid modeling” in the Clean Air Act to mean “ ‘having as the foundation’ or ‘arising from’ ”);

McDaniel v. Chevron Corp.,

203 F.3d 1099
, 1111-12

*406

(9th Cir.2000) (noting that courts interpret “based upon” to mean “arising from” and to refer to a “starting point” or “foundation”);

United States v. Becton Dickinson & Co.,

21 F.3d 1339
, 1348 (4th Cir.1994) (finding that a

qui tarn

action is “based upon” a public disclosure when the allegations are “actually derived” from the disclosure rather than an independent source).

1. In this case, the context in which the phrase “based on” is used in section 206B of the Gramm-Leach-Bliley Act, and the statutory scheme as a whole, support the conclusion that “based

on” in

that statute does not require a necessary dependence or exclusive relationship.

1. The Gramm-Leach-Bliley Act broadly defines “swap agreement” to include not only CDSs, but also, among other things, interest rate swaps, currency swaps, and weather swaps — items which clearly are not “security-based swap agreement[^]” for purposes of applying section 10b and Rule 10b-5’s anti-fraud provisions.

See School District of Erie v. J.P. Morgan Chase Bank,

No. 08 Civ. 7688,
2009 WL 234128
, at *1 (S.D.N.Y. Jan. 30, 2009) (finding that interest rate swap agreement was not security-based swap agreement);

St. Matthew’s Baptist Church v. Wachovia Bank Nat’l Ass’n,

No. 04 Civ. 4540,
2005 WL 1199045
, at *12-13 (D.N.J. May 18, 2005) (finding that swap agreement based on LIBOR was not security-based).

1. The fact that Congress extended section 10(b) and Rule 10b-5’s anti-fraud rules to “security-based swap agreement[s],” and not other “swap agreement[s]” that clearly are not based on securities, appears to bring CDSs like those in this case into the heartland of the swap agreements Congress intended to govern under section 10(b) and Rule 10b-5. The defendants in this case allegedly exchanged inside information regarding securities that affected the price of CDSs that were based on those securities. It is no surprise that Congress intended to extend the antifraud provisions that would prohibit sharing inside information in connection with trading those securities to also prohibit insider trading in transactions involving the CDSs themselves.

2. The legislative history of the CFMA supports the view that Congress intended to extend section 10(b) and Rule 10b-5’s protections to CDSs such as those at issue in this case.

3. At the time of its passage, it was noted that the CFMA’s amendment to section 10(b) would allow “current and future anti-fraud rules [to] apply to swap agreements to the same extent as they do to securities.” Thus, the Act would “enhance protection for investors and for the financial markets, and will permit the SEC to respond as necessary to developments in these markets.” 147 Cong. Rec. S1194601 (daily ed. Jan. 2, 2001) (statement of Sen. Sarbanes). The relevant legislative history prior to its passage is consistent. Administration officials and congressional members expressed support for making it clear that the SEC’s traditional anti-fraud and insider trading enforcement authority applied to novel financial instruments.

See The Commodity Futures Modernization Act of2000: Hearing on S. 2697 Before the Senate Committee on Agriculture, Nutrition, and Forestry and the Senate Committee on Banking, Housing and Urban Affairs,

106th Cong. 4 (2000) (statement of Sen. Gramm) (“We need the SEC in all areas to exercise its authority on anti-fraud and insider trading.”);

at 20
(statements of Sen. Sarbanes and Federal Reserve Chairman Greenspan, expressing agreement that “we should focus on insider trading, fraud, manipulation, and make sure that any possibility for those practices

*407

to take place is precluded under the regulatory scheme”).

1. The defendants’ interpretation of “based on,” as requiring a direct, explicit relationship that must be spelled out in the text of a CDS contract, would allow traders to escape the ambit of section 10(b) and Rule 10b-5 through clever drafting. Under the defendants’ view, as long as CDSs’ material terms did not make actual reference to the price or value of securities, the CDSs would not be “security-based,” no matter how closely tied to securities their material terms actually were.

C. The Price Term of the CDSs Was “Based On” the Price, Yield, and Value of VNU Securities

1. While it is possible that not all CDSs are “based on” securities, the jurisdictional issue in this case is whether the material terms of the particular VNU CDSs purchased by Mr. Negrin were based on the price, yield, value, or volatility of securities.

2. While Mr. Negrin may have considered other factors in determining the price at which he was willing to purchase VNU CDSs, it is clear from the evidence in this case that a fundamental part of his decision was the spread or yield (or, inversely, the price) of deliverable VNU bonds and the value of deliverable VNU bonds.

3. Mr. Negrin’s deposition testimony and his recorded conversations with Mr. Rorech reveal that the spread of deliverable VNU bonds was central to his decision to buy VNU CDSs. Mr. Negrin and Mr. Rorech twice discussed and calculated the target price of VNU CDSs based on the expected spread of the VNU holding company bonds. (Findings of Fact ¶ 247.)

4. Moreover, the value of deliverable VNU bonds served as a fundamental part of Mr. Negrin’s evaluation of the target price of the VNU CDSs. Mr. Negrin was keenly interested in the odds of VNU issuing a holding company tranche of bonds and repeatedly discussed the issue with Mr. Rorech. Mr. Negrin and Mr. Rorech also discussed the fact that the price of the VNU CDSs would increase if the value of deliverable bonds increased. (Findings of Fact ¶ 257.)

5. The importance of the price, yield, and value of VNU bonds to Mr. Negrin in determining whether to purchase VNU CDSs is unsurprising in light of the evidence from other market participants that the price, yield, and value of VNU’s bonds was critical to the price of the VNU CDSs. Many market participants, including investors such as Mr. Masel and Mr. Sherry, and investment bank professionals at Deutsche Bank and other institutions, were focused on the price, yield, and value of deliverable VNU bonds in evaluating the price of VNU CDSs in July 2006.

6. Moreover, apart from the VNU transaction, the evidence suggests that market analysts and experts considered CDS prices in general to be based on the price, yield, or value of the referenced entity’s bonds.

7. The fact that bond spreads and CDS prices can move in opposite directions on a daily basis (DEX 1 at ¶ 70), and the fact that CDSs can continue to be priced and traded even after their reference obligations have matured (DEX 1 at ¶ 94), is not dispositive of the question whether the material terms of the VNU CDSs actually purchased by Mr. Negrin in this case were based on the price, yield, value, or volatility of VNU bonds.

D. Section 9.9 of the ISDA Definitions Was a Material Term of the CDSs and Was “Based On” the Price of Securities

1. In addition, the SEC argues that a material term of the VNU CDSs was

*408

based on the price of a security because Section 9.9 of the ISDA Credit Derivatives Definitions, a terra incorporated in the CDSs through the Master Confirmation Agreements, was based on the price of VNU securities.

1. Section 9.9 allows CDS counterparties to deduct the price of the reference entity’s securities from the amount owed to the CDS-buyer if a triggering credit event occurs and the CDS-buyer fails to deliver the covered securities. Because the provision explicitly relies on the price of deliverable VNU obligations as the basis for calculating the cash settlement terms of the CDS, the provision is “based on” the price of a security for the purposes of section 206B of the Gramm-Leach-Bliley Act.

(See

Tr. 1636:10-1337:4.)

1. The question remains whether Section 9.9 is a “material term” of the CDSs for the purposes of the Gramm-Leach-Bliley Act.

2. The material terms of a contract are those terms that must be sufficiently definite to allow the contract to be enforceable. Examples of material terms include subject matter, price, payment terms, quantity, timing, compensation, and duration.

See, e.g., Local 917, Int'l Bhd. of Teamsters v. N.L.R.B.,

577 F.3d 70, 74
(2d Cir.2009) (citing 17A

Am.Jur.2d Contracts

§ 190 (2004));

Sevel Argentina, S.A. v. Gen. Motors Corp.,

46 F.Supp.2d 261, 269
(S.D.N.Y.1999);

Rosenthal v. Nat'l Produce Co.,

573 A.2d 365, 370
(D.C.1990).

1. In this case, Section 9.9, together with the contracts’ physical settlement provisions, provided the terms on which the VNU CDSs were to be settled if a credit event occurred. The CDS-sellers’ agreement to pay the CDS-buyer the notional amount at settlement upon the occurrence of a credit event was plainly part of, if not all of, the consideration for which the CDS-buyer agreed to make the premium payments.

2. If Millennium actually held the referenced VNU bond when a credit event occurred, it could deliver the bond for the notional amount. But the actual value of the settlement would depend on the value of the bond surrendered. The greater the value of the bond, the less valuable the exchange would be for Millennium. If Millennium did not deliver the bond, then Section 9.9 would be used to determine the amount of money that the CDS-seller would have to pay Millennium and that would be calculated based on the notional amount minus the price of the VNU bond that could be acquired in the marketplace.

3. Therefore, the terms of that settlement were central to the VNU CDSs and are material terms without which the contracts would be unenforceable.

4. Moreover, the defendants’ financial economics expert testified that the settlement terms, including Section 9.9, were part of the “key terms” in the CDS contracts.

5. For all of the reasons stated above, the material terms of the VNU CDS contracts were based on the price, yield, value, or volatility of VNU’s securities. Therefore, the CDSs at issue in this case are security-based swap agreements for the purposes of section 206B of the Gramm-Leach-Bliley Act and are subject to section 10(b)’s antifraud provisions and the rules promulgated, and judicial precedents decided, thereunder.

II. Misappropriation Theory

1. Under the misappropriation theory, an individual violates section 10(b) and Rule 10b-5 “when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.”

O’Hagan,

521 U.S. at 652
,
117 S.Ct. 2199
.

*409

1. One engages in “misappropriation” for purposes of insider trading laws when he engages in “conduct constituting secreting, stealing, [or] purloining ... [of] material non-public information in breach of an employer-imposed fiduciary duty of confidentiality.”

United States v. Carpenter,

791 F.2d 1024, 1031
(2d Cir.1986),

aff'd,

484 U.S. 19
,
108 S.Ct. 316
,
98 L.Ed.2d 275
(1987).

1. Therefore, to establish that the defendants are liable for insider trading under the misappropriation theory, the SEC must prove that the information at issue was both material and nonpublic.

See SEC v. Lyon,

605 F.Supp.2d 531, 541
(S.D.N.Y.2009). The SEC must also show that Mr. Rorech breached a duty of confidentiality in sharing the information — “the cornerstone of a misappropriation liability case.”

at 542
. Finally, the SEC must prove that the defendants acted with scienter.

Aaron,

446 U.S. at 691
,
100 S.Ct. 1945
.

A. Mr. Rorech’s Conduct

1. There is no evidence of what was actually said on the cellular phone calls between Mr. Rorech and Mr. Negrin on July 14, 2006, and July 17, 2006. The SEC asks the Court to draw the inference that Mr. Rorech shared inside information with Mr. Negrin from circumstantial evidence. However, that evidence does not support the conclusion that Mr. Rorech or Mr. Negrin violated insider trading laws.

2. Mr. Rorech Did Not Know that Deutsche Bank Would Recommend that the Sponsors Issue the Holding Company Bonds at the Time of His Calls with Mr. Negrin

3. It is self-evident that insider trading liability cannot be premised on the disclosure of information that did not exist at the time of the allegedly illegal activity.

See SEC v. Gonzalez de Castilla,

184 F.Supp.2d 365, 376-77
(S.D.N.Y.2002) (granting summary judgment for defendants where the alleged insider information “could not have been known at the time of the attacked [stock] purchases as it did not, as a matter of uncontroverted fact, exist at that time”);

SEC v. Truong,

98 F.Supp.2d 1086, 1102
(N.D.Cal.2000) (“A tippee cannot be liable, of course, where the SEC fails to show that the alleged tipper possessed inside information.”).

1. The SEC alleges that Mr. Rorech improperly shared with Mr. Negrin information regarding Deutsche Bank’s intention to recommend that the sponsors issue holding company bonds during a cellular phone call on July 14 and, again, on another cellular phone call on July 17. (Joint Pretrial Order, Plaintiffs Summary of Claims at 6.)

2. At the time of the cellular phone calls on July 14 at 8:58 a.m. and July 17 at 9:49 a.m., Mr. Rorech did not possess any information about Deutsche Bank’s recommendation because Deutsche Bank had not yet made any decision to recommend that the financial sponsors issue the holding company bonds.

3. Even if Deutsche Bank or Mr. Fedorcik had decided to recommend the holding company deal to the sponsors as of the morning of July 17, Mr. Fedorcik had not yet told Mr. Rorech of his or the bank’s intention to do so.

(See

Findings of Fact ¶ 87.)

1. Mr. Fedorcik did not share his intention to recommend a holding company issuance to the sponsors with Mr. Rorech until nearly four hours after the second cellular phone call, at 1:28 p.m. on July 17, and even then his tentative recommendation was conditional on investor demand for a holding company tranche of bonds. Thus, Mr. Rorech did not, and could not,

*410

possess this information at the time that he and Mr. Negrin spoke.

1. Deutsche Bank, consistent with the standard practice in the industry, had a wall in place to control the flow of information between its investment banking and sales and trading businesses. Rorech was never wall-crossed in connection with the VNU bond offering, and there is no evidence that Deutsche Bank’s wall was breached or failed to function during the marketing for the VNU bond offering.

2. The fact that Mr. Rorech was a Deutsche Bank employee, and that he may have spoken with Mr. Fedorcik (or merely had the opportunity to do so) does not mean that Mr. Rorech actually possessed information about Mr. Fedorcik’s plans prior to the recorded telephone conversation between Mr. Rorech and Mr. Fedorcik at approximately 1:28 p.m. on July 17, 2006. Potential “access” to material nonpublic information, without more, is insufficient to prove that Mr. Rorech actually possessed any such information.

See Truong,

98 F.Supp.2d at 1097-99
(finding that the fact that an employee worked in an office with open cubicles and had “routine interactions with senior management” who knew of the company’s negative financial condition did not create a triable issue of fact that the employee possessed information);

see also SEC v. Anton,

No. 06 Civ. 2274,
2009 WL 1109324
, at *7-8 (E.D.Pa. Apr. 23, 2009) (finding that the fact that insider was aware that increasing loss reserves was a “strong possibility” but was not involved in internal discussions on the issue was insufficient to establish that insider possessed the information).

1. In short, because the alleged material nonpublic information about Deutsche Bank’s, recommendation did not exist at the time of the cellular phone calls, there could have been no insider trading based on that information.

See SEC v. Hoover,

903 F.Supp. 1135, 1143
(S.D.Tex.1995) (“A defendant’s liability for insider trading can be based only on material nonpublic information known at the time of the trade, not on information learned later.”).

1. The Information Mr. Rorech Did Know at the Time of the Calls Was Not Material

2. For purposes of the securities laws, information is deemed “material” if there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of [available] information.”

Basic, Inc. v. Levinson, 485

U.S. 224, 231-32,
108 S.Ct. 978
,
99 L.Ed.2d 194
(1988) (quoting

TSC Indus., Inc. v. Northway, Inc.,

426 U.S. 438, 449
,
96 S.Ct. 2126
,
48 L.Ed.2d 757
(1976)). With respect to “contingent or speculative” information, “materiality will depend at any given time upon a balancing of both indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.”

Basic,

485 U.S. at 238
,
108 S.Ct. 978
(citing

SEC v. Texas Gulf Sulphur Co.,

401 F.2d 833
, 849 (2d Cir.1968)) (internal quotation marks omitted).

1. A generalized confirmation of an event that is “fairly obvious” to every market participant who was knowledgeable about the company or the particular instrument at issue is not material information.

See, e.g., SEC v. Monarch Fund,

608 F.2d 938, 942
(2d Cir.1979) (generalized tips that do not divulge the specific terms of an impending but not yet publicly announced securities offering, where no specific terms or dates or names of participants was divulged, “lack[ ] the basic elements of specificity” to be considered material for purposes of insider trading laws);

Anton,

2009 WL 1109324
, at *8 (quoting

SEC v. Bausch & Lomb, Inc.,

565 F.2d 8
,

*411

15 (2d Cir.1977)) (alleged tip that company was increasing its loss reserves, without any specific information as to the extent of the reserves, was not material where the likelihood that reserves would be increased was subject of analyst speculation in research reports).

a. Information Regarding the Potential Restructuring

1. Even if Mr. Rorech had shared his opinions with Mr. Negrin as to the likelihood of a holding company issuance or provided Mr. Negrin with general information about the potential deal, such information does not constitute material inside information.

See Anton,

2009 WL 1109324
, at *7-8 (finding that information about possible increased loss reserves without any specifics was not material);

In re Allaire Corp. Sec. Litig.,

224 F.Supp.2d 319, 333
(D.Mass.2002) (“vaguely optimistic language” by corporation not material nonpublic information).

1. Information that Deutsche Bank’s investment bankers were advising the sponsors on the deliverability issues in general, and that the sponsors were likely to address the investor demand for deliverable bonds was widely discussed in the marketplace in July 2006. In this context, Mr. Rorech’s opinion, or even knowledge, that Deutsche Bank was working on a solution to solve the deliverability problem was not sufficiently different from the information that was available in the marketplace to be material.

2. Moreover, any information that Mr. Rorech allegedly shared with Mr. Negrin regarding Deutsche Bank’s intention to recommend a holding company issuance was speculative information that does not rise to the level of materiality. First, there is no evidence that Deutsche Bank made, or that Mr. Rorech was informed of, any decision to recommend the holding company deal to the sponsors by the time of his cellular phone calls with Mr. Negrin. Second, the ultimate decision as to whether or not to actually issue a holding company tranche was up to the financial sponsors, not Deutsche Bank. Indeed, even if Deutsche Bank recommended a holding company issuance, the sponsors’ approval was far from guaranteed. Issuers regularly decline structural changes proposed by investors in high-yield bond offerings. Furthermore, there were additional issues discussed in the market that made a holding company issuance less likely notwithstanding a recommendation from Deutsche Bank, including tax and jurisdictional concerns. Given the inherently speculative nature of any information that Mr. Rorech possessed at the time of the cellular phone calls, the SEC has failed to prove by a preponderance of the credible evidence that the information was material.

See Glazer v. Formica Corp.,

964 F.2d 149, 155
(2d Cir.1992) (finding that mere fact that some discussion has occurred on matters that may not eventuate is not necessarily material).

b. Information Regarding Customers’ Indications of Interest

1. Nor was the fact that a customer had given an indication of interest for $100 million of holding company bonds material information. This information was not materially different from the information in the market that there was substantial investor demand for deliverable bonds.

2. Information about investor interest in, and demand for, deliverable bonds was widely discussed in the market. In fact, Mr. Barnum testified that because there was such strong demand, market participants expected that indications of interest or orders for deliverable bonds would be submitted to the underwriter, such that information about his particular indication

*412

of interest was expected and not different from the information in the market.

1. In addition, Ms. Tournier had assessed as early as July 12, based solely on publicly available information, that there was quantifiable demand in the market for deliverable bonds in the amount of Q100150 million, or more than $200 million.

2. As a result of the public knowledge of demand for deliverable bonds, Blue Mountain’s indication of interest in $100 million of potential holding company bonds was not sufficiently different from the general discussions in the marketplace at the time to be deemed material.

See Monarch Fund,

608 F.2d at 942-43
(finding that generalized information from insider about upcoming financing that was consistent with market rumors was not material nonpublic information).

1. Furthermore, where there is a question of whether certain information is material, courts often look to the actions of those who were privy to the information in determining materiality.

See Basic,

485 U.S. at 241
n. 18,
108 S.Ct. 978
(“[Trading (and profit making) by insiders can serve as an indication of materiality ....”) (emphasis omitted);

Texas Gulf Sulphur,

401 F.2d at 851 (noting that a “major factor in determining whether [discovery of mineral ore] was a material fact” was “the importance attached to the drilling results by those who knew about it”);

Rothberg v. Rosenbloom,

771 F.2d 818, 821
(3d Cir.1985) (“The best proof of the materiality of that information is that the ... experienced investors, found it to be sufficiently material ... to purchase [the] stock.”).

1. Here, the evidence does not establish that the information about Deutsche Bank’s recommendation and an indication of interest for holding company bonds was material information. Indeed, after learning of Mr. Fedorcik’s likely recommendation and after placing his own indication of interest, Mr. Barnum sold VNU CDSs. This demonstrates that the information in question was not viewed by reasonable investors as having “significantly altered the ‘total mix’ of [available] information.”

Basic,

485 U.S. at 231-32
,
108 S.Ct. 978
.

64.Under these circumstances, Mr. Rorech’s opinion about a recommendation and information about an indication of interest was not material information.

Bausch & Lomb, Inc.,

565 F.2d 8, 17
(2d Cir.1977) (finding that fact of company’s negative sales was “common knowledge” and thus was not material nonpublic information);

Hartford Fire Ins. Co. v. Federated Dep’t Stores, Inc.,

723 F.Supp. 976, 987-88
(S.D.N.Y.1989) (finding that company’s own view that it was likely to be target of takeover was not material nonpublic information where there was widespread speculation in the market that company was a likely takeover candidate).

1. Sharing the Information Mr. Rorech Did Know Was Not a Breach of His Duty of Confidentiality

2. Furthermore, Mr. Rorech did not breach his duty of confidentiality to Deutsche Bank either by sharing his opinion regarding whether Deutsche Bank would recommend that the sponsors issue the holding company bonds or by sharing his customer’s indication of interest.

3. One engages in “misappropriation” for purposes of insider trading laws when he engages in “conduct constituting secreting, stealing, or purloining ... [of] material nonpublic information in breach of an employer-imposed fiduciary duty of confidentiality.”

Carpenter,

791 F.2d at 1031
.

1. There cannot be liability under section 10(b) and Rule 10b-5 unless the owner of the information that was allegedly misappropriated expected the information to remain confidential.

See O’Hagan,

521

*413

U.S. at 647,
117 S.Ct. 2199
(emphasizing that both Grand Met and Dorsey

&

Whitney, O’Hagan’s employer, “took precautions to protect the confidentiality of Grand Met’s tender offer plans”);

Dirks v. SEC,

463 U.S. 646
, 655 n. 14,
103 S.Ct. 3255
,
77 L.Ed.2d 911
(1983) (in order for a fiduciary duty to be imposed on a temporary insider tipper, “the corporation must expect [him] to keep the disclosed nonpublic information confidential, and the relationship [between the corporation and the tipper] at least must imply such a duty”).

a. Information Regarding the Potential Restructuring

1. Deutsche Bank had no expectation that Mr. Rorech’s personal opinions or general information concerning the restructuring of the VNU bond offering would be kept confidential. Indeed, it was consistent with the custom and practice in the high yield bond market for Mr. Rorech, a salesperson, to share his ideas and opinions with Mr. Negrin, a prospective purchaser of the bonds.

2. Furthermore, the non-confidential status of the information Mr. Rorech possessed is confirmed by the fact that Deutsche Bank took no steps to ensure the confidentiality of the information. Pursuant to Deutsche Bank policy, capital markets officers, who are responsible for controlling the flow of confidential information from the private side of the Bank to the public side, cannot share confidential information with any public-side employee, including a salesperson, unless that individual is first “wall-crossed.” The capital markets officers who worked on the VNU bond offering openly shared information about the potential restructuring of the deal, including considerations of recommending a potential holding company issuance, with Mr. Rorech and other salespeople without ever instituting “wall-crossing” procedures.

b. Information Regarding Customers’ Indications of Interest

1. In addition, sharing information about other investors’ indications of interest or orders for deliverable bonds could not have breached a duty of confidentiality to Deutsche Bank because the information was not “confidential information” under Deutsche Bank’s policy and Deutsche Bank did not consider the information to be confidential. The investors who provided the indications of interest or orders did not expect that the information would be kept confidential; on the contrary, they anticipated that that their indications of interest or orders would be shared with others in the marketplace. (Tr. 540:10-541:9 (Mr. Sherry testifying that customarily investors did not expect their indications of interest to be confidential).) In fact, Mr. Barnum specifically said that he did not think that his order was confidential and that he wanted it to be used by Deutsche Bank to anchor the deal. (Tr. 830:15-20, 833:11-834:12.)

1. 1.At trial, Mr. Rorech testified that his use of the phrase "you’re listening to my silence right?” was "meaningless to [him].” (Tr. 1311:14-1312:2.)