A federal appeals court handed US prosecutors another big loss when they rejected Preet Bharara’s request to rehear the case which led to their overturning two key insider trading convictions last December, leaving the Department of Justice with few options.
In a three-sentence document issued Friday, the U.S. 2nd Circuit Court of Appeals rejected Preet Bharara’s petition to rehear the U.S. versus Newman insider trading case. Bharara requested that the three-judge panel that overturned the insider trading convictions of Anthony Chiasson and Todd Newman in December hear the case again in order to clarify certain specific legal issues.
In addition, Bharara’s request that the entire appeals court hear the Newman case (known as an en banc proceeding) was also denied by the 2nd Circuit Court of Appeals. The court did not provide any explanation for its decision to both requests.
Background of this Decision
In its December ruling, the appeals court concluded that government prosecutors presented “no evidence that Newman and Chiasson knew that they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.” The appeals court found that without this evidence, Newman and Chiasson could not be found guilty.
In other words, the court argued that to be convicted of insider trading a person must have direct knowledge that the insider providing the material non-public information was breaching his or her duty to the company by doing so, and that the source also received a significant benefit in exchange for the information they provided.
Impact of this Decision
The appeals court’s ruling effectively redefines insider trading making it much more difficult for the government to successfully win insider trading convictions – particularly when the investor is a few steps removed from the source of the tips.
Over the past few years, the US Attorney’s office in Manhattan obtained successful convictions (or guilty pleas) in more than 80 insider trading cases. However, we believe that the appeals court decision threatens to result in a number of insider trading convictions being reversed.
Probably the most high profile case that could be overturned as a result of this ruling is Michael Steinberg, a former SAC Capital portfolio manager, who was sentenced to three-and-a-half years in prison for insider trading. Steinberg, however, is not the only one who could benefit from the 2nd Circuit Court of Appeals ruling.
Former Goldman Sachs Group Inc. director Rajat Gupta, who is serving a two-year prison term for passing inside information to fund manager Raj Rajaratnam, has also asked that his conviction be reversed, citing the December appeals court ruling. That request is pending.
Hedge fund manager Doug Whitman, who is serving a two-year prison sentence after his insider trading conviction in 2012, recently filed a motion to vacate his conviction on similar grounds.
The appeals court ruling has already impacted other insider trading cases. Citing that decision, in January a district court judge vacated the guilty pleas of four defendants who were charged with insider trading related to IBM’s 2009 acquisition of software firm SPSS.
Next Steps for Preet?
So, what does U.S. attorney for Manhattan, Preet Bharara do now? The only obvious step would be to appeal the case to the U.S. Supreme Court. However, to do so, Bharara would need to get permission from the U.S. solicitor general. Most legal experts explain that this outcome is highly unlikely.
With this option seemingly off the table, Bharara might be forced to rely on a legislative solution to fix the redefinition of insider trading brought about by the 2nd Circuit Court of Appeals’ decision. Fortunately for him, at least three bills are currently being introduced in Congress to address this topic. This includes:
Insider Trading Prohibition Act: introduced by Congressman Jim Himes (D-CT) and co-sponsored by Steve Womack (R-AR), Carolyn Maloney (D-NY) and Emanuel Cleaver (D-MO).
Stop Illegal Insider Trading Act: co-sponsored by U.S. Senators Jack Reed (D-RI) and Bob Menendez (D-NJ).
Ban Insider Trading Act: introduced by Representative Stephen Lynch (D-MA).
Impact on the Research Biz
What does this all mean for sell-side and alternative research providers? We think in the short run these developments should reduce buy-side pressure and anxiety about receiving material nonpublic information from their research providers. In fact, third-party research firms might actually provide a useful buffer between information sources and the investor which reduces insider trading risk.
However, we think that any benefit that research firms might experience is likely to be short lived as momentum within Congress to pass insider trading legislation could resurrect concerns about unwittingly receiving MNPI among institutional investors. Consequently, we suspect that both sell-side and independent research firms will need to continue implementing controls to mitigate the risk of receiving and passing on illegal inside information to their customers.