Last week, the US Department of Justice asked the Supreme Court to reverse two insider trading convictions which were overturned in December by an Appeals Court in a particularly huge blow against the government’s war on insider trading.
Government’s Filing
On Thursday, US Solicitor General Donald Verrilli filed a petition asking the Supreme Court to reinstate the convictions against hedge fund managers Todd Newman and Anthony Chiasson which were overturned by the Second Circuit Court of Appeals in December, 2014 (U.S. vs Newman).
In recent months it had been unclear whether the solicitor general’s office would take the case to the Supreme Court, as many felt the government could not win given the current makeup of the high court. US Attorney for Manhattan, Preet Bharara, who has led the government’s war against insider trading with more than 80 convictions, lobbied to have the case brought before the Supreme Court.
In his petition, Mr. Verrilli expalined his decision to file the petition, “The effect of the new rule will be to hurt market participants, disadvantage scrupulous market analysts and impair the government’s ability to protect the fairness and integrity of the securities markets. Those harmful consequences warrant this court’s review and reversal of the court of appeals’ effort to rewrite this court’s decision.”
Four of the nine Supreme Court justices must agree to hear the case before it can be considered. The court won’t be back in session until October.
2nd Circuit Ruling
In its December 2014 ruling, the Second Circuit Court of Appeals concluded that US government prosecutors had 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.
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 “pecuniary benefit” in exchange for the information they provided.
Click here for Integrity’s analysis of the Second Circuit Court of Appeals’ decision.
Split Develops
One of the possible reasons US Solicitor General Donald Verrilli decided to petition the Supreme Court to take up the case is because last month, the Ninth Circuit Court of Appeals upheld an insider trading case, despite the fact that the tipper didn’t receive any “pecuniary benefits” from providing inside information.
The California District Appeals court heard the case of Bassam Salman’s insider trading conviction. Salman, who allegedly made $5.0 million in profits trading off illegal tips that came indirectly from a Citigroup investment banker named Maher Kara (U.S. vs Salman). Salman appealed the lower courts conviction arguing that Kara didn’t make any money by providing the tips, and so he received no “pecuniary benefit.” Salman argued that this meant he could not be convicted of insider trading.
However, the presiding judge in the case, Judge Jed Rakoff, did not agree with this argument. He and his fellow panel members concluded that the Supreme Court had already answered the question of what constitutes a personal benefit to tippers in its 1983 Dirks vs the SEC decision, which said that a tipster benefits when he or she “makes a gift of confidential information to a trading relative or friend.” Rakoff saw this scenario as directly relevant to tipper Maher Kara’s actions, consequently they upheld Salman’s conviction.
In their written opinion, Rakoff and the 9th Circuit also addressed the issue of whether the 2nd Circuit’s ruling in the Newman case narrowed the Dirks definition of a personal benefit. “To the extent Newman can be read to go so far, we decline to follow it,” the Salman opinion said. “Doing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an ‘insider makes a gift of confidential information to a trading relative or friend.’”
This ruling prompted some in the legal profession to conclude that the decisions by the 9th Circuit in the Salman case and 2nd Circuit in the Newman case established a potential split that could only be resolved by the Supreme Court.
Government’s Argument
It appears that U.S. Solicitor General Verrilli agrees with Judge Rakoff’s Salman opinion. In its petition to the high court, Verrilli argues that the Second Circuit’s “unprecedented ruling” reinterpreted the Supreme Court’s prior decision in Dirks v. SEC that an insider can personally benefit if he “makes a gift of confidential information to a trading relative or friend.” Newman changed this standard dramatically by requiring “proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”
In its petition, the U.S. argues that the Second Circuit’s opinion requiring an “exchange” to show that a tipper personally benefited (and thus violated insider trading laws) conflicts with the Dirks ruling where a tipper’s mere “gift” of inside information can be sufficient to establish liability.
Verrilli contends that an “exchange” is, by definition, not the same as a “gift”. Instead, it is a quid pro quo where “something is provided in return for something.” If the personal-benefit test cannot be met by a gift-giver unless an “exchange” takes place, then Dirks’s two categories of personal benefit are collapsed into one — and the entire “gift” discussion in Dirks becomes meaningless.
Our Take
So clearly, SCOTUS has an important decision to make. First, it will need to decide whether it is willing to hear the Newman case based on the Solicitor General’s arguments. We suspect the high court will agree that the potential split caused by the 2nd Circuit and 9th Circuit Courts’ decisions should be clarified (after all, only 4 justices need to agree to hear the case). However, it is not a foregone conclusion how the Supremes will decide on this case.
First, recent opinions written by several of the Supreme Court justices indicate that they don’t agree with the government’s aggressive approach towards financial crimes. Unfortunately for Verrilli, the number of judges who are not supportive of the government’s proactive approach towards these crimes would make it almost impossible to overturn the 2nd Circuit Court’s Newman decision.
However, the substance of the case is also not a clear winner for the government. Even Judge Rakoff, who upheld the insider trading conviction in the Salman case, has argued that the opinions in the Newman and Dirks cases are not inconsistent.
Recently, in refusing to overturn Rajat Gupta’s insider trading conviction, Rakoff explained that Gupta’s legal team had misread the Newman opinion. Rakoff said that based on the Newman decision, “a tipper’s intention to benefit the tippee is sufficient to satisfy the benefit requirement so far as the tipper is concerned, and no quid pro quo is required.” Rakoff added that this is in line with Dirks, and it is also consistent with the 9th Circuit opinion reached in the Salman case.
What all of this means is that the U.S. government will be hard pressed to win its case reversing the overturning the Newman decision, even if the High Court decides to hear it. Ultimately, this could be bad news for the government’s war on insider trading as a number of prior convictions could also be overturned if SCOTUS upholds the 2nd Circuit’s decision. In addition, the government will find it increasingly more difficult to win future insider trading cases where the tippee does not receive an obvious financial benefit.