Earlier this week, the SEC filed an amicus brief in support of the DOJ’s petition for rehearing en banc of the panel decision overturning two insider trading convictions in United States v. Newman. The Newman decision is discussed here: US v. Newman: 2d Circuit Hands Government Stunning, Decisive, and Far-Reaching Insider Trading Defeat. The DOJ’s petition for en banc review is discussed here: DOJ Petition for En Banc Review in Newman Case Comes Up Short. The SEC’s amicus filing did little to show why the Second Circuit should take the extraordinary step of reviewing en banc the unanimous panel decision. The SEC’s brief can be found here: SEC Amicus Brief in US v Newman.
The SEC started from the same flawed foundation as the DOJ, contending that existing law mandated that an insider “engages in prohibited insider trading” merely by “disclosing information to a friend who then trades.” SEC Brief at 1. That supposedly is “because that is equivalent to the insider himself profitably trading on the information and then giving the trading profits to the fried.” Id. This makes me want to scream out loud: Just because you say something over and over again does not make it true! This proposition leaves out the key requirement in the law, flowing directly from the language of the Supreme Court in Dirks v. SEC, that a tipper-insider must “personally … benefit … from his disclosure” (463 U.S. at 662), and that this benefit could arise out of “a gift of confidential information to a trading relative or friend” 463 U.S. at 664 (emphasis added). The DOJ and SEC continue to pretend that every disclosure of confidential information to a friend is of necessity, a “gift,” and therefore no further evidence is required to show that a “gift” was intended. In other words, the required “personal benefit” flowing to the tipper is conclusively presumed whenever the tippee is a “friend.” No aspect of Dirks suggests such a result.
The holding of the Newman court was not an extraordinary extension or expansion of the “personal benefit” requirement. The court did no more than examine the evidence – or actually, lack of evidence – of any real benefit flowing to the tippers in the case, and insist that there actually be such evidence before there is tippee liability, because, as Dirks made clear, there can be no tippee liability if there is no tipper liability.
This passage from Dirks makes that clear: “Determining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts. But it is essential, we think, to have a guiding principle for those whose daily activities must be limited and instructed by the SEC’s inside trading rules, and we believe that there must be a breach of the insider’s fiduciary duty before the tippee inherits the duty to disclose or abstain. In contrast, the rule adopted by the SEC in this case would have no limiting principle.” Dirks v. SEC, 463 U.S. 646, 664 (1983). As for the wisdom of allowing law enforcement authorities decide the lines to be drawn for enforcement actions, the Dirks Court wrote: “Without legal limitations, market participants are forced to rely on the reasonableness of the SEC’s litigation strategy, but that can be hazardous, as the facts of this case make plain.” Id. n.24.
True to this Supreme Court insight, ever since Dirks was decided, the SEC and DOJ have been trying to water down the “personal benefit” element of tipper liability to the point that they now argue that this element has no substance at all – mere proof of “friendship” – which, by the way, is itself an extraordinarily stretched concept, in the SEC and DOJ view – is all you need to show “beyond a reasonable doubt” that a tipper personally benefited from a disclosure. The law enforcement authorities have tried over many years to negate Dirks (and its predecessor decision Chiarella v. United States, which provided the foundation for Dirks) by stretching “personal benefit” to the point of near infinite elasticity if a “friend” is involved, and stretching the concept of “friend” to be the equivalent of “acquaintance.” The Newman panel simply said, in no uncertain terms, they’d had enough of this.
In this context, it is more than a little “rich” for the SEC to argue that the “panel decision also creates uncertainty about the precise type of benefit … an insider who tips confidential information must receive to be liable.” SEC Brief at 2. For years, the SEC has tried, mostly successfully, to make the standards of insider trading liability as amorphous as possible, and has resisted efforts to develop precise definitions. Its explanation for this is that if you give a precise definition, you allow someone to evade liability with sharp practices that fall outside of the definition. In the SEC’s view, the Commission and the Division of Enforcement should decide which trading practices should be unlawful, almost always in after-the-fact enforcement actions. They view themselves as “keepers of the faith,” who, of course, will always act in the public interest, and therefore do not need precise legal standards to govern their enforcement actions. Suffice it to say that many of us who have represented clients on the other side of SEC investigations do not have quite this level of confidence in the SEC staff’s determination of the “public interest.” That is in part because the Division of Enforcement is a huge aggregation of weakly-managed lawyers whose judgments on these issues are usually deferred to, but many of whom exercise questionable judgment, and give more weight to their personal views of the world than the actual evidence in the case. See, e.g., SEC Insider Trading Cases Continue To Ignore the Boundaries of the Law, and SEC Enforcement Takes Another Blow in SEC v. Obus.
Hence, the SEC believes that an argument for rehearing the Newman decision is that the SEC has brought many enforcement actions “where the only personal benefit to the tipper apparent from the decisions was providing inside information to a friend” and Newman’s insistence on evidence of “personal benefit” to the tipper beyond this would “impede enforcement actions.” SEC Brief at 12. But what if those prosecutions were overly aggressive under the law, as laid out in Dirks? The SEC is always trying to stretch the law so that it has increased discretion to determine what to prosecute “in the public interest” (and to get added leverage in efforts to force settlements of enforcement actions with questionable factual support). One example of this is the recent extraordinary effort of the Commission in In re Flannery and Hopkins to expand the scope of Rule 10b-5 by edict (not by rulemaking), and thereby negate the impact of the Supreme Court’s decision in Janus Capital Group v. First Derivative Traders, as discussed here: SEC Majority Argues for Negating Janus Decision with Broad Interpretation of Rule 10b-5.) The attempt to negate the “personal benefit” requirement, and expand the Dirks reference to “a trading relative or friend” beyond reasonable recognition, are part and parcel of that “we know it when we see it” approach to the law. But, especially in criminal cases, there is no place for allowing prosecutors such discretion and providing citizens no reasonable notice of the parameters of the law.
U.S. v. Newman does not represent a significant limit on the ability of the DOJ or SEC to bring meritorious insider trading claims. It merely requires that before tippees are held criminally liable, or subjected to severe civil penalties and employment bars, law enforcement authorities present evidence sufficient to support a finding that a tipper-insider actually benefitted from the tip, and that the defendants had the requisite scienter. If, as the SEC argues, friendship and “gifting” are almost inevitably synonymous, this is not a high burden, especially in SEC enforcement actions, which need only satisfy a “preponderance of the evidence” standard of proof.
January 29, 2015
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