With all of the publicity, hubbub, and hype surrounding the Second Circuit’s decision in United States v. Newman and Chiasson, a grant of writ of certiorari at the Government’s request is a foregone conclusion, right? In a word, “no.” The filings on the Government’s motion seeking certiorari make it pretty clear that if you remove the publicity, hubbub, and hype – and consider what the Newman opinion says, and not just what the Government portrays it as saying – the Supreme Court’s normal standards for hearing a case simply are not satisfied. Let me explain.
The Government’s entire push for Supreme Court review turns on two arguments: (1) the Second Circuit amended the Supreme Court’s decision in Dirks v. SEC by mandating that a tippee exchange tangible value for tipped material nonpublic information from the tipper, when Dirks says that “gifts” of such information by the tipper to the tippee can be sufficient to create liability; and (2) the Second Circuit’s revision threatens the integrity of the securities markets by undermining investors’ belief in the fairness of those markets. The briefing on certiorari, however, leaves little doubt that the Government cannot (or at least does not) provide support for either of these arguments. Instead, these arguments are based on (i) a reading of the opinion that ignores what the court said, and is not how the courts have treated the Newman opinion since it was issued; and (ii) ipse dixit assertions by the Government about the terrible consequences of Newman on markets and law enforcement, which lack any substantiation.
But beyond this, the briefing makes it clear that Newman simply is not the kind of case that the Supreme Court normally would review, for three reasons: (1) the ruling the Government asks for would not, in fact, change the result – Messrs. Newman and Chiasson will be not be prosecutable in any event because the Government does not seek review of determinative aspects of the Second Circuit opinion that prevent any conviction; (2) the aspect of the Newman decision that the Government does challenge is an evidentiary issue – not an important issue of law – that is limited in its impact, other than in support of the view that the actual evidence presented in a case matters, which the Supreme Court is unlikely to countermand; and (3) the ruling the Government asks for would make it difficult for investors and their advisers to gather and use information in ways the Dirks court sought to protect as critical to the functioning of an efficient marketplace.
The Supreme Court Usually Doesn’t Review Cases To Provide an Advisory Opinion
Let’s start with what should be the most important issue for a cert. petition: will Supreme Court review actually make a difference in the case. The answer here plainly is that it would not. Why? Well, the Government presents for review only a single question: “whether the court of appeals erroneously departed from this Court’s decision in Dirks by holding that liability under a gifting theory requires ‘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.’” Cert. Pet. at (I). But the Second Circuit reversed the convictions of Messrs. Newman and Chiasson for another, totally independent reason: that because this is a criminal case, a conviction required proof that the defendants knew that the information they used to trade securities was obtained through a breach of duty by an insider, and there was no evidence from which a reasonable juror could make such a finding. Because of this, even if the Supreme Court were to agree with the Government on its question presented, the defendants’ convictions would still be overturned. The Supreme Court typically does not accept cases in which its opinion, in effect, becomes an advisory opinion on the law and does not impact the determination of the case before it.
Here is how the Newman cert. opposition discusses this point:
The central legal holding in the court below was that insider trading liability requires a tippee to know that the tipper received a personal benefit. While the government opposed such a requirement in the trial court and on appeal, it does not challenge that ruling now. Instead, the Petition seeks review of a single, fact-based sufficiency determination regarding whether there was a personal benefit in the first place. Notably, the government’s articulation of the question presented addresses only the type of evidence required to prove a personal benefit; it does not implicate the court of appeals’ independent holding that Newman committed no crime because he did not know of the benefit. Accordingly, even if this Court were to agree with the government that the Second Circuit misstated the type of evidence required to support an inference of a benefit, the decision dismissing the indictment on the independent ground that Newman did not know of any benefit would stand.
The government understands, of course, that the Supreme Court does not grant review to issue advisory opinions. To overcome that obstacle, the government proposes that this Court “correct” the Second Circuit’s analysis of what evidence may be used to prove a personal benefit and then remand to the Second Circuit for reconsideration of both the sufficiency of whether there was a benefit and whether Newman knew of the benefit. Pet. 29-31. This attempted sleight of hand is unconvincing. The Second Circuit determined that, “[e]ven assuming that the scant evidence . . . was sufficient to permit the inference of a personal benefit,” the proof was insufficient to establish knowledge of any benefit because the defendants “knew next to nothing” about the insiders or the circumstances of their disclosures, and the government “presented absolutely no testimony or any other evidence that Newman and Chiasson knew . . . that those insiders received any benefit in exchange for such disclosures . . .” . . . . This conclusion was not based on a nuanced view of how personal benefit should be defined; it was based on the utter lack of evidence that the defendants knew of any benefit, however defined, or even the basic circumstances under which the disclosures were made. No decision by this Court on the narrow issue presented for review would change the ultimate disposition of this case.
Newman Cert. Opp. at 1-3.
The Second Circuit Decision Is Inaccurately Portrayed by the Government
Let’s turn now to the guts of the Government argument, and show why it fails because it is founded on a reading on the Newman opinion that is inaccurate and misleading.
The Government’s core argument is that the Second Circuit broke from Dirks by refusing to allow a “gift” from the tipper to the tippee to be considered a basis for the required breach of duty to support an insider trading violation:
The court of appeals’ decision is irreconcilable with Dirks. In the guise of interpreting this Court’s opinion, the court of appeals crafted a new, stricter personal-benefit test, stating that “[t]o the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades ‘resemble trading by the insider himself followed by a gift of the profits to the recipient,’ *** we hold that such an inference is impermissible in the absence of 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.” . . .
That new “exchange” formulation erases a form of personal benefit that this Court has specifically identified. Under Dirks, an inference of a personal benefit to the insider arises in two situations: when the insider expects something in return for the disclosure of the confidential information, or when the insider freely gives a gift of information to a trading friend or relative without any expectation of receiving money or valuables as a result. . . . The Second Circuit purported to recognize that second form of personal benefit . . . but then rewrote the concept of a “gift” so as to eliminate it. The court held that an insider cannot be liable on a gift theory unless he receives something from the recipient of information “that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature” . . . But such an “exchange” is, by definition, not the same thing as a “gift”; rather, it is a quid pro quo, “something for something.”
Cert. Pet. at 18-19.
This argument should fail because the Supreme Court Justices – and their clerks – should easily see that the Second Circuit decision does not say what the Government argument describes. The Government accepts that the entire discussion of “personal benefit” occurred as the Second Circuit “considered the sufficiency of the evidence that the . . . insiders personally benefitted from disclosing confidential corporate information,” and that in doing so, the court of appeals “acknowledged that in [Dirks, the Supreme] Court stated that ‘personal benefit’ includes reputational benefit and ‘the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend.’” Cert. Pet. at 11 (emphasis added).
The problem was that the Government introduced no evidence showing that in either of the two instances of alleged tipping (involving communications between insiders at Dell and NVIDIA with industry analysts they knew), the tipper either (a) received a tangible benefit in return, or (b) provided the information as a “gift.” Instead, the Government relied on the mere circumstances of the relationship between the alleged tippers and the alleged tippees to provide a sufficient inference of a “gift” to satisfy the breach of duty requirement laid out in Dirks. The Second Circuit rejected this effort because a review of the evidence showed no meaningful relationships between these people that would suggest that the insiders transferred information as an intended “gift” to the analysts.
The actual evidence showed that the relationship between the Dell insider and the analyst he spoke to was no more than that they knew each other at business school, spoke on limited occasions when they both worked at Dell, and that the analyst gave career advice to the insider that was not terribly meaningful. The evidence also showed that the communications between them were consistent with the insider’s job responsibilities to develop relationships with financial firms that could be a source for possible investors, and the insider was never told anyone was trading on information he provided. The NVIDIA insider attended the same church as the analyst he spoke to and sometimes had lunch with him. While the analyst said he sometimes traded NVIDIA stock, he never said he would use information they discussed to trade.
Based on this evidence, the Second Circuit proceeded to try to implement the Dirks duty standard, not revise that standard. As the Newman cert. opposition says: “the Second Circuit’s refusal to accept the mere fact of friendship as per se evidence that a tipper intended to bestow a gift on a tippee is consistent with, and indeed compelled by, Dirks.” Newman Cert. Opp. at 20.
Dirks said that “there may be a relationship between the insider and the recipient that suggests a quid pro quo . . . or an intention to benefit the particular recipient,” but said no more about the parameters of such a relationship. See Dirks, 463 U.S. at 663. The Dirks Court also said that an inference of personal gain to the tipper that would evidence the required breach of duty could flow “when an insider makes a gift of confidential information to a trading relative or friend” (id.), but said nothing about how to determine if such an inference is reasonable, except that such a circumstance could “resemble trading by the insider himself followed by a gift of profits to the recipient.” Id. The Dirks Court left it to lower courts to figure out how best to implement these principles. See id. The Second Circuit plainly was trying to work out when it might be reasonable to conclude that a communication of information is intended as a “gift” based solely on the nature of the parties’ relationship.
The Government’s argument turns on the appellate court’s use of the term “exchange”:
The court reinterpreted this Court’s holding that an insider personally benefits when he “makes a gift of confidential information to a trading relative or friend,” . . . to require “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.” . . . That holding cannot be reconciled with Dirks, which did not require an “exchange” to find liability for a gift of inside information and did not impose amorphous standards for the relationships that can support liability.
. . . .
Under Dirks, an inference of a personal benefit to the insider arises in two situations: when the insider expects something in return for the disclosure of the confidential information, or when the insider freely gives a gift of information to a trading friend or relative without any expectation of receiving money or valuables as a result. . . .
The Second Circuit purported to recognize that second form of personal benefit . . . but then rewrote the concept of a “gift” so as to eliminate it. The court held that an insider cannot be liable on a gift theory unless he receives something from the recipient of information “that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature” . . . . But such an “exchange” is, by definition, not the same thing as a “gift”; rather, it is a quid pro quo, “something 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 superfluous.
Cert. Pet. at 14.
This argument intentionally ignores the gist, and the actual language, of the Newman opinion. It begins by ignoring the paragraphs leading up to the quoted passage, which emphasize that the intent to gift confidential information to another person can be sufficient, but there needs to be evidence proving it. If that evidence is nothing more than the nature of the relationship between the parties, then that relationship has to be strong enough to warrant a reasonable inference that the information exchange was intended as a gift. Here is what the court said:
The circumstantial evidence in this case was simply too thin to warrant the inference that the corporate insiders received any personal benefit in exchange for their tips. As to the Dell tips, the Government established that Goyal and Ray were not “close” friends. . . . The evidence also established that Lim and Choi were “family friends” that had met through church and occasionally socialized together. The Government argues that these facts were sufficient to prove that the tippers derived some benefit from the tip. We disagree. If this was a “benefit,” practically anything would qualify.
We have observed that “[p]ersonal benefit is broadly defined to include not only pecuniary gain, but also, inter alia, any reputational benefit that will translate into future earnings and the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend.” . . . This standard, although permissive, does not suggest that the Government may prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature. If that were true, and the Government was allowed to meet its burden by proving that two individuals were alumni of the same school or attended the same church, the personal benefit requirement would be a nullity. To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades “resemble trading by the insider himself followed by a gift of the profits to the recipient,” see 643 U.S. at 664, we hold that such an inference is impermissible in the absence of 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 other words . . . this requires evidence of “a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter].”. . .
United States v. Newman, slip op. at 21-22 (emphasis added and some cites omitted).
This quote makes it apparent that to justify its argument, the Government badly, and misleadingly, truncates the Second Circuit discussion on this issue. The Government’s argument ignores language that makes it clear that the Second Circuit did not limit the “gift” concept to a tangible “exchange.” Instead, in the very paragraph the Government quotes, the court twice says that evidence showing a tipper’s intent to gift information to a tippee would be sufficient to satisfy the Dirks personal benefit standard — (i) including “the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend” as sufficient to show a personal benefit, and (ii) using the disjunctive “or” in describing the need for evidence of “a relationship . . . that suggests a quid pro quo . . . or an intention to benefit the [tippee].”
This makes it plain that the court was not excluding from the range of potentially sufficient evidence an “exchange” in which the tipper’s value received was consummating an “intention to benefit” the tippee. But there still needs to be evidence of that intention to benefit, and if that evidence is solely the relationship between the parties, proof of a “meaningfully close relationship” is important because relying solely on evidence of a “friendship . . . of a casual or social nature” would undermine the Dirks “personal benefit requirement” by making it an effective “nullity.”
(By the way, this explains why the Second Circuit reached a different result in Newman than the Ninth Circuit did in U.S. v. Salman. In Salman, there was direct evidence that the transfer of information was made with an intent to benefit the tippee, and even beyond this, the tipper and tippee where brothers, which is well beyond the kind of “casual” friendships at issue in Newman. In truth, Salman is not even a close case under the Newman standard. See In U.S. v. Salman, Judge Rakoff Distinguishes Newman in 9th Circuit Opinion Affirming Insider Trading Conviction. The Government’s argument that this represents a split in the Circuits is, with respect, laughable.)
This is how the Newman cert. opposition addressed this key point:
Dirks recognized that “[d]etermining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.” 463 U.S. at 664. By characterizing the inquiry as “a question of fact” the Court appreciated that lower courts would need to formulate rules for weighing the evidence in the particular circumstances before them. That is exactly what the Second Circuit did here. The court of appeals’ assessment of what kind of proof would support a factual inference is the type of evidence-based analysis that Dirks recognized would be within the province of the lower courts to develop.
Dirks also recognized that a personal benefit in the form of a gift is not simply a matter of whether a tipper gives inside information to a friend or relative. The Court repeatedly emphasized that it is the purpose of the disclosure that is determinative. E.g., 463 U.S. at 662 “Whether disclosure is a breach of duty therefore depends in large part on the purpose of the disclosure.”). . . . The Court’s focus on the purpose of a disclosure would be undermined if a jury were permitted to infer a personal benefit from the bare fact that two people knew each other. That is because it is not reasonable to presume that the purpose of communicating financial information between casual acquaintances is to provide a gift. Casual acquaintances typically do not give each other the kind of gifts contemplated by Dirks, i.e. the equivalent of the insider trading stock and gifting the proceeds to someone else. On the other hand gifts, especially of money, are much more likely among people who take a deep personal interest in each other’s lives, such as close friends or relatives. The Second Circuit’s evidentiary formulation is thus consistent with the gift theory as articulated in Dirks because it limits the inference of an intentional gift of trading proceeds to circumstances that reasonably support that conclusion.
Newman Cert. Opp. at 20-21.
So, what the Government cert. petition comes down to is a request that the Supreme Court re-examine the evidentiary record to determine whether the agreed-upon Dirks standard was satisfied in this case, even though that issue is not even case-determinative. That’s not the resolution of an important securities law issue, it is an effort to get the High Court to relieve the Justice Department of the embarrassment of being shot down for an overly-aggressive prosecution fueled more by ambition than evidence. That’s not cert.-worthy in my book.
There Is No Basis To Expect Harmful Market Consequences from the Newman Decision
The Government’s last argument in support of certiorari – that absent Supreme Court reversal the securities markets and securities law enforcement will be devastated by the purportedly “new,” limited scope of the insider trading prohibition adopted in Newman – fails for multiple reasons.
First, as discussed above, The Newman court did not limit the scope of the law as stated by Dirks. It tried its best to articulate an evidentiary standard for satisfying the Dirks “personal benefit” standard in the narrow circumstances where there was no quid pro quo from tippee to tipper, and there was no evidence of an intended “gift” from the tipper to the tippee apart from the nature of their relationship.
Second, the Government cited no empirical data even suggesting that requiring evidence of a “meaningfully close relationship” between tipper and tippee to prove insider trading fraud in such cases would harm investor confidence or undermine the overall integrity or efficiency of the securities markets. Both the Newman and Chiasson cert. oppositions lay out the facts showing that since the Newman decision, Government insider trading cases have not failed because of Newman. See Newman Cert. Opp. at 27-30; Chiasson Cert. Opp. at 30-33. Such unsupported “sky is falling” predictions are hardly the grounds for granting certiorari. In fact, Dirks itself undermines this Government argument, because the Dirks opinion warned against low standards for proving insider trading fraud based on communications with securities analysts, whose purpose is to ferret out information and incorporate it into the market:
Imposing a duty to disclose or abstain solely because a person knowingly receives material nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes is necessary to the preservation of a healthy market. It is commonplace for analysts to ‘ferret out and analyze information,’ . . . and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that the analysts obtain normally may be the basis for judgments as to the market worth of a corporation’s securities. The analyst’s judgment in this respect is made available in market letters or otherwise to clients of the firm. It is the nature of this type of information, and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporation’s stockholders or the public generally.
Dirks, 463 U.S. at 658-59 (footnotes and cites omitted). Dirks makes it clear that “objective facts and circumstances” must provide evidence of misconduct, especially when we are dealing with communications of information between businesses and analysts. The Newman opinion is a step in the direction Dirks espoused, made with due regard for the fact that communications of the nature involved in Newman provide the foundation for efficient securities markets.
In Contrast, the Government’s Proposed Rule Would Undermine the Securities Markets
As we have written before, it has long been the Government’s view that the securities laws should be interpreted to mandate equal access of information to all investors, even though that concept is inconsistent with market efficiency, and even market fairness. (Market efficiency depends on dissemination of information. Market fairness is undermined when preventing the dissemination of information causes securities transactions to be completed on the basis of incomplete information, and the consequential mispricing of the securities traded.) See The Myth of Insider Trading Enforcement (Part I), and SEC Insider Trading Cases Continue To Ignore the Boundaries of the Law. The Government’s cert. petition continues to reflect this bias, notwithstanding the fact that the Supreme Court has rejected this view repeatedly, including this quote from Dirks itself:
Here, the SEC maintains that anyone who knowingly receives nonpublic material information from an insider has a fiduciary duty to disclose before trading. In effect, the SEC’s theory of tippee liability in both cases appears rooted in the idea that the antifraud provisions require equal information among all traders. This conflicts with the principle set forth in Chiarella that only some persons, under some circumstances, will be barred from trading while in possession of material nonpublic information. Judge Wright correctly read our opinion in Chiarella as repudiating any notion that all traders must enjoy equal information before trading: ‘[T]he ‘information’ theory is rejected. Because the disclose-or-refrain duty is extraordinary, it attaches only when a party has legal obligations other than a mere duty to comply with the general antifraud proscriptions in the federal securities laws.’ . . . We reaffirm today that “[a] duty [to disclose] arises from the relationship between parties . . . , and not merely from one’s ability to acquire information because of his position in the market.”
Dirks, 463 U.S. at 656-58 (footnotes and cites omitted).
This bias is reflected in the Government’s revisionist view that Dirks was consistent with the view that communications between what the Second Circuit called “casual” friends should be sufficient to satisfy the “breach of duty” requirement, and suggesting that in such cases, the burden should shift to the accused to show that “selective disclosures” had “a valid business purpose” or were a “mistake.” That view, if accepted, would greatly impact the nature of communications between and among securities analysts, and would undermine market efficiency and fairness by presuming every communication of information between acquaintances is unlawful absent their ability to prove otherwise. This is what the Government says:
Dirks recognizes that not all selective disclosures of confidential information trigger the disclose-or-abstain-from-trading rule. . . . It explains that if an insider has a valid business purpose for selective disclosure (for instance, supplying data to another company in the course of merger talks), or mistakenly believes that information is not material or is already in the public domain, disclosure does not violate the insider’s fiduciary duties. . . . The fact that analysts (or others) may be friends with company insiders does not automatically preclude such a legitimate business reason for disclosure.”
Cert. Pet, at 21.
In fact, Dirks makes it crystal clear that the burden falls on the Government to prove that even communications between friends or acquaintances rise to the level of a breach of duty that could support an insider trading fraud finding. The Chiasson cert. opposition addresses this attempted Government sleight-of-hand:
Finally, at the close of its discussion of Dirks, the Government tips its hand. The Government’s problem is not really with the decision below; it is with Dirks itself. The Government asserts (at 21) that an insider violates his fiduciary duty by disclosing information unless the insider “has a valid business purpose for selective disclosure” or “mistakenly believes that information is not material or is already in the public domain.” But that turns Dirks on its head. Dirks does not require the insider to prove some “legitimate” reason for his disclosure to avoid liability. . . . To the contrary, under Dirks, an insider is not liable unless the Government proves that “the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders.” . . . And the circumstances under which an insider may disclose information without receiving a personal benefit are hardly limited to the two scenarios the Government acknowledges. The Court in Dirks made clear that mistaken disclosures were only an “example” of the type of disclosure that would not constitute a breach. . . . Even disclosures that violate company policy or confidentiality obligations are not necessarily made for the insider’s personal benefit. . . . The Government may wish to pursue prosecutions that go beyond what Dirks contemplated, but that is no reason to revisit precedent that has been on the books since the Burger Court.
Chiasson Cert. Opp. at 19-20.
It seems especially strange that the Government is pursuing this argument in the context of a case with facts that seem so close to the kind of communications that Dirks wanted to protect. The evidence here is that securities analysts were discussing company performance with company officials. That’s what analysts are supposed to do. The evidence is also that for at least one of these companies — Dell — the insider’s job was to stay in touch with, and develop relationships with, market analysts who could ultimately be a source of investors. The communications were not known to be for the purpose of trading. This strikes me as precisely the kind of communications between company insiders and outside analysts that Dirks wanted to enshrine, not attack. It truly seems like it is the Government that is trying to alter Dirks, not the Second Circuit.
* * *
The flaws in the Government’s argument in support of granting the writ of certiorari are manifold and serious. One normally expects the Justices and their clerks to recognize this, even when the proponent of the writ is the Government. Yet, it remains possible that all of the brouhaha over the Newman decision – much of which can be traced to the Government’s own hissy fit over losing these cases (which are certainly marginal at best) – will drive the Court towards granting cert. This person’s view is that if this happens, the Government will regret the decision to elevate this case. There is much more potential for downside for the Government than upside, because when the Court further specifies the elements of insider trading fraud under section 10(b) and Rule 10b-5, the Government’s discretion to pursue its favored “equality of information” policies is likely to become more, rather than less, constrained.
September 3, 2015
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