Tag Archives: Newman en banc petition

Chiasson Opts for Mocking Tone in U.S. v. Newman Brief

Counsel for defendant Anthony Chiasson used a rhetorical mocking tone in the appellate brief filed on his behalf in response to the DOJ’s petition for rehearing en banc in United States v. Newman.  The brief opens by likening the DOJ to “Chicken Little” screaming “the sky is falling,” arguing that the Government’s rehearing petition “echoes Chicken Little’s complaint.”  It then declares that the DOJ’s “tone is less that of a frightened hen and more that of a petulant rooster whose dominion has been disturbed.”  The brief later takes a rhetorical shot at the SEC: “The SEC, like “Turkey Lurkey” in the “Chicken Little” folk tale, joins in the lament that the regulatory “sky is falling.”  (Dropping a footnote to explain who Turkey Lurkey is seems more than a little self-indulgent.)  A copy of the Chiasson brief can be found here: Brief of Anthony Chiasson in opposition to DOJ Petition for Rehearing en banc in U.S. v. Newman and Chiasson.

An appellate brief is not a blog post (where we have in the past taken the Government for “sky is falling” arguments: see SEC’s Amicus Brief in U.S. v. Newman Fails To Improve on DOJ’s Effort).  Rhetoric rarely is the winning play in an appellate brief, and ridicule is a dangerous way to play the upper hand in an appellate dispute with the Government.  That is especially so when a “just the facts ma’m” approach seems well-tailored to win the day.

Fortunately, the Chiasson brief does come back down to earth to present compelling arguments in favor of denying the rehearing petition.  The brief does point out in its first section that “contrary to the government’s argument, the Opinion leaves intact the rule that the government can prevail if it shows that the tipper made a gift of material nonpublic information to a friend, anticipating and intending that the friend would trade on the information and earn trading profits. . . .  However, the mere existence of a friendship, and the disclosure of information to a friend, is not enough.  There must be either the expectation of a quid pro quo or the intention that the recipient trade on the information and reap profits.  This analysis is faithful to Dirks and its progeny.”  Chiasson Brief at 6-7.  And it also captures the key flaw in the DOJ’s approach to the “personal benefit” requirement: “In its Petition, as in its prior briefing, the government ignores the central point of Dirks, which identifies the tipper’s exploitation of confidential information for personal benefit as the gravamen of culpable insider trading.  Rather than accepting this rule of law, which has been stated more than once by the Supreme Court, the government apparently wishes to water down the meaning of ‘personal benefit’ so that, as a practical matter, it can bring insider trading charges whenever someone trades on material nonpublic information that is disclosed without authorization by a company insider.”  Id. at 7-8.

Most importantly, the brief emphasizes that an insider trading section 10(b) violation must be anchored in fraud, noting that conduct that “may violate corporate policy or the SEC’s Regulation FD” but still not be “fraudulent self-dealing under Dirks and its progeny, and does not open the door to prosecution for insider trading.”  Id. at 8.  They might have added that the “personal benefit” requirement is what converts the conduct to fraud, which requires deceit to obtain property or its equivalent.

All of this harkens back to the decision in Dirks v. SEC itself.  The DOJ and SEC arguments in Newman effectively seek a Second Circuit imprimatur that they may elide the Dirks opinion.  The Dirks Court noted that the requirement was critical to assure there were limits on the breadth of insider trading enforcement actions, which the DOJ and SEC are now trying desperately to avoid: “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).  Lest this not be perfectly clear, the Dirks Court added by footnote: “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.  Chiasson or Newman might well add: “as the facts of this case make plain as well.”

The Chiasson brief goes on to explain why the DOJ provides no valid reason for a rehearing to reconsider the analysis of the evidence of personal benefit in the panel decision.  This is especially so as to the lack of any evidence of knowledge by Messrs. Newman or Chiasson of any possible personal benefit that may have flowed to the original tippers.  As the brief points out: “The government now explicitly declines to challenge” the key holding “that a tippee must know that an insider has disclosed material nonpublic information in exchange for personal benefit in order to commit insider trading.”  Id. at 2.

Finally, the brief does a good job of laying waste to the Government’s contention that the Newman decision “threatens the integrity of the securities markets” (albeit with unnecessary recurring references to Chicken Little).  The brief points out that virtually all of the DOJ’s and SEC’s traditional insider trading cases are unaffected by the Newman decision.  It goes on: “It is only recently that the government has decided to push the doctrinal envelope, and bring cases in which tippers have not been charged with criminal acts and the defendants are remote tippees who are ignorant of the circumstances attending the tippers’ disclosure of material nonpublic information.  To the extent that convictions are jeopardized because the government cannot prove that the tippees knew that the tippers were receiving a personal benefit . . . the government is not in a position to complain.  The Court has determined that such knowledge is required, and the government has explicitly decided not to contest this holding on rehearing.”  Id. at 19.

In the finale, Chaisson argues that “there is no indication” that the Government intends to abide by the law as stated by the Supreme Court.  It chastises the DOJ for taking conflicting positions in its insider trading cases, which “reflects either its confusion about insider trading doctrine or, worse, its inclination to take whatever legal position serves its immediate interest in a particular case.  At best, it illustrates that the government’s legal analysis about the subtleties of insider trading jurisprudence should be taken with a considerable grain of salt. The law as depicted in the brief that the government filed in this case—on a point with which this Court agreed—is now portrayed as something that is not the law and never was the law!” (Violating the sound practice that one never, never uses an exclamation point in an appellate brief.)

The conclusion is as it should be, pointing out that any “confusion” in the law could and should easily be handled by the SEC in its rulemaking capacity: “[T]o the extent that the government and the SEC do sincerely believe that their enforcement agendas are threatened by the decision in this case, the SEC can promulgate a regulation either implementing a different formulation of the ‘personal benefit’ requirement or defining what constitutes fraudulent insider trading.  Having failed for more than 50 years to issue a regulation that defines insider trading, it is remarkable that the agency now comes before this Court to complain about ‘confusion’ in insider trading jurisprudence.  If there is any ‘confusion,’ it results mainly from the SEC’s refusal to use its authority to promulgate an appropriate regulation.  It has been content instead to leave the job of defining insider trading to the courts, basking in the freedom to bring cases on a ‘we know fraud when we see it’ basis.  Having left to the courts the job of articulating the meaning of insider trading, the SEC should not now be heard to complain about ‘confusion’ when it gets a result that it does not like.”

One hopes and expects that the Second Circuit judges will look past the questionable rhetorical flourishes and focus on the strong substantive arguments laid out in the Chiasson brief.

Straight Arrow

February 22, 2015

Contact Straight Arrow privately here, or leave a public comment below:

Mark Cuban Amicus Brief Puts U.S. v. Newman Insider Trading Prosecution in Proper Context

Mark Cuban recently filed an amicus brief in the Second Circuit, addressing the DOJ petition for rehearing en banc, which provides helpful context amid the flurry of arguments made by the DOJ and SEC about the United States v. Newman panel decision.  The Cuban brief dismantles the prosecutors’ notion that the Supreme Court’s decision in Dirks v. SEC made every transfer of material inside information from one “friend” to another a sufficient basis for convicting the recipient for violating section 10(b) of the Securities Act of 1934 if there is a trade made in possession of that information.  We previously discussed the flaws in the DOJ and SEC contentions here: DOJ Petition for En Banc Review in Newman Case Comes Up Short, and here: SEC’s Amicus Brief in U.S. v. Newman Fails To Improve on DOJ’s Effort.  The Cuban brief is available here: Mark Cuban Amicus Brief in US v. Newman.

One very helpful aspect of the Cuban brief is to put insider trading law into its proper historical context.  We began to do this in one of our early posts: The Myth of Insider Trading Enforcement (Part I),  That post described how a statute that never barred insider trading was converted by SEC and judicial fiat into one that prohibited trading that the SEC thought was inequitable.  Regrettably, that discussion ends just before the critical Supreme Court decision in Chiarella v. United States, which represented the Supreme Court’s first effort to bring high-flying theories of insider trading liability endorsed by the SEC and the Second Circuit back to earth.  In particular, the long-standing effort of the SEC to found insider trading fraud on the concept of equal access to information, rather than conduct that constitutes fraud, was — or should have been — halted by the Chiarella decision.  The Cuban brief goes into some of this history, explaining how the SEC and DOJ have consistently tried to expand the scope of what is unlawful based on theories of equity among investors, rather than what section 10(b) actually does, which is to prohibit fraud in connection with securities trades.

In many respects, the Cuban brief follows and expands on our “Myth of Insider Trading” analysis (which perhaps explains why we like it):

While Congress was aware of concerns regarding insider trading at the time the Securities Exchange Act of 1934 was enacted, see, e.g., Donald Cook & Myer Feldman, Insider Trading under the Securities Exchange Act, 66 Harv. L. Rev. 385, 386 (Jan. 1953), the Act addresses only a narrow subspecies of insider trading – namely, where a director, beneficial owner, or officer personally achieves shortswing profits by using nonpublic information to make both a purchase and a sale of company stock within six months of each other.  Securities Exchange Act of 1934,404, tit. 1, § 16(b) (codified as amended at 15 U.S.C. § 74p(b)).  And even in that situation, only the company (or a shareholder acting derivatively on behalf of the company) may sue for disgorgement; there is no criminal liability, and the SEC may not bring an action to enforce the prohibition.  Id.

Despite the lack of Congressional proscription (or even intent) regarding insider trading beyond the limited context of section 16(b), the SEC has not hesitated to argue that section 10(b)’s fraud provision and Rule 10b-5 broadly proscribe “insider trading.”  Addressing the issue in In the Matter of Cady, Roberts & Co., 40 S.E.C. 907 (1961), the SEC held that a trader committed a fraud – and thus violated Rule 10b-5 – whenever he or she traded while knowing material nonpublic information that the counterparty did not.  In effect, the SEC demanded a parity of information between traders: A trader either had to disclose his informational asymmetry or abstain from trading. See Chiarella v. United States, 445 U.S. 222, 227 (1980).

This expansive view of insider trading had little basis in the Exchange Act – indeed, it went well beyond Congress’s narrow proscription in section 16(b) against short-swing trades by a limited group of insiders.  The SEC nevertheless managed to convince lower courts – including this one – to adopt its “disclose or abstain” rule, and many successful (but baseless) insider trading actions were brought accordingly.  See, e.g., SEC v. Tex. Gulf Sulfur Co., 401 F.2d 833 (2d Cir. 1968).

The SEC pressed its flawed parity-of-information rule for nearly two decades. It jettisoned the rule only when the Supreme Court reversed a decision of this Court to hold that information parity is “inconsistent with the careful plan that Congress has enacted for regulation of the securities markets.”  Chiarella, 445 U.S. at 235.  The Chiarella Court explained that Congress did not outlaw all forms of insider trading but only those that constitute fraud.  IdTrading on nonpublic information is fraudulent only when the investor has an independent duty under the common law to disclose that information or abstain from trading. Id. By contrast, the SEC’s parity-of-information rule had created a “general duty between all participants in market transactions to forego actions based on material, nonpublic information” and thus “depart[ed] radically” from both the Exchange Act and established fraud doctrine.  Id. at 233.

Despite the setback in Chiarella, the SEC continued to press for expanded insider trading proscriptions.  Three years after Chiarella, the Supreme Court again took up the issue in Dirks v. SEC, 463 U.S. 646 (1983).  There, the SEC had charged an analyst with insider trading after he had received and passed on to traders information from insiders concerning corruption at a financial firm.  Id. at 648-49.  The SEC’s position was that the analyst automatically inherited the insiders’ common law duty not to trade on confidential information by virtue of having received information from those insiders . Id. at 655-56. In other words, the SEC believed that every tippee is subject to the parity-of-information rule. Id.

Once again, the Supreme Court rejected the SEC’s view of insider trading as overly expansive. After repeating Chiarella’s holding that there can be no liability for insider trading unless there is a fraud, id. at 666 n.27, the Court held that a tippee does not per se acquire a duty to disclose or abstain whenever he acquires insider information, id. at 659. To the contrary, a tippee “assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.”  Id. at 660 (emphasis added); see also Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 313 (1985) (explaining that Chiarella and Dirks make clear that “a tippee’s use of material nonpublic information does not violate § 10(b) and Rule 10b-5 unless the tippee owes a corresponding duty to disclose the information”).

History thus demonstrates that the SEC and DOJ will relentlessly push to expand the outer limits of what constitutes insider trading until they are reined in. But expanding the reach of the insider trading laws is Congress’s purview. . . .  And time and again, Congress has declined to define insider trading.

Cuban Brief at 5-9 (footnotes and some citations omitted).

The Cuban brief also provides some history about the failure of Congress to provide any definition of what falls inside, and outside, of an insider trading prohibition.  Despite continuing uncertainty about what is and is not lawful conduct, no clarification of the law has ever occurred, although numerous unsuccessful efforts were made.  See the Cuban Brief at 9-12.  Of course, the SEC has always had it within its power to use the rulemaking process to create more clear parameters of what is and is not prohibited.  It has never done so, in no small part because the SEC has no desire to have a clear standard that would limit the ability of law enforcement authorities to exercise wide discretion effectively to legislate the scope of what is prohibited through enforcement actions.  See our post: SEC Insider Trading Cases Continue To Ignore the Boundaries of the Law.

The Cuban brief sums up well where this leaves the state of insider trading law:

[T]he ambitious stance of the Department of Justice (egged on by the SEC in its own cases) [is] to take every opportunity to seek an expansion of the parameters of prohibited insider trading by bringing claims based on novel theories for which there is no precedent.  Without definitive guidance as to what is a violation and what is not, well-meaning innocent individuals are left in the untenable position of having to worry that what is (and should be) a lawful transaction today will suddenly be alleged by the Government to violate the federal securities laws tomorrow.

The Government, in its ever-broadening campaign against insider trading, seems to have lost sight that its underlying goal should be to assure that the markets are fair and equitable so that companies and investors are able to participate with confidence, thus encouraging capital formation. Companies need capital to grow, and investors need to know that the companies in which they invest, and the markets in which they transact, will treat them fairly. Pursuing individuals under novel theories does nothing to improve the fairness of the markets.

Cuban Brief at 2-3 (footnote omitted).

Our previous posts on Newman explain that the panel decision did not open the floodgates for insider trading or impose any new great burden on the DOJ or SEC to prove violations of section 10(b).  But even if the DOJ’s and SEC’s “sky is falling” prediction in their rehearing filings with the Second Circuit were right, reconsidering the Newman decision is not the solution to that problem.  The solution is a studied effort to define what is and is not unlawful and provide certainty in this area of the law that prevents fraud but allows trading markets to function fairly and efficiently.

Straight Arrow

February 20, 2015

Contact Straight Arrow privately here, or leave a public comment below: