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Supreme Court Filings in U.S. v. Newman and Chiasson Leave Serious Doubts on Grant of Certiorari

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 filings on the petition for certiorari can be read here: Petition for Writ of Certiorari in US v. Newman; Newman Opposition to Cert. Petition; Chiasson Opposition to Cert. Petition.

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 ConvictionThe 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.

Straight Arrow

September 3, 2015

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DOJ Petition for En Banc Review in Newman Case Comes Up Short

On January 23, 2015, the Department of Justice filed its petition for rehearing en banc in United States v. Newman.  A copy of that submission is available here: US v Newman Petition for En Banc Review.  Our previous discussion of the unanimous panel opinion can be read here: US v. Newman: 2d Circuit Hands Government Stunning, Decisive, and Far-Reaching Insider Trading Defeat.  The brief argues for review on several grounds.  Individually and together, they do not provide a basis for granting en banc review.  (On the standards for en banc review, see the linked article: Once More Unto The Breach — Rehearing In Newman?)

First, the DOJ argues that the 2d Circuit panel got it wrong because it misstated the appropriate standard for determining whether a tipper received a “benefit” in return for his or her tip:

The Panel’s holding on the definition of “personal benefit” in insider trading cases—specifically, that illegal insider trading has occurred only when an insider-tipper’s deliberate disclosure of material non-public information was for pecuniary gain or was  part 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”—cannot be squared with governing Supreme Court precedent, conflicts with prior holdings of other circuits and this Court, and defies practical application.

Petition at 10-11 (citation omitted).

The support for this argument is founded entirely in the contention that the panel misread the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983).  The brief points to statements in Dirks that the required personal benefit may be “direct or indirect,” that it need not be monetary, that “there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient,” and that it could be “a gift of confidential information to a trading relative or friend,” as “[t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”  Petition at 11 (quoting from Dirks, 463 U.S. at 663-64).  The DOJ brief argues that although the panel decision acknowledges Dirks‘s language, “it added an unprecedented limitation” that effectively upended Dirks: “‘To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee,’ the Panel held, ‘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.'”  Petition at 12 (quoting Newman).  The DOJ calls this “flatly inconsistent with Dirks.”  Id. at 13.

But the DOJ brief then departs from the actual Dirks language to make the argument that “the mere fact of friendship” could be enough to satisfy the Dirks requirement: “The Opinion says that Dirks ‘does not suggest that the Government may prove the receipt of a personal benefit by the mere fact of a friendship.’  But that is in fact precisely what Dirks says, see Dirks, 463 U.S. at 664 (benefit can be ‘a gift of confidential information to a trading relative or friend’).”  Petition at 13 (citation omitted).  The quote from Dirks does not support the view that a “mere fact of friendship” can satisfy the requirement —  the evidence of friendship must be accompanied by evidence that the transmittal of information was “a gift” to the tippee.  The difference between “mere facts of friendship” and evidence supporting a “gift” or “personal benefit” was critical to the Newman decision and, at least in this part of its discussion, the DOJ ignores it.

The DOJ argues in this section that the Newman court “nullifies” part of the Dirks  benefit test by “replacing it” “with a set of novel, confounding criteria for the type of ‘exchange’ that will now be required before an insider’s deliberate transmission of valuable inside information to a friend or relative could be punishable under the laws against insider trading.”  Petition at 14.  But the Newman opinion plainly does not “replace” the Dirks standard — it tries to explain how to apply the standard in the face of negligible evidence of either a “gift” or a “personal benefit.”  The Newman court’s statement that showing a benefit to the tipper requires 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” is made in the context of no other evidence of a benefit to the tipper or an intent to “gift” the information to the tippee.  In that context, the language is perfectly consistent with the statements in Dirks that “there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient,” and that the benefit requirement could be met by showing “a gift of confidential information to a trading relative or friend,” which would make the tip and trade “resemble trading by the insider himself followed by a gift of the profits.”

The DOJ petition does not address the key aspect of this portion of the Newman holding: that under Dirks, it was impermissible to allow a conviction for insider trading based on a “benefit” concept that is so broad and diffuse that it becomes no standard at all.  The court’s quoted language was an effort to make it clear that a real benefit must be shown, not just “the mere fact of friendship,” and that is plainly consistent with, and in furtherance of, the Dirks holding.  The DOJ’s brief paragraph on that issue essentially says nothing more than the DOJ’s view that it doesn’t think a broad and diffuse standard is a problem.  See Petition at 14-15No doubt that is so from the DOJ’s perspective, since the broader the standard, the more discretion the DOJ has to decide which conduct should be prosecuted and which should not.  But as a basis for imposing criminal sanctions — for imposing lengthy prison terms on purported violators — a broad standard that makes it difficult to determine what is lawful and what is not is no gift to society.

Second, the DOJ brief argues that the evidence against Newman and Chiasson was sufficient to show a true benefit to the respective tippers, as well as knowledge of that benefit by Newman and Chiasson.  This argues that the Second Circuit panel simply stated the evidence incorrectly by (i) failing to credit evidence showing benefits to the tippers, and (ii) failing to adopt a standard that allows a finding of knowledge of such benefits based on the mere fact that the information conveyed to the defendants by their subordinates was too accurate to have been obtained without giving a benefit to the original tipper.  See Petition at 15-22.  To begin, it seems highly unlikely that factual arguments that an undivided panel simply misread the record will be sufficient to induce the Second Circuit to grant en banc review.  But beyond this, the argument on knowledge seems particularly weak.  Although it appears to concede that proof of knowledge is, in fact, required (a concession not previously made in the district court or the court of appeals), it essentially asks that the Second Circuit rule that in this context the only evidence required to show such “knowledge” is that it is implausible that tippers give reliable tips without receiving some sort of benefit.  That is no more than a barely-veiled way to do away with the requirement altogether by conflating it with evidence that the tips were reliable (i.e., material).

Third, the DOJ makes a public policy argument that the Newman decision should not be permitted to stand because it uses a standard that would permit securities trading that would “threaten the integrity of the securities markets.”  See Petition at 22-25.  In the DOJ’s view, the Second Circuit should be deciding the breadth of section 10(b) by the DOJ’s (or the circuit court’s) view of what rule is most beneficial to the “securities markets.”  This is wrong in so many respects that it’s hard to know where to start.

First, it ignores the fact that the issue here involves two individuals’ criminal convictions.  Whether what they did was, or was not, criminal, should not be determined by what the DOJ or the courts may think is good or bad for the securities markets.  It must be determined by whether the statute in question bars the conduct proved, and does so with clarity, not what the DOJ or the courts think would be a desirable public policy to govern trading activity.

Second, the argument reflects a flawed core assumption by the DOJ about what section 10(b) is all about.  Strangely, in the entire DOJ brief, there is not a single discussion of the statute and why the panel decision misconstrues it.  The reason is clear: The Supreme Court has now held on multiple occasions that section 10(b) prohibits only fraudulent conduct in connection with securities trades.  It does not adopt any particular view about “fairness” of trading in the securities markets.  It certainly says nothing about whether securities markets are rendered “unfair” if some people trade with more information than others.  Indeed, as this blog previous made clear, section 10(b) was enacted at a time, and with an understanding, that it was not addressing the propriety of trading on nonpublic corporate information.  See The Myth of Insider Trading Enforcement (Part I).

Nevertheless, the DOJ argues that the panel decision should be rejected because it “significantly weakens protections against the abuse of inside information by market professionals with special access, and threatens to undermine enforcement efforts that are vital to fairness (and the perception thereof) in the securities markets.”  Petition at 23.  The short answer to this is that not all “abuses of inside information” are fraudulent, and therefore not all such “abuses” are prohibited by section 10(b).  See SEC Insider Trading Cases Continue To Ignore the Boundaries of the Law.  If the DOJ wants to criminalize all “abuses of inside information” — whatever that may mean — it should draft a statute doing so and get it enacted.  It should not ask the Second Circuit to define the boundaries of the law to achieve an end that the law never addresses.

Third, the DOJ argues (with no foundation) that somehow the issue of what is or is not a “personal benefit” to a tipper will impact “investor confidence”: “The consequences for investor confidence are plain: individuals will perceive that cozy relationships between  insiders and the most sophisticated traders allow exploitation of nonpublic information for personal gain.”  Petition at 24.  That argument makes the flawed assumption that is “plain” that “investors” are more interested in assuring that no one can “exploit” nonpublic information for personal gain than they are in assuring that to the extent possible, market prices for securities reflect the best available information, public or nonpublic.  The issue may be worthy of debate, but I seriously doubt that “investors” would prefer markets where better-informed people are barred from trading, with the result that securities are mispriced until information becomes “public.”  In any event, the securities laws contain no such requirement, and are founded instead on the paradigm of maximizing market efficiency, which is fundamentally different than the DOJ’s apparent concept of “fairness.”

Straight Arrow

January 26, 2015

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