Tag Archives: tipper

SEC’s Amicus Brief in U.S. v. Newman Fails To Improve on DOJ’s Effort

Earlier this week, the SEC filed an amicus brief in support of the DOJ’s petition for rehearing en banc of the panel decision overturning two insider trading convictions in United States v. Newman.  The Newman decision is discussed here: US v. Newman: 2d Circuit Hands Government Stunning, Decisive, and Far-Reaching Insider Trading DefeatThe DOJ’s petition for en banc review is discussed here: DOJ Petition for En Banc Review in Newman Case Comes Up Short.  The SEC’s amicus filing did little to show why the Second Circuit should take the extraordinary step of reviewing en banc the unanimous panel decision.  The SEC’s brief can be found here: SEC Amicus Brief in US v Newman.

The SEC started from the same flawed foundation as the DOJ, contending that existing law mandated that an insider “engages in prohibited insider trading” merely by “disclosing information to a friend who then trades.”  SEC Brief at 1.  That supposedly is “because that is equivalent to the insider himself profitably trading on the information and then giving the trading profits to the fried.”  Id.  This makes me want to scream out loud: Just because you say something over and over again does not make it true!  This proposition leaves out the key requirement in the law, flowing directly from the language of the Supreme Court in Dirks v. SEC, that a tipper-insider must “personally … benefit … from his disclosure” (463 U.S. at 662), and that this benefit could arise out of “a gift of confidential information to a trading relative or friend”  463 U.S. at 664 (emphasis added).  The DOJ and SEC continue to pretend that every disclosure of confidential information to a friend is of necessity, a “gift,” and therefore no further evidence is required to show that a “gift” was intended.  In other words, the required “personal benefit” flowing to the tipper is conclusively presumed whenever the tippee is a “friend.”  No aspect of Dirks suggests such a result.

The holding of the Newman court was not an extraordinary extension or expansion of the “personal benefit” requirement.  The court did no more than examine the evidence – or actually, lack of evidence – of any real benefit flowing to the tippers in the case, and insist that there actually be such evidence before there is tippee liability, because, as Dirks made clear, there can be no tippee liability if there is no tipper liability.

This passage from Dirks makes that clear: “Determining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.  But it is essential, we think, to have a guiding principle for those whose daily activities must be limited and instructed by the SEC’s inside trading rules, and we believe that there must be a breach of the insider’s fiduciary duty before the tippee inherits the duty to disclose or abstain.  In contrast, the rule adopted by the SEC in this case would have no limiting principle.”  Dirks v. SEC, 463 U.S. 646, 664 (1983).  As for the wisdom of allowing law enforcement authorities decide the lines to be drawn for enforcement actions, the Dirks Court wrote: “Without legal limitations, market participants are forced to rely on the reasonableness of the SEC’s litigation strategy, but that can be hazardous, as the facts of this case make plain.”  Id. n.24.

True to this Supreme Court insight, ever since Dirks was decided, the SEC and DOJ have been trying to water down the “personal benefit” element of tipper liability to the point that they now argue that this element has no substance at all – mere proof of “friendship” – which, by the way, is itself an extraordinarily stretched concept, in the SEC and DOJ view – is all you need to show “beyond a reasonable doubt” that a tipper personally benefited from a disclosure.  The law enforcement authorities have tried over many years to negate Dirks (and its predecessor decision Chiarella v. United States, which provided the foundation for Dirks) by stretching “personal benefit” to the point of near infinite elasticity if a “friend” is involved, and stretching the concept of “friend” to be the equivalent of “acquaintance.”  The Newman panel simply said, in no uncertain terms, they’d had enough of this.

In this context, it is more than a little “rich” for the SEC to argue that the “panel decision also creates uncertainty about the precise type of benefit … an insider who tips confidential information must receive to be liable.”  SEC Brief at 2.  For years, the SEC has tried, mostly successfully, to make the standards of insider trading liability as amorphous as possible, and has resisted efforts to develop precise definitions.  Its explanation for this is that if you give a precise definition, you allow someone to evade liability with sharp practices that fall outside of the definition.  In the SEC’s view, the Commission and the Division of Enforcement should decide which trading practices should be unlawful, almost always in after-the-fact enforcement actions.  They view themselves as “keepers of the faith,” who, of course, will always act in the public interest, and therefore do not need precise legal standards to govern their enforcement actions.  Suffice it to say that many of us who have represented clients on the other side of SEC investigations do not have quite this level of confidence in the SEC staff’s determination of the “public interest.”  That is in part because the Division of Enforcement is a huge aggregation of weakly-managed lawyers whose judgments on these issues are usually deferred to, but many of whom exercise questionable judgment, and give more weight to their personal views of the world than the actual evidence in the case.  See, e.g., SEC Insider Trading Cases Continue To Ignore the Boundaries of the Law, and SEC Enforcement Takes Another Blow in SEC v. Obus.

Hence, the SEC believes that an argument for rehearing the Newman decision is that the SEC has brought many enforcement actions “where the only personal benefit to the tipper apparent from the decisions was providing inside information to a friend” and Newman’s insistence on evidence of “personal benefit” to the tipper beyond this would “impede enforcement actions.”  SEC Brief at 12.  But what if those prosecutions were overly aggressive under the law, as laid out in Dirks?  The SEC is always trying to stretch the law so that it has increased discretion to determine what to prosecute “in the public interest” (and to get added leverage in efforts to force settlements of enforcement actions with questionable factual support).  One example of this is the recent extraordinary effort of the Commission in In re Flannery and Hopkins to expand the scope of Rule 10b-5 by edict (not by rulemaking), and thereby negate the impact of the Supreme Court’s decision in Janus Capital Group v. First Derivative Traders, as discussed here: SEC Majority Argues for Negating Janus Decision with Broad Interpretation of Rule 10b-5.)  The attempt to negate the “personal benefit” requirement, and expand the Dirks reference to “a trading relative or friend” beyond reasonable recognition, are part and parcel of that “we know it when we see it” approach to the law.  But, especially in criminal cases, there is no place for allowing prosecutors such discretion and providing citizens no reasonable notice of the parameters of the law.

U.S. v. Newman does not represent a significant limit on the ability of the DOJ or SEC to bring meritorious insider trading claims.  It merely requires that before tippees are held criminally liable, or subjected to severe civil penalties and employment bars, law enforcement authorities present evidence sufficient to support a finding that a tipper-insider actually benefitted from the tip, and that the defendants had the requisite scienter.  If, as the SEC argues, friendship and “gifting” are almost inevitably synonymous, this is not a high burden, especially in SEC enforcement actions, which need only satisfy a “preponderance of the evidence” standard of proof.

Straight Arrow

January 29, 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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First Post-Newman Shoe Drops: Insider Trading Guilty Pleas Vacated in U.S. v. Conradt

We now have the first official judicial reaction to the Second Circuit’s recent opinion in United States v. Newman and Chiasson.  On January 22, 2015, District Judge Andrew Carter of the Southern District of New York vacated previously-accepted guilty pleas in United States v. Conradt, 12 Cr. 887 (ALC) (S.D.N.Y.).

Conradt is an insider trading prosecution based on securities trades by alleged tippees who learned and traded on the basis of nonpublic information about an impending IBM acquisition of a software firm. Briefly, the facts are as follows.  A law firm employee learned about the impending IBM acquisition of SPSS and improperly communicated that information to a friend, Trent Martin.  There apparently is no evidence that the lawyer who leaked the information in the first place received any proceeds or benefits from doing so.  Martin was a roommate and friend of defendant Thomas Conradt, and told Conradt about the SPSS deal.  Conradt told other defendants about the deal.  The defendants bought SPSS options and profited on them when the transaction was announced.  Four defendants pleaded guilty to insider trading charges before Newman was decided. The fifth, Benjamin Durant, pleaded not guilty and is scheduled for trial on February 23.  The four pleading defendants admitted in their plea allocutions that they committed insider trading and knew what they did was illegal.

We previously wrote a post about the Department of Justice’s brief arguing against dismissal of the Durant indictment, explaining that the DOJ’s grounds for distinguishing U.S. v. Newman ­– that Newman involved the “classical” theory of insider trading and the Durant prosecution was based on the “misappropriation” theory – were specious and should be rejected by the court.  You can review that discussion here: U.S. v. Durant: DOJ Argument that Newman Reasoning Does Not Apply to Misappropriation Theory Misses the Mark.

Having reviewed the DOJ position, Judge Carter rejected it in the context of considering the four previously-accepted guilty pleas. His decision is brief and decisive. It can be read here: United States v. Conradt, but this is the core of what he says:

[T]his Court finds that, as indicated in Newman, the controlling rule of law in the Second Circuit is that “the elements of tipping liability are the same, regardless of whether the tipper’s duty arises under the ‘classical’ or the ‘misappropriation’ theory.”. . . Additionally, even if Newman did not specifically resolve the issue, the Court is swayed by the fact that Newman’s unequivocal statement on the point is part of a meticulous and conscientious effort by the Second Circuit to clarify the state of insider-trading law in this Circuit. Accordingly, even assuming arguendo that the Government is correct that the cited language in Newman is dicta, it is not just any dicta, but emphatic dicta which must be given the utmost consideration. . . . Finally, the Court notes that it agrees with Newman’s articulation of the requirements of tipping liability and its statement that such analysis applies equally in misappropriation cases.

Conradt, slip op. at 2-3.  The court also rejected the DOJ argument that previous Second Circuit cases held that a personal benefit to the tipper is not required in misappropriation cases, noting that “Newman construes each one of the authorities the Government cites in this regard to be consonant with its holding.” Id. at 3 n.1.

In other news, today (January 23) the DOJ announced that it would seek en banc review from the Second Circuit of the Newman decision. See Bharara To Appeal 2nd Circ.’s Landmark Newman Decision.

Straight Arrow

January 23,2015

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