Now that you’ve seen what ACA Insight has to offer, don’t be without it. Subscribe now!

The weekly news source for investment management legal and compliance professionals

Current subscribers - please log in to the website in the upper right-hand corner

News February 2, 2015 Issue

U.S. Attorney’s Office Seeks Overturn of Appeals Court Insider Trading Ruling

The December 10 insider trading ruling by the U.S. Court of Appeals’ Second Circuit was "wrong," "breaks with Supreme Court and Second Circuit precedent, conflicts with the decisions of other circuits, and threatens the effective enforcement of the securities laws."

So said the U.S. Attorney’s Office for the Southern District of New York in its January 23 petition, made to both the three-judge Second Circuit panel that ruled on the original appeal and to the full Second Circuit, to review the opinion. It was joined on January 27 by an amicus curae brief from the SEC, which argued that "the panel’s narrowed definition of personal benefit and lack of clarity about the evidence required for establishing such a benefit could negatively affect the SEC’s ability to bring insider trading actions."

The U.S. Attorney’s Office decision to request a rehearing was "not surprising," said University of Michigan law professor Adam Pritchard, as it has little to lose. "The worst outcome for it is if the opinion gets affirmed and the government has a chance to go to the Supreme Court."

"This case, as the immediate and widespread attention to the [panel’s] opinion evinces, is of surpassing importance to the integrity of the securities markets," the U.S. Attorney’s Office said in its petition.

The Second Circuit opinion

The three-judge panel’s decision in United States of America v.

Todd Newman and Anthony Chiasson reached near-landmark decision status almost immediately after it was released (ACA Insight, 1/26/15). It not only reversed the convictions and threw out the indictments of two hedge fund portfolio managers accused of insider trading, but, according to legal scholars and practicing attorneys, rewrote insider trading case law. It has, in fact, already been cited by defense attorneys arguing for their clients and judges in making rulings.

Whether it stands the test of time, however, is something that will be determined in the months, and perhaps years, ahead. "If the Second Circuit reverses Newman, is that an open invitation to the Supreme Court?" asked

Georgetown University law professor Donald Langevoort. The Second Circuit has built a solid reputation for insider trading expertise and may not want the issue to leave its jurisdiction, even for the higher court, he said.

If the government wins before the Second Circuit, it is not likely the case would go to the Supreme Court, said Pritchard. If the government loses, he said, the case might eventually go there. However, Pritchard noted, the government might well choose to wait for a better case, perhaps one that it won, where the defense would take the case to the Supreme Court, in the hopes that it would have a better chance at winning.

Issues at play

A number of issues underlie the disagreement between the Second Circuit panel and the government in this case.

Perhaps the most prominent of these is the question of what defines the personal benefit that a tipper would derive. The Second Circuit panel relied on what the U.S. Attorney’s Office and the SEC believe is an incorrect reading of part of the 1983 U.S. Supreme Court case, Dirks v. the SEC

, considered to be a benchmark for insider trading cases. The Second Circuit ruling said, in effect, that a benefit received by a tipper cannot be just friendship, but would have to represent "at least a potential gain of a pecuniary or similarly valuable nature."

"It was a grounded, well-reasoned decision that may clarify Dirks," said

Mayer Brown partner Matthew Rossi.

But the U.S. Attorney’s Office, in its review request, said such a view is "flatly inconsistent with Dirks, as well as cases in this Circuit and others." Receipt of a personal benefit by the mere fact of friendship "is in fact precisely what Dirks says."

"As it currently stands, the opinion’s 'exchange'-based, pecuniary limitation on what constitutes a personal benefit, and its resulting absolution of deliberate, corrupt and formerly criminal insider trading that fails this new test, arguably represents one of the most significant developments in insider trading law in a generation," the U.S. Attorney’s Office said. "And the opinion is wrong."

The SEC, in its brief in support of the U.S. Attorney’s Office, attributed to Supreme Court and prior Second Circuit decisions that "an insider derives a personal benefit – and thus engages in prohibited insider trading – by disclosing inside information to a friend who then trades, because that is equivalent to the insider himself profitably trading on the information and then giving the trading profits to the friend, which is obviously illegal."

But the government has stretched that reasoning to the point that it "argues that almost any kind of relationship" where material non-public information was shared would be insider trading, said Rossi.

The views of the two parties aside, "the Supreme Court did not get into defining the personal benefit test in any detail," said Pritchard, and that is why such differences in interpretation exist. "The real question is the tradeoff between the policy question (in terms of what should be considered a personal benefit) and the rule of law (should the defendant know its conduct was on the wrong side of the law)."


Any number of outcomes to the case are possible. "It wouldn’t be surprising to see the Second Circuit clarify what needs to be proved in terms of what constitutes a benefit, as well as address the issue of what constitutes a violation by tippees," said

Wilmer Hale partner Douglas Davison.

It is quite possible, Langevoort said, for the Second Circuit to provide a middle-ground position on this and some of the other issues involved in the case, such as what defines tippee knowledge that the tipper received the information in exchange for a benefit. The full Circuit might decide, for instance, that the panel’s ruling stands for criminal cases, but not for civil. Or it might set the bar for a benefit somewhere between friendship and the receipt of a pecuniary benefit.

"There have been 20 years of court decisions on friendships and benefits," he said, since insider trading is not defined by any one statute, but is, to a large degree, set by court precedent.

The Supreme Court, Pritchard said, found those boundaries "in the common law of deceit."

What’s ahead

It will probably take several weeks for the full Second Circuit to decide whether it will grant the review request. Time must be allowed for a response from the defendants. The clerk of the court would then poll all the judges to see if they want to review, and there might be some time taken as judges confer with one another here, Pritchard said.

Requests for en banc review, that is, review by all the judges in an Appeals Court circuit, are granted, but not often, said Pritchard. The fact that this is a relatively high profile case and that the government is requesting the review make approval of the request somewhat more likely. If it is heard en banc, the Court will need to allow time for a full briefing and arguments, as well as various motions. Such a process could take months or years, he said.

"It shouldn’t be presumed that if the government does get a review, it means the Court will reach a different decision," said Pritchard. All it means is that the Court thinks the matter is important enough for the full Court to decide.