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News April 13, 2015 Issue

Second Circuit Chooses Not to Review Key Insider Trading Decision

The new definition of insider trading may be here to stay – at least for a while.

The full U.S. Court of Appeals for the Second Circuit on April 3 denied U.S. Attorney Preet Bharara’s petition that it review the December 10 decision of a Second Circuit three-judge panel that overturned the conviction of two hedge fund portfolio managers and makes it more difficult to prove insider trading. The Second Circuit gave no rationale for its decision not to review the panel’s ruling in the case, United States of America v. Todd Newman and Anthony Chiasson.

"At this point, it is the Supreme Court or Congress," said University of Michigan Law School professor Adam Pritchard, referring to the remaining options before the U.S. Attorney’s Office for the Southern District of New York. The SEC, which filed an amicus curae brief supporting Bharara’s request for review and which also prosecutes insider trading, was also affected by the ruling.

An appeal to the Supreme Court is the one remaining judicial path open to the government. Congress is currently considering three bills that would, in different ways, define insider trading as a statutory crime, something that is not now the case (ACA Insight, 4/6/15). None of those bills is given much of a chance of passing, however.

"There is not much the U.S. Attorney’s Office can do other than appeal to the Supreme Court or try to contain the Second Circuit holding in later cases," said University of North Carolina School of Law professor Thomas Lee Hazen. He added that it remains to be seen how the SEC will make use of the Newman decision, given that it was a criminal case with a higher burden of proof. Cases brought by the SEC are civil cases, which require a lower burden of proof.

"The SEC might prefer Congress, which is generally happy to crack down on white-collar crime," said Pritchard. "You could see five justices being skeptical of the government’s effort to expand insider trading doctrine, particularly in a criminal context."

There is, of course, a third possibility: that the new rules for insider trading, as established by the Second Circuit three-judge panel, become, in effect, the new standard by which insider trading is judged. That would require either a government decision not to appeal to the Supreme Court or a loss from a government Supreme Court appeal, as well as no new insider trading bills passed by Congress and signed by the President. Don’t expect the Department of Justice or the SEC to be happy about such a possibility, now a bit more likely than it was before the Appeals Court’s decision not to review.

Barring an overturn of the Second Circuit by the Supreme Court or new statutory definitions from Congress, the main option for U.S. attorneys, given the Second Circuit’s tighter definition on when tippees received inside information (see below), is to "draw back a bit on remote tippee liability—leaving those cases to the SEC—but otherwise business as usual," said Georgetown University law professor Donald Langevoort. "Each case is different, and different judges from those who were on the Newman panel will weigh in on precisely how heavy the burden is for the prosecution. We may well see Newman ‘refined’ in future cases, in ways that put to rest the worst of the prosecutors’ fears."

In considering its options, the Department of Justice may well conclude not to pursue an appeal to the Supreme Court and instead see how its cases do in court, said Wilmer Hale partner Douglas Davison. A risk with going to the Supreme Court is uncertainty and the danger of further changes to insider trading that prosecutors may not like, he said. Instead, Justice Department prosecutors may choose to "pursue cases that meet the new insider trading requirements."

The Newman-Chiasson case

The Second Circuit panel’s decision in Newman reached near-landmark decision status almost immediately after it was released (ACA Insight, 1/26/15). It not only reversed the convictions of Newman and Chiasson, but, according to legal scholars and practicing attorneys, rewrote insider trading case law.

The panel threw out the government’s premise that the mere receipt of material, non-public information was, in and of itself, insider trading. Instead, it provided a stricter definition of insider trading that requires:

Evidence of personal benefits received by the insiders who passed on the information. It must be proved that the tipper personally benefitted. Without that, there is no tippee liability, according to the decision.

Evidence that the tippees knew they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties. The government presented no evidence of this in Newman, according to the panel.

But perhaps the most significant implication of the Second Circuit panel’s decision was that it came up with a new definition of what constitutes a benefit. In doing so, it interpreted a benchmark 1983 U.S. Supreme Court case, Dirks v. the SEC, differently than it had been up to that point. The Second Circuit panel said, in effect, that a benefit received by a tipper would have to be quite tangible – "objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature" – for it to be considered a benefit given in return for material, non-public information.

With this tighter definition of the elements of insider trading, the U.S. Attorney’s Office on January 23 petitioned both the three-judge panel and the full Second Circuit to review the decision – and the April 3 ruling by the full Second Circuit left all U.S. Attorneys’ Offices and the SEC back where they were before the petition was filed.