Federal Court Overturns Insider Trading Convictions
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UPDATED: Jul 15, 2021
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This week, a federal appeals court raised a stir in the world of securities regulation by unanimously overturning two insider-trading convictions, and significantly limiting the reach of the Securities and Exchange Commission. Federal prosecutors, who up until this week had a sparkling record in insider trading cases, were chastened by a three-judge panel of the Second U.S. Circuit Court of Appeals for overreaching on criminal charges for illegal trading.
Appeals Court Dismisses Insider Trading Convictions
In a unanimous decision, the 2nd Circuit Court of Appeals overturned the December 2012 convictions of former hedge-fund traders Todd Newman and Anthony Chiasson. Newman and Chiasson were convicted after acting on information that they had obtained through a long chain of individuals, some of whom had connections to insiders supplying earnings information ahead of the scheduled release. Chiasson used this information to earn up to $68 million in profits for his fund while Newman produced $4 million in earnings for his employer. Neither Newman nor Chiasson had direct contact, or even knowledge of, the individual or individuals receiving benefit for supplying insider tips.
According to Preet Bharara, a federal prosecutor in New York, Newman and Chiasson were sufficiently connected to insider trading to warrant criminal charges, and jury in 2012 agreed. However, the 2nd Circuit rebuked Mr. Bharara’s office, and clarified that federal law does not allow for such prosecution of remote “downstream tippees” such as Newman and Chiasson.
New Standard for Insider Trading Prosecution
The 2nd Circuit Appeals panel took issue with the lack of evidence that the Government offered to directly link the two defendants to the individuals receiving benefit for insider trading. In order to prove insider trading, prosecutors must demonstrate a defendant had knowledge of the incident, which Mr. Bharara’s office argued could be implied in this case because Newman and Chiasson were experienced enough to suspect that the source of their information may have engaged in illegal trading. This line of argument did not pass mustard with the Court of Appeals, however, and the unanimous opinion turned on the fact that there was not sufficient evidence to suggest either defendant knew that they were receiving insider information or knew that the source of the information received substantial benefit in exchange for the illegal tip.
Finding that prosecutors must more directly connect defendants accused of insider trading to the source of the information, the court wrote in its opinion, “In sum, we hold that to sustain an insider trading conviction against a tippee, the Government must prove each of the following elements beyond a reasonable doubt: that (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit.” (Emphasis added).
By overturning the convictions of Newman and Chiasson because they were too far removed from the insider trading event, the 2nd Circuit changed the course of future insider trading prosecutions. Federal prosecutors are no longer able to aggressively pursue individuals well down the line from the initial illegal trading transaction, which is a change that not everyone in Washington DC is appreciative of.
SEC Reviews Appeals Court Ruling
Mary Jo White, chair of the Securities and Exchange Commission, issued an initial statement in response to the ruling that called the 2nd Circuit Court’s view on insider trading to be “overly narrow.” White went on to say that the SEC was going to continue to review the opinion, which allows for investors to gain advantage in markets from tips as long as they did not know that the source of their information benefitted by illegally sharing trader knowledge.
The ruling represents a significant shift in how federal prosecutors can proceed, but it is unclear what an SEC review will accomplish. The agency could push for a specific change to the law that allows prosecution of downstream tippees, but absent legislative or regulatory changes, the 2nd Circuit’s opinion is fairly clear on the limits of federal prosecution of insider trading regardless of objections.