Can inside trader be guilty without knowledge of tipster’s motives?

February 13, 2014

There was a very interesting exchange of letters this week at the 2nd Circuit Court of Appeals, where former Diamondback Capital portfolio manager Todd Newman and his co-defendant, Level Global Investors co-founder Anthony Chiasson, are appealing their December 2012 convictions for insider trading in Dell and Nvidia stock. And after the 2nd Circuit Court addresses the issue highlighted in the letters, not only the Newman and Chiasson convictions but also the guilty verdict against SAC Capital portfolio manager Michael Steinberg and the government’s prosecution of Raj Rajaratnam’s brother Rengan could be imperiled.

Lawyers representing Newman and Chiasson – Stephen Fishbein of Shearman & Sterling for Newman and Mark Pomerantz of Paul, Weiss, Rifkind, Wharton & Garrison for Chiasson – contend that the jury’s guilty verdicts should be overturned because the judge in the case, U.S. District Judge Richard Sullivan of Manhattan, made a fatal mistake in his instructions to the jury. Sullivan decided not to instruct jurors that the government must prove Newman and Chiasson were aware that Dell and Nvidia insiders stood to gain from passing along non-public information. Instead, he told the jury that it could find the defendants guilty as long as prosecutors proved the defendants knew they were trading on information the insiders disclosed in breach of their duty of confidentiality.

Newman and Chiasson argue that Sullivan’s jury instruction is contrary to the law of insider trading. As Fishbein explained in Newman’s appellate reply brief, the defendants believe that two U.S. Supreme Court decisions, Dirks v. Securities and Exchange Commission in 1983 and Bateman Eichler v. Berner in 1985, stand for the proposition that if the recipients of insider information don’t know that the original tipster stands to benefit from disclosing the tips, then no crime has been committed.

Newman and Chiasson were so-called remote tippees, which means that they had no direct ties to the Dell and Nvidia insiders who first passed along information about the companies. At trial, their defense lawyers asked Judge Sullivan to instruct the jury that to reach a guilty verdict, jurors had to find that Newman and Chiasson knew the tipsters had disclosed inside information in exchange for personal benefits, citing the Supreme Court’s Dirks decision. The government argued that under the 2nd Circuit’s 2012 decision in a Securities and Exchange Commission enforcement action against Wynnefield Capital’s Nelson Obus and several co-defendants, it only had to show that Newman and Chiasson knew they were trading on non-public information that insiders had disclosed in breach of their duty of confidentiality.

Faced with similar arguments in the prosecution of Doug Whitman of Whitman Capital, U.S. District Judge Jed Rakoff held in November 2012 that remote tippees “must have a general understanding that the inside information was obtained from an insider who breached a duty of confidentiality in exchange for some personal benefit.” But Judge Sullivan sided with the government and instructed jurors that they could convict Newman and Chiasson if they found the defendants traded on inside information disclosed in a breach of the insiders’ duty of confidentiality.

After Newman and Chiasson filed appellate briefs asserting that the judge’s instruction is contrary to the law, the 2nd Circuit signaled that it is at least concerned about the question of what accused insider traders must know about tipsters’ motives when it ruled that the onetime hedgies can stay out of prison until their appeal is decided. Judge Sullivan, however, stuck by his reasoning when he instructed the jury last December in the government’s case against Steinberg of SAC, another remote tippee. In that case, as in the prosecution of Newman and Chiasson, Sullivan agreed with the government that jurors need not find Steinberg was aware of the personal benefits to tipsters in order to convict him.

U.S. District Judge Paul Gardephe, however, held earlier this month in the criminal case against former SAC trader Mathew Martoma that for jurors to find Martoma guilty, the government had to show that he knew inside information was disclosed in exchange for a personal benefit to the tipster. Gardephe’s Feb. 4 jury instruction in the Martoma case prompted Fishbein to write to the 2nd Circuit, highlighting the “core argument” that Sullivan wrongly instructed the jury in the Newman and Chiasson case.

“Apart from Judge Sullivan, every district court that we are aware to have considered the issue- including now Judge Gardephe- has adopted appellants’ position that knowledge of the personal benefit is required,” Fishbein wrote in his Feb. 6 letter, noting that prosecutors in the Martoma case, as in the Whitman case before Judge Rakoff in 2012, made the same arguments as they did in the Newman and Chiasson cases: that they merely had to show knowledge of wrongfully disclosed information. Those arguments convinced Sullivan but not his fellow judges. “It is apparent that (Newman and Chiasson), who had no knowledge of any personal benefit, were convicted based on an erroneous and increasingly isolated statement of insider trading liability. The law should not be varied in order to assist the government to fill a gap in proof.”

In the government’s response, filed Wednesday, assistant U.S. Attorneys Antonia Apps and Brent Wible said that the jury instruction in the Martoma trial isn’t of consequence in the Newman and Chiasson appeal because the cases are factually distinct. Martoma dealt directly with tipsters so he knew they were benefiting personally from disclosing inside information, the letter said. Because of this evidence, the government told the 2nd Circuit, Martoma’s prosecutors didn’t bother to object when Judge Gardephe showed them draft jury instructions that required them to prove Martoma’s knowledge of the tipsters’ gains.

“The government in Martoma accepted a higher burden than the law requires in light of the fact that Martoma himself conferred the benefit, and thus avoided an appellate issue,” the letter to the 2nd Circuit said.

It seems to me that the U.S. Attorneys’ letter raises some points the 2nd Circuit will want to explore. By acknowledging that in the Martoma case, the government essentially dropped the tippee knowledge issue because prosecutors had enough evidence to meet a higher standard against Martoma, is the U.S. Attorney’s office suggesting that it is applying two different standards of proof in criminal trials – one for cases in which it has evidence that tippees knew what benefits were derived by tipsters and one for cases involving remote tippees? That’s what Lankler Siffert & Wohl is arguing in a brief filed Friday that seeks the dismissal of insider trading charges against Rengan Rajaratnam. Like Newman and Chiasson, Rengan was a remote tippee, separated by several degrees from the tipsters who provided Galleon Group with inside information. Rengan’s lawyers contend that the government is prosecuting him for the same crimes as his brother but asserting a lower standard of proof.

The 2nd Circuit hasn’t directly answered the question of what the government must show tippees knew about the benefits tipsters received in order to win an insider trading conviction, so the Newman and Chiasson appeal is one of first impression. If Newman and Chiasson win, the holding won’t affect the vast majority of the insider trading convictions won by U.S. Attorney Preet Bharara, since almost all of the judges who have heard those cases have held the government to the higher standard of proof demanded by Newman and Chiasson. But a clear holding against prosecutors could impact future cases against remote tippees.

The Newman and Chiasson appeal is scheduled for argument the week of April 21.

For more of my posts, please go to WestlawNext Practitioner Insights

Follow me on Twitter

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see