In insider trading appeal, Justice Department makes big concession

January 26, 2015

On Friday evening, the Justice Department filed its brief asking the entire 2nd U.S. Circuit Court of Appeals to review U.S. v. Newman, the biggest insider trading appellate decision in recent memory. It’s a long shot, considering how infrequently the 2nd Circuit agrees to hear cases en banc. But even in the unlikely event that the government ultimately prevails in the appeal, the Justice Department will still have lost ground in insider trading prosecution because the new brief abandons a position the government defended in earlier stages of the case.

When Todd Newman and Anthony Chiasson appealed their 2012 convictions for insider trading, the main issue seemed to be their knowledge of the supposed benefit to corporate insiders from disclosing confidential information that eventually reached the two defendants. Newman and Chiasson said they were too remote from the tipsters to know whether the corporate insiders had gotten anything in return for disclosing inside information, but at their trial, U.S. District Judge Richard Sullivan of Manhattan did not tell jurors they had to find the defendants were aware of the tipsters’ gains. Instead, at the government’s urging – and in contrast to other Manhattan judges who have overseen recent insider trading cases – Sullivan told jurors that Newman, a onetime portfolio manager at Diamondback Capital, and Chiasson, a co-founder of Level Global Investors, could be convicted of insider trading as long as the government had proved they knew their trades were based on improperly disclosed confidential information.

On appeal, lawyers for the hedge fund executives asserted that Judge Sullivan’s instructions were improper. The government argued throughout the appeal that Sullivan’s jury instruction was appropriate because prosecutors don’t have to show tip recipients knew what tipsters received in exchange for their information.

In December, a three-judge 2nd Circuit panel agreed with Newman and Chiasson that Sullivan gave the wrong jury instruction. But Judges Barrington Parker, Ralph Winter and Peter Hall didn’t stop there. The panel also redefined what constitutes a personal benefit for tipsters. “The mere fact of a friendship” isn’t enough to justify insider trading charges, the panel said. A tipster must have a “meaningfully close personal relationship” with the initial recipient of confidential information, according to the opinion, or else stand to receive a pecuniary benefit from the disclosure.

That new definition turned the 2nd Circuit opinion into a blockbuster, since tipsters’ gains from passing information are at the heart of insider trading prosecution. The decision is already reverberating: Last week, based on the Newman and Chiasson opinion, U.S. District Judge Andrew Carter of Manhattan threw out guilty pleas by four men accused of illegal trading in advance of an IBM acquisition, rejecting government arguments that the 2nd Circuit decision only applies in so-called “classic” insider trading cases and not also misappropriation cases. (In classic insider trading, corporate insiders breach their duty by disclosing confidential information; in misappropriation cases, corporate outsiders breach their duty to their source of information, such as a lawyer who takes advantage of confidential information about clients of the firm.) My Reuters colleague Nate Raymond, who is closely tracking the fallout from the 2nd Circuit opinion, also reported Monday on defendants from outside the 2nd Circuit’s jurisdiction who are citing the decision in the hope that it will persuade judges to throw out the cases against them.

In the en banc brief filed Friday, the government emphasized the far-reaching impact of the opinion’s supposedly misguided analysis of tipsters’ personal benefits. “The panel’s missteps will have serious consequences far beyond this case,” wrote appellate lawyers from the office of Manhattan U.S. Attorney Preet Bharara. “Put simply, if the opinion stands, the panel’s erroneous redefinition of the personal benefit requirement will dramatically limit the government’s ability to prosecute some of the most common, culpable and market-threatening forms of insider trading.” (The Justice Department, via the U.S. Solicitor General, authorized Bharara’s petition for en banc review, according to a footnote in the brief.) The 2nd Circuit’s remaking of the standard for a tipster’s benefit, the brief said, “cannot be squared with governing Supreme Court precedent, conflicts with prior holdings of other circuits and this court, and defies practical application.”

What you won’t find in the new brief, however, is any argument by the government that Sullivan’s jury instruction was correct. Prosecutors contend that if the en banc court reinstates the case, they will be able to prove Newman and Chiasson knew or deliberately shielded themselves from knowing that the original tipsters stood to gain from disclosing confidential information. (The defendants – and the 2nd Circuit panel opinion – say there’s no such evidence.) But nowhere in the filing does the government claim that it isn’t required to show tippees’ knowledge of tipsters’ benefits.

That is a big step back from the arguments prosecutors made to Judge Sullivan in the Newman and Chiasson trial and in the trial of former SAC Capital trader Michael Steinberg, who is also appealing his conviction. In its original briefing to the 2nd Circuit panel that heard Newman and Chiasson’s appeal, the government asserted that precedent supports the jury instruction Sullivan gave. It is no longer pushing that argument.

No matter what else happens, in other words, the 2nd Circuit panel opinion in the Newman and Chiasson will require prosecutors in future insider trading cases to prove beyond a reasonable doubt that defendants knew tipsters stood to gain from breaching their duty of confidentiality. That’s an important check on the government’s power.

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