2nd Circuit was right to curtail insider trading cases: profs’ amicus brief

February 26, 2015

The most interesting amicus brief in the government’s landmark appeal of a December 2014 ruling by the 2nd U.S. Circuit Court of Appeals that overturned the convictions of accused insider traders Todd Newman and Anthony Chiasson was not from the Securities and Exchange Commission. It wasn’t much of a surprise that the SEC agreed with U.S. Attorney Preet Bharara that a three-judge 2nd Circuit panel made a grievous mistake when it held that the government can’t bring an insider trading case if a tipster’s only gain is helping a casual friend. Nor was it a shock that the National Association of Criminal Defense Lawyers backed Newman and Chiasson, who oppose the government’s request for reconsideration of the panel’s hearing.

No, I was intrigued by another amicus brief filed on the defendants’ behalf. Not the brief by onetime SEC defendant and billionaire sports team owner Mark Cuban, but the one by three professors as famous in the securities law biz as Cuban is in the rest of the world. Stephen Bainbridge of UCLA, Jonathan Macey of Yale and Todd Henderson of the University of Chicago argued in a brief docketed Thursday that the 2nd Circuit panel in the Newman and Chiasson case was exactly right on what constitutes a personal benefit to a corporate insider. (As it happens, the same three, along with Allen Ferrell of Harvard, also filed an amicus brief backing Mark Cuban when the SEC appealed the dismissal of its case against him to the 5th Circuit.)

The U.S. Supreme Court, the professors said, has recognized, most recently in the 1983 case Dirks v. SEC, that not all disclosures of inside information are illegal. Important policy considerations undergird the court’s ruling in Dirks, according to the professors’ brief, which was filed by Jonathan Bach of Cooley.

The justices recognized that the exchange of information between corporate insiders and securities analysts promotes the integrity of the market. The professors said that despite the SEC’s arguments in Dirks for the prohibition of all trades based on material, non-public information, the Supreme Court concluded blanket insider trading rules would “ultimately damage the overall health of the market, because they limit the incentives of market participants to seek out information on which to trade.”

Instead, the professors’ brief said, the Supreme Court came up with the “personal benefit” test, which was supposed to draw an objective line between tips passed by a corporate insider with an improper motive and information provided innocently. The Dirks opinion did say that an insider’s improper purpose can be to enrich a friend, but, according to the securities professors, the court “was not endorsing the proposition that an insider who discloses inside information to a ‘friend’ is therefore seeking a personal benefit.”

Yet that was how Bharara’s office and the SEC read Dirks in prosecuting Newman, Chiasson and many other defendants in the wave of recent insider trading cases. The professors contend that the government interpretation – which the Justice Department and the SEC want the 2nd Circuit to enshrine in a reconsideration of the Newman and Chiasson decision – would undermine the free-market policy concerns at the heart of Dirks. They urged the 2nd Circuit to deny the government’s petition.

Bainbridge said in an email that he’s done about 10 such amicus briefs in his 25-year career and that the Newman filing reflects views he has been espousing on his blog, ProfessorBainbridge.com, for about a year. He didn’t respond to my followup email asking how their amicus coalition came together.

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