Alison Frankel

Sometime in the next few days of testimony in the prosecution of former Goldman Sachs director Rajat Gupta, U.S. Senior District Judge Jed Rakoff will probably take a moment to give jurors what he has described in previous trials as a “heads-up.” Rakoff will offer the jury a preliminary instruction on what insider trading is. If you think that’s an easy task, you should look at the proposed instructions the government and defense counsel from Kramer Levin Naftalis & Frankel submitted to Rakoff this week. The two sides agree that Rakoff should use phrases like “material non-public information,” but beyond that they’re each trying to use the preliminary instruction to sway jurors.

The nine-page proposal from prosecutors Reed Brodsky and Richard Tarlowe (which includes transcripts of Rakoff’s instructions in two previous insider-trading cases) asks the judge to tell the jury that corporate directors have a “legal duty not to disclose to anyone outside the company financial or other confidential information about the company that the company has not yet made public or authorized to be made public.”

That’s straightforward enough, but prosecutors went on to suggest how Rakoff should describe the link between insider trading and securities fraud. “In connection with this charge, the government must show that Mr. Gupta anticipated some kind of benefit, directly or indirectly, however modest, from providing (Raj) Rajaratnam with the inside information,” prosecutors proposed Rakoff tell jurors. “Examples of a benefit include Mr. Gupta giving the information to Rajaratnam as a gift, giving the information to maintain a good relationship with a frequent business partner, or giving the information to receive money in exchange.”

That language would paper over one of the big evidentiary gaps in the government’s case: Gupta didn’t make any money from the information he allegedly passed to Rajaratnam, and he actually lost millions on investments with Rajaratnam’s hedge fund, Galleon Group. The government would very much like to establish early that it believes any kind of benefit Gupta derived from tipping Rajaratnam – even just maintaining their friendship – is enough to sustain a securities fraud charge. Having those words come out of Rakoff’s mouth would be a boon to the prosecution.

The jury instruction proposed by Gupta’s lawyers, a mere one-paragraph document, begins by noting a director’s fiduciary (not legal) duty not to disclose material, non-public information. Gupta’s lawyers then append a phrase to define what constitutes insider trading on that information: It has to be “for the improper purpose of deriving a personal benefit as a result of another person’s use of the information to purchase or sell the securities of the corporation.” Note how Kramer Levin wants Rakoff’s instruction to link disclosure to “a personal benefit” – that’s because a pillar of Gupta’s defense is that prosecutors can’t show any personal benefit to Gupta from the alleged tips.

Specifically, Kramer Levin suggests Rakoff tell jurors that Gupta “knowingly, intentionally and willfully breached his fiduciary duty … for the improper purpose of deriving a personal benefit as a result of Mr. Rajaratnam’s use of the information for trading securities.” The defense wants Rakoff to warn jurors that the government has to establish a much tighter link between tips and profits than prosecutors’ vague “some kind of benefit, directly or indirectly, however modest.”

Rakoff, of course, knows exactly what each side is trying to do, so you can be sure he’ll carefully craft the preliminary instruction he delivers. But these proposed preliminary instructions show why these big trials are so exhausting for both sides. Every single word counts.

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Remember the children’s game Telephone? One kid whispers something in another kid’s ear, the second kid turns around and whispers what she heard to the next child, and so on down the line. At the end, the last one to receive the whispered message says aloud what she heard, the kid at the start of the chain announces the original phrase, and everyone laughs because the message was inevitably mangled as it was passed along. That’s why courts have a rule barring hearsay. Witnesses can testify about conversations they participated in, but they can’t generally tell jurors what they heard secondhand about discussions they weren’t directly involved in, because hearsay isn’t considered sufficiently reliable.

The same principle applies when prosecutors obtain wiretap evidence of phone conversations. Obviously, wiretaps provide a record of direct conversations. But when one person on a recorded phone call tells another about a conversation he had with someone else, is that evidence or hearsay?

For Rajat Gupta, the former McKinsey chief and Goldman Sachs director accused of passing tips to convicted inside-trader Raj Rajaratnam, the hearsay rule could well be the difference between acquittal and a long prison sentence. As I’ve previously reported, prosecutors from the U.S. Attorney’s office in Manhattan are relying on tapes of three conversations between Rajaratnam and his colleagues at the Galleon Group hedge fund to link Rajaratnam’s illegal trades with tips he allegedly received from Gupta. The government conceded in a brief filed earlier this month that those tapes are the best evidence it has – in a case in which there’s no proof Gupta profited from his alleged insider trading – that Gupta actually passed confidential information to the hedge fund billionaire. Without Rajaratnam’s fleeting recorded references to tips about Goldman Sachs, the government’s case against Gupta is all inference, requiring jurors to draw lines between phone records and Rajaratnam trades.

The prosecutors, Assistant U.S. Attorneys Reed Brodsky and Richard Tarlowe, don’t assert that the wiretap evidence is anything but hearsay. But they argued in their brief that the recorded conversations fall under exceptions to the bar on hearsay evidence in the federal rules of evidence. The government has asked U.S. Senior District Judge Jed Rakoff for a pretrial ruling that the tapes are admissible because they contain statements that were against Rajaratnam’s interests and were made in furtherance of a conspiracy involving both Rajaratnam and Gupta. Prosecutors also argued, in a bit of circular reasoning, that Rakoff should admit the hearsay evidence because the government really needs it to prove its case. The tapes “are the most probative evidence available that Rajaratnam traded Goldman shares based on a tip from Gupta,” the government’s brief said, citing a rarely invoked “residual exception” to the hearsay rule. “The introduction of these statements would be consistent with the rules of evidence and advance the interests of justice.”

Late Friday, Gupta’s lawyers at Kramer Levin Naftalis & Frankel filed their 41-page response to the prosecutors’ hearsay brief. It’s a do-or-die filing that argues against admission of the tapes on both procedural and substantive grounds. This is as good an examination of the hearsay rule, and its application in the 2nd Circuit Court of Appeals, as you’re going to find.

Kramer Levin first of all asserts that Rakoff cannot rule on the admissibility of the crucial Rajaratnam tapes until the government has established by a preponderance of evidence at trial that Gupta is part of the insider-trading conspiracy. That’s been the rule in the 2nd Circuit for more than 40 years, according to the brief. “The government seeks to dispense with the inconvenience of a trial – and Mr. Gupta’s testing of its trial evidence – by asking the court to admit alleged co-conspirator statements before trial, with virtually no evidence in hand, based largely (or perhaps even entirely) on bald statements in its brief that are unproven and, in many instances, unprovable,” Gupta’s lawyers wrote. “Worse, the government seeks to apply that truncated procedure with respect to out-of-court statements it believes are central to the case. The government cites no case in which any court in this circuit has departed from long-settled practice to proceed in that fashion.”

The brief goes on to analyze why the taped conversations between Rajaratnam and Galleon trader Ian Horowitz and Galleon Asia chief David Lau aren’t admissible because they don’t implicate Gupta in a conspiracy. In two conversations with Horowitz on the morning after the Goldman board was informed that Berkshire Hathaway was investing $5 billion in the bank in September 2008, Rajaratnam made elliptical references to “something good” he had learned about Goldman that led him to snap up some 200,000 shares of the bank in the final minutes of trading the previous day. Prosecutors allege that the “something good” was early news of the Berkshire investment, passed along by Gupta (as per phone records) immediately after the Goldman board learned of the capital infusion. And in a call the next month with Lau, Gupta said he’d “heard yesterday from someone who’s on the board of Goldman Sachs” that Goldman’s earnings would be drastically lower than analysts expected. Prosecutors assert the tip came from Gupta, and Rajaratnam dumped 150,000 shares of Goldman after receiving it.

But according to Gupta’s lawyers, to bring in the tapes under the hearsay exception for conspiracy, prosecutors have to show that Gupta knew Horowitz and Lau were part of Rajaratnam’s insider-trading ring and made the wiretapped statement to advance the conspiracy. They assert the government fails to do either. Prosecutors, they argue, can’t even establish that Horowitz, an unindicted co-conspirator in the Gupta case, took part in Rajaratnam’s insider trading on the stocks at issue in the Gupta prosecution, let alone that Gupta had any idea of Horowitz’s involvement with Rajaratnam (whose conduct Gupta claims to be ignorant of). And even if prosecutors can squeak through the gate linking Gupta, Horowitz, and Lau to Rajaratnam’s insider-trading scheme, Kramer Levin’s brief said, they can’t show that Rajaratnam’s statements to Horowitz and Lau furthered the conspiracy.

The Galleon chief’s “vague and generalized statements about ‘something good’” actually suggest that Horowitz wasn’t part of any conspiracy and that Rajaratnam wasn’t tipped about Berkshire, according to Gupta’s lawyers. “It makes no sense that Rajaratnam would use such vague and indefinite words with Horowitz if he had, in fact, received a valuable tip the day before,” the brief said. “Likewise, Rajaratnam’s complete failure in two separate conversations to supply Horowitz with the name of the person from whom he purportedly heard the ‘something good,’ or even some identifying information concerning that person, further confirms that Rajaratnam’s statements were not part of any insider trading conspiracy.”

According to Kramer Levin, the vagueness of the comments to Horowitz also argues against their admission as statements against Rajaratnam’s interest. The hearsay rules assume that when witnesses offer secondhand evidence that incriminates them, that evidence is reliable because it’s a statement against their interest. The government contended that Rajaratnam’s alleged disclosures that he received Goldman Sachs tips are incriminating statements that fall under that hearsay exception. Kramer Levin countered that Rajaratnam didn’t incriminate himself in those inconclusive conversations, and, moreover, the exception for statements against interest only applies when there’s corroborating evidence that the hearsay is trustworthy. Rajaratnam is a known braggart who lied about and exaggerated his access to inside information, Kramer Levin argued. Nothing he said is trustworthy.

The same is true, Gupta argued, of Rajaratnam’s statements to Lau – who’s not even an unindicted co-conspirator. That taped evidence “merely described supposed past events without requesting action by Lau, [so] settled law precludes any finding that they were ‘in furtherance of’ a conspiracy,” the brief asserted.

Gupta’s lawyers are asking Rakoff not only to deny the government’s request for a pretrial ruling on the admissibility of the tapes but to flat-out exclude the hearsay evidence from the trial. The judge hears arguments Wednesday.

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From the beginning of the criminal prosecution of Rajat Gupta, it was clear that the government didn’t have the sort of evidence usually at the heart of insider-trading cases. Gupta didn’t profit directly from the tips he allegedly passed to Raj Rajaratnam, who has since been convicted of insider trading. In fact, as his lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel has said repeatedly, Gupta lost millions in his investment with Galleon, Rajaratnam’s hedge fund. That evidentiary gap has left space for Naftalis to argue that the government unfairly targeted his client because of Gupta’s high profile as a former head of McKinsey and director at Goldman Sachs. It also puts pressure on prosecutors to link Gupta directly to Rajaratnam’s tainted trades, since nothing else shows he was part of the conspiracy.

As Gupta’s May 21 trial date fast approaches, the latest filings from both sides disclose exactly how the government intends to establish that link, using phone records and wiretap evidence to show that Rajaratnam traded specifically because of tips he received from Gupta. But the new briefs also spotlight the inferences prosecutors will have to ask jurors to draw. The government’s case leans heavily on wiretapped conversations in which Rajaratnam tells associates at Galleon what he found out in alleged phone conversations with Gupta that were not taped by the government. Prosecutors argued in a motion in limine last week that Rajaratnam’s taped calls with Galleon conspirators fall under an exception to the rule barring hearsay evidence. If U.S. Senior District Judge Jed Rakoff disagrees, the government will have a much tougher time convincing jurors that Rajaratnam’s inside information came from Gupta.

The prosecution’s latest bill of particulars against Gupta includes allegations that Gupta tipped off Rajaratnam about Procter & Gamble news (Gupta was also a director there). But the government’s strongest evidence appears to involve two alleged Goldman tips. The first alleged tip came on the day in September 2008 that Goldman Sachs directors learned of Warren Buffett’s $5 billion investment in the bank. Moments after Gupta disconnected from the board’s conference call, his assistant placed a call to Rajaratnam, according to phone records. After that very brief call, which concluded only minutes before the end of the trading day, Rajaratnam placed orders to buy as much Goldman Sachs stock as he could snap up. He ended up paying about $25 million for more than 200,000 shares. The next day, according to wiretap evidence, Rajaratnam told his personal Galleon trader, an unindicted co-conspirator named Ian Horowitz, that he rushed to order hundreds of thousands of Goldman shares because he “got a call at 3:58 … saying something good might happen to Goldman.”

Similarly, prosecutors assert, Gupta tipped off Rajaratnam after a Goldman board meeting the next month at which directors learned that the bank was projecting a quarterly loss of $2 per share rather than the $2.50 per share gain Wall Street anticipated. The Goldman board meeting took place after the market had closed, but as soon as trading opened the next day, Rajaratnam dumped all of the 150,000 Goldman shares he held. Later that day, in a wiretapped conversation with a colleague in Asia, David Lau, Rajaratnam said he “heard yesterday from somebody who’s on the board of Goldman Sachs,” that earnings would be way off.

As assistant U.S. attorneys Reed Brodsky and Richard Tarlowe conceded in their Apr. 30 brief asking Rakoff to let in evidence from Rajaratnam’s wiretapped conversations with Horowitz and Lau, they need that evidence to tie Gupta’s calls to Rajaratnam with Rajaratnam’s subsequent trades. Ordinarily, Rajaratnam informing other people of what he allegedly learned from Gupta would be considered inadmissible hearsay. But prosecutors said Rajaratnam’s statements fall under exceptions to the hearsay rule because (among other things) they were made to co-conspirators in the course of an ongoing insider-trading scheme. Gupta, they argued, should reasonably have expected that Rajaratnam would involve others at his hedge fund in the alleged conspiracy. The hearsay evidence, prosecutors asserted, is the only way for them to establish what was said in the unrecorded conversations between Gupta and Rajaratnam, since neither of them is talking.

The government does have a tape of one conversation between Gupta and Rajaratnam, but Kramer Levin argued – in a May 7 motion to bar prosecutors from playing it to the jury – that the tape doesn’t show Gupta giving Rajaratnam inside information. There’s also no evidence Rajaratnam made any trades based on the phone call, according to Gupta’s lawyers. On July 29, 2008, Gupta and Rajaratnam talked for about 25 minutes, including a brief discussion about Goldman Sachs’s rumored plan to acquire a commercial bank. Prosecutors played the tape for the jury at Rajaratnam’s criminal trial last year, arguing that it showed Gupta breaching his duty as a Goldman director by disclosing confidential information. But Kramer Levin said in its new brief that Gupta was only telling Rajaratnam what Goldman had already told analysts.

Nevertheless, Gupta’s lawyers argued, prosecutors should not be permitted to play the tape because it’s impermissible “propensity” evidence that the government will twist to suggest Gupta’s guilt by association with Rajaratnam. Similarly, Gupta’s lawyers argued in a separate motion filed Monday that Rakoff should bar wiretap evidence of conversations between Rajaratnam and other conspirators that have no bearing on the accusations against Gupta.

“It appears that the government seeks to reprise the Rajaratnam trial in order to shore up its weak circumstantial case against Mr. Gupta, resorting to evidence about other companies and other alleged conspiracies,” the brief said. “The court should exclude these conversations because they lack even remote relevance to the conspiracy charged in the indictment and because they are extremely prejudicial, likely to focus the jury’s attention on matters outside the indictment, and likely to create the risk of a finding of guilt based on evidence of separate (and distinct) conspiracies.”

There are other clues to Gupta’s likely defenses in the government’s briefs, both the Apr. 30 hearsay filing and a May 7 brief asking Rakoff for additional pretrial rulings. Prosecutors expect Gupta to argue that someone else must have told Rajaratnam about Buffett’s $5 billion investment in Goldman, raising doubts about whether Gupta and Rajaratnam even spoke after the Goldman board’s conference call that day. Prosecutors also said Gupta’s lawyers may argue that Galleon’s last-minute Goldman purchases on the day the board learned of the Buffett announcement were part of a broader market move in Goldman Sachs, suggesting that someone other than Gupta was spreading word of Buffett’s investment.

Prosecutors are also expecting Gupta to argue that, far from wanting to help Rajaratnam, he actually bore a big grudge against the Galleon chief. According to the government’s May 7 brief, which asks Rakoff to compel the disclosure of privileged communications between Gupta and some of his civil lawyers, Gupta contemplated suing Rajaratnam for unilaterally redeeming money from an investment they held jointly. The government argued that Gupta’s anger at Rajaratnam in 2009 has no bearing on the 2008 conspiracy it alleges. It also asked Rakoff to bar defense arguments that Gupta is being unfairly singled out for prosecution.

Gupta’s lawyers haven’t yet filed what will likely be their most consequential brief asking Rakoff to bar that all-important wiretap evidence from Rajaratnam’s conversations with Horowitz and Lau (neither of whom, incidentally, has been accused of wrongdoing by prosecutors). Rakoff has previously ruled that wiretap evidence is broadly admissible, but he has not addressed specific tapes the government wants to play.

By prosecutors’ own admission, the whole case may depend on what Rakoff decides.

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Jed Rakoff has bounced back quite nicely, thank you, from his appellate smackdown in the Securities and Exchange Commission’s collateralized debt obligation case against Citigroup. In the unlikely event you’ve forgotten, earlier this month the 2nd Circuit Court of Appeals stayed the SEC’s case before Rakoff, finding a strong likelihood that the government and Citi would prevail in their argument that the judge overstepped his bounds when he rejected their proposed $285 million settlement. Despite the notably critical language in the three-judge panel’s per curiam ruling in the Citi case, Rakoff, a U.S. Senior District Judge in federal court in Manhattan, seems undaunted in his determination to hold the SEC accountable. On Tuesday, he ruled that the agency must disclose documents used to prepare Goldman CEO Lloyd Blankfein for his deposition in the Rajat Gupta insider trading case.

Rakoff’s 10-page ruling, issued on the same day that he said the government can use wiretap evidence in the parallel Gupta criminal case, rejects the SEC’s argument that work-product privilege protects its preparation of Blankfein. The judge pointed to a 1993 case from the 2nd Circuit, In re Steinhardt Partners, and a 2003 ruling from the same appeals court, In re Grand Jury Subpoenas, in holding that the government waived its privilege claim when it voluntarily shared materials with Blankfein, a third-party witness. Rakoff said that Blankfein doesn’t have a “common interest” with the government in the Gupta case, so disclosures to him amount to “‘deliberate, affirmative, and selective’ use of work product [that] waives the SEC’s ability to now assert the privilege against the defendants.”

Here’s the fascinating backstory. At Blankfein’s deposition on Feb. 24, Gupta’s lawyers at Kramer Levin Naftalis & Frankel asked him standard questions about how he prepared to testify. Blankfein, according to Kramer Levin’s March 1 brief, revealed that on two occasions leading up to the deposition, he met with SEC lawyers, an agent from the Federal Bureau of Investigation, and prosecutors from the Manhattan U.S. Attorney’s office. At those two sessions, he said, prosecutors asked him 75 percent of the prep questions; the SEC asked the other 25 percent of the questions. Blankfein’s own lawyers at Sullivan & Cromwell, according to Kramer Levin, didn’t ask him questions at the two prep sessions with government lawyers. Blankfein also disclosed that government lawyers showed him 10 or 12 documents in advance of his deposition testimony.

The SEC cut off Kramer Levin’s questioning when Gupta’s lawyers tried to follow up with more questions about Blankfein’s preparation, claiming privilege. According to Kramer Levin’s brief, Blankfein’s S&C lawyer, who was also at the deposition, “made plain that the objections were the SEC’s alone and were not being asserted by the witness or Goldman.” Kramer Levin then took the matter to Rakoff, who asked for briefs after a joint phone call on the issue.

In Tuesday’s decision, the judge ruled that Kramer Levin may ask Blankfein follow-up questions about the government-led deposition prep sessions — and that the government must turn over to the defense any documents Blankfein was shown. (Interestingly, Rakoff disregarded one of his own old rulings, Morales v. United States, a 1994 case in which he upheld a privilege claim by prosecutors. The judge said he hadn’t considered Steinhardt when he ruled in Morales.)

Here’s what Rakoff wrote:

To allow the invocation of work product protection to succeed in such circumstances would leave the party taking a deposition with no remedy to determine how, if at all, a witness’s testimony was influenced, not by advice from the witness’s own counsel, but by suggestions from the questioner’s adversary, who, especially if possessing governmental power, was in a position to unfairly pressure the witness…

By asking Blankfein what topics he recalls were discussed, what questions he was asked and what documents he was shown, defendants seek to discover how the preparation sessions affected Blankfein’s testimony, and do not demonstrate a mere naked attempt to obtain the SEC’s and the USAO’s legal opinions and strategy.

Rakoff rulings against government privilege claims are becoming a habit. I reported last month on his order that the Justice Department disclose emails the Solicitor General’s office created when it was drafting a brief in an immigration case at the U.S. Supreme Court. Jess Bravin of the Wall Street Journal wrote on March 13 that Rakoff said the immigration case had grown “curiouser and curiouser” with additional government disclosures. According to Bravin, the Justice Department is consi de ring a correction of possibly misleading statements in the Supreme Court brief.

It’s not entirely clear how much Tuesday’s ruling will benefit Gupta. Blankfein’s testimony, after all, doesn’t address the core relationship between Gupta and Raj Rajaratnam, the now-convicted hedge fund founder Gupta is accused of tipping off. But establishing the government’s heavy-handed coaching of Blankfein, who is expected to testify about Goldman board meetings Gupta attended, could help Kramer Levin raise doubts about the strength of the government’s criminal and civil cases.

Lead Gupta counsel Gary Naftalis of Kramer Levin declined to comment. An SEC spokesman said the agency is “reviewing the opinions.”

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The Justice Department and the Securities and Exchange Commission apparently do not have the evidence to assert a classic insider-trading case against former Goldman Sachs and Procter & Gamble director Rajat Gupta. Typically, the government brings insider-trading cases against people who profited directly from trades based on confidential information. Gupta doesn’t fall into that category. Neither the SEC nor the DOJ claims that he realized any direct profits from the trades Galleon Group chief Raj Rajaratnam allegedly made based on his tips. Indeed, Gupta’s lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, has said many times that Gupta “lost his entire investment” in Rajaratnam’s hedge fund. “[Gupta] did not trade in any securities, did not tip Mr. Rajaratnam so he could trade, and did not share in any profits as part of any quid pro quo,” Naftalis told Reuters in a statement.

But while the absence of a direct profit motive complicates the Justice Department and SEC cases against Gupta, it doesn’t preclude them. The government doesn’t have to show that Gupta directly profited by tipping Rajaratnam, only that he benefited in some way from passing along inside information. “It’s not your standard model, but it’s not unprecedented,” said Thomas Gorman of Dorsey & Whitney, who represented an Ohio State business-school professor convicted in a no-profits insider-trading case in 2005.

The government, in fact, has broad leeway to define the benefits a tipster derived from disclosing confidential information, Gorman said. Benefits can be as amorphous as enhancing a friendship or angling for future favors. In the Gupta case, the SEC and the Manhattan U.S. Attorney are so far offering only vague motives for his alleged insider trading. The SEC’s new complaint asserted that Gupta received indirect profits from Rajaratnam’s illicit trades, since he was an investor in Galleon funds. The complaint also refers to Gupta’s “variety of business dealings with Rajaratnam,” and alleges that the former McKinsey chief “stood to benefit from his relationship with Rajaratnam.” Similarly, the U.S. Attorney’s indictment said Gupta revealed inside information to Rajaratnam to deepen his relationship with the Galleon chief. “Gupta benefited and hoped to benefit from his friendship and business relationships with Rajaratnam in various ways, some of which were financial,” the indictment said.

But in a twist, Gupta’s best defense may turn out to be the close relationship with Rajaratnam that’s at the heart of the government’s allegations against him. That defense relies on an SEC rule and a September 2011 ruling by the U.S. Court of Appeals for the Second Circuit in a previous insider trading case, U.S. v. Gansman.

James Gansman, a former Ernst & Young lawyer, was, like Gupta, accused of passing inside information to someone who subsequently used it to make money. In Gansman’s case, he allegedly gave his lover details of M&A deals E&Y was working on. Gansman didn’t make money from her trades, but the government implied that he gave her the information in order to prolong their affair.

At Gansman’s 2009 trial, his lead defense lawyer, Barry Bohrer of Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, focused on an SEC rule enacted in 2000 to address when family members or close personal friends owe a duty of confidentiality or loyalty to someone who has disclosed inside information. The rule was intended to specify when the people who receive confidential information can be prosecuted for misusing it, but Bohrer turned the rule into a defense. He argued that Gansman had a right to tell jurors that he expected his girlfriend to keep the inside information confidential, because they had a history of sharing work-related disclosures. Over the government’s objection, Manhattan federal judge Miriam Cedarbaum agreed to instruct Gansman’s jury that he contended “any material non-public information that [his girlfriend] may have received from him was shared with her as part of a relationship in which they shared work and personal confidences.”

The jury convicted Gansman, who appealed to the Second Circuit. In appellate filings here and here, Bohrer argued that the jury instruction Cedarbaum delivered didn’t go far enough. He contended Gansman was entitled to tell jurors that he disclosed inside information to his girlfriend only “as part of a relationship of trust and confidence, in which they had a history and practice of sharing work and personal confidences,” so he “reasonably expected that [she] would keep any confidences he shared with her confidential and would not use those confidences to buy or sell securities.”

The Second Circuit denied Gansman’s appeal, concluding that the jury instruction Cedarbaum delivered wasn’t far enough from the one Gansman wanted to warrant overturning his conviction. (The appellate panel also pointed to evidence that Gansman knew his girlfriend was trading on the information he provided.) But, crucially, the appeals court ruled it’s appropriate for accused tipsters to argue that they trusted the people who received their inside information not to trade on it.

“The SEC has recognized a number of situations … in which a tippee, but not the tipper, may be liable for insider trading on the theory that the tippee owed a duty of trust or confidence to the tipper and the tipper conveyed confidential information without intending to have it used for securities trading purposes,” the Second Circuit opinion said. “Here, it was perfectly appropriate for Gansman to seek to present to a jury a defense that his relationship and interactions with [his girlfriend] exemplified just such circumstances. That is, Gansman was entitled to support his general defense that he lacked the intent to commit securities fraud by showing, in particular, that he shared ‘a history, pattern, [and] practice of sharing confidences’ with [her] sufficient to create a duty of trust running to Gansman.”

The Gansman appellate ruling, said Gorman, could certainly be extended to the Gupta case, in which, according the government’s indictment, the tipper and tippee maintained “a personal relationship and friendship.” “Gupta could argue, ‘I didn’t think he’d trade on it,’” Gorman said. “If Gupta believed Rajaratnam would keep the information confidential, based on the facts of circumstances of their longstanding relationship, that could be an effective defense.”

There are risks for Gupta in that defense, of course. To show that he trusted Rajaratnam to keep his disclosures to himself, he would have to show a history of exchanging confidences with the now-convicted Galleon chief. That might not go over well with jurors, who, in the government’s criminal case, would ultimately decide whether Gupta was justified in believing Rajaratnam wouldn’t trade on his disclosures.

Michael Kendall of McDermott Will & Emery, a former federal prosecutor who’s not involved with Gupta’s defense, said Gupta would have a hard time convincing jurors that he believed Rajaratnam wouldn’t trade on confidential information. “It wasn’t like [Gupta] was telling his priest or rabbi,” said Kendall.

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Former Goldman Sachs director Rajat Gupta and his lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, declared what might seem to be a very strange kind of victory last week when the Securities and Exchange Commission agreed to drop its administrative proceeding against Gupta. The two-page stipulation between Gupta and the SEC makes it clear that the SEC isn’t giving up on its claims that Gupta engaged in insider trading when he allegedly passed confidential information about Goldman Sachs and Procter & Gamble to Galleon Group hedge fund chief Raj Rajaratnam. All Gupta won was a pledge that the agency will sue him in federal court. And that is indeed a huge victory.

The SEC chose an anomalous vehicle for its March 1 suit accusing Gupta of helping Rajaratnam engage in insider trading. Instead of bringing a case against Gupta in Manhattan federal court — as the SEC did when it sued 28 other Galleon insider trading defendants — the agency filed what’s known as a public administrative proceeding. Those proceedings take place before an administrative law judge under SEC rules, not the federal rules of civil procedure. There’s no jury, and the first appeal of any adverse ruling goes to the SEC commissioners, not to an appeals court.

As Gupta counsel Naftalis laid out in his March 18 federal court complaint against the SEC, the differences between an SEC administrative proceeding and a federal court case added up to a big pile of prejudice against Gupta. Gupta wouldn’t be able to take depositions or conduct full discovery to counter the SEC’s assertions. The SEC, meanwhile, would be able to introduce hearsay evidence that it might not be able to get into evidence in federal court, according to the Gupta complaint. “The only plausible inference is that the Commission is proceeding how and where it is against Mr. Gupta for the bad faith purpose of shoring up a meritless case by disarming its adversary,” the complaint asserted.

The SEC’s attempt to sue Gupta in an administrative proceeding was all the more reprehensible, Gupta claimed, because the SEC has no regulatory power over him. He’s not an officer of a public company or a broker-dealer, or in any other position that falls under the purview of the SEC. Instead, the agency relied on provisions of the Dodd-Frank Wall Street Reform Act to bring the Gupta case as an administrative proceeding — even though all of Gupta’s alleged misconduct took place before Dodd-Frank was passed.

Gupta and Naftalis argued that the retroactive application of Dodd-Frank to hamstring Gupta’s defense amounted to an unconstitutional violation of his due process rights, since he alone, of all the Galleon defendants, had been sued in an administrative proceeding. In the federal court suit, which landed before Judge Jed Rakoff, Gupta and Naftalis asked for a declaration that the SEC can’t apply the Dodd-Frank civil penalty provisions retroactively and an injunction barring the SEC from bringing an administrative proceeding against Gupta.

The SEC’s response, styled as a motion to dismiss Gupta’s federal court complaint, essentially said that the agency has the right to sue Gupta where it wanted to, and if he didn’t like the SEC’s choice of forum, he could just wait until the end of the administrative proceeding to appeal.

Judge Rakoff sided with Gupta. “A funny thing happened on the way to this forum,” he wrote in a July 11 opinion (with no apology to Stephen Sondheim). “The Securities and Exchange Commission — having previously filed all of its Galleon-related insider trading actions in this federal district — decided it preferred its home turf.” The judge found he had jurisdiction over the case by virtue of the U.S. Supreme Court’s 2010 ruling in Free Enterprise Fund v. Public Company Accounting Oversight Board, and concluded that Gupta could litigate his constitutional due process claim in federal court, en route to the injunction he had asked for.

Instead of appealing Rakoff’s ruling, the SEC agreed to last week’s stipulation. The agreement, said an agency spokesman, doesn’t let Gupta off the hook. “The staff is committed to the case against Mr. Gupta and will proceed as appropriate,” spokesman John Nester told me.

But as Gupta counsel Naftalis said in a statement to Reuters at the time, the stipulation gives Gupta everything he wanted in his suit against the SEC-a chance to defend himself in federal court. “Mr. Gupta denies all allegations of wrongdoing and stands ready to mount a defense against each and every one of the Commission’s charges,” Naftalis wrote.

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