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Clock ticking for decision on landmark insider-trading ruling

July 27, 2015

Time is running out for the United States to ask the Supreme Court to review a ruling that could lay the framework for how insider trading will be prosecuted for years to come.

Solicitor General Donald Verrilli has until Aug. 3 to decide whether to let stand an appeals court ruling that makes it harder to prosecute insider traders.

The government won more than 80 insider-trading convictions in New York over the past six years. If Verrilli declines to pursue an appeal—or the Supreme Court lets the ruling stand—challenges to some convictions will be strengthened, others might be encouraged to fight and future prosecutions may be harder to win.

That will “have real impact on the government’s ability to bring insider-trading cases,” said Jonathan Streeter. Streeter was one of the lawyers who successfully prosecuted Galleon Group LLC co-founder Raj Rajaratnam for insider trading in 2011.

The decision in question came from the U.S. Court of Appeals in New York in December, throwing out the convictions of Todd Newman, a former portfolio manager at Diamondback Capital Management, and Anthony Chiasson, co-founder of Level Global Investors. The court’s known for making law in securities cases and is Wall Street’s home court. The ruling became known as the Newman decision.

In addition to proving traders knew their tip came from someone who breached a duty to keep it secret, prosecutors must also prove the tipper got a personal benefit of “some consequence” in exchange, the appeals court said. Providing a tip out of mere friendship isn’t enough, the judges said.

Chain of people

Both regulators and prosecutors have said the ruling makes it harder to bring cases against traders who get inside information through a chain of tippers.

“It will often be hard to prove downstream tippees had knowledge of the benefit,” said Streeter, a partner at Dechert LLP. Newman also “put real substance into what the government must prove to show a benefit in every case -- not just those involving remote tippees.”

Manhattan U.S. Attorney Preet Bharara said it also “invites selective leaking” of inside information to friends and associates.

Insider trading isn’t expressly prohibited by U.S. criminal law. Instead, prosecutors charge defendants with securities fraud, applying decades of judge-made law to pursue illegal trading. The high court, which has been skeptical of government arguments in some recent criminal appeals, might give prosecutors a ruling that’s even harder to live with than Newman.

Court review

The Supreme Court justices generally follow recommendations from Verrilli’s office on which cases to take. A high court review may have been made more likely by a July 6 ruling by the U.S. Court of Appeals in San Francisco, which declined to adopt the Newman court’s reasoning in the insider-trading appeal.

Newman and Chiasson were convicted in 2012 as part of a scheme in which analysts and insiders swapped tips on technology stocks and funneled the information to their bosses. Newman got 4 1/2 years in prison for making about $3.8 million in illicit profits; Chiasson got 6 1/2 years after making more than $68 million.

Others may be watching for the Solicitor General’s decision closely.

Michael Steinberg, a former SAC Capital portfolio manager, was sentenced to 3-1/2 years in prison after being convicted on much the same evidence as the Newman case. The success of his appeal could depend on whether the decision stands.

Decision impact

Since Newman and Chiasson’s appeal relied in part on them not knowing the tipsters benefited from passing on information, the decision may not be as helpful for other convicted insider traders such as Rajaratnam, former Goldman Sachs Group Inc. Director Rajat Gupta or former SAC fund manager Mathew Martoma.

So far, the Newman decision has had limited effect outside New York.

“It has not resulted in opening the floodgates” to invalidate insider-trading prosecutions throughout the country, said Lathrop Nelson, a partner with Montgomery McCracken Walker & Rhoads LLP in Philadelphia.

In deciding whether to seek Supreme Court review of Newman, Verrilli is considering Bharara’s views as well as those of top Justice Department officials, said Andrew Pincus, who served as an assistant to the solicitor general in the 1980s and has argued 24 cases before the Supreme Court. The Securities and Exchange Commission is also a likely participant in the decision-making process, Pincus said.

Emily Pierce, a spokeswoman for Verrilli, declined to comment on whether the government will seek a Supreme Court review.

Supreme Court Justice Harry Blackmun once called the appeals court in New York the “Mother Court” for securities law. That makes it all the more important to the Supreme Court to make sure securities rulings there are correct, lawyers said.

“This is the sort of issue that might not arise as often in the rest of the country,” said Pincus, now a partner at Mayer Brown LLP. “Such a disproportionately large number of the cases arise in New York.”

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