Appeals Court Casts Cloud Over Future of Insider Trading Cases

December 10, 2014
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by Jason M. Breslow Digital Editor

Getting away with insider trading may have just gotten a little bit easier.

In a major blow for the Justice Department’s effort to root out the practice on Wall Street, a federal appeals court on Wednesday reversed two high-profile convictions, ruling that the department has relied on too broad a definition of insider trading laws.

The decision by the U.S. Court of Appeals for the Second Circuit in New York overturns the convictions of Anthony Chiasson and Todd Newman. In 2012, the two hedge fund traders were found guilty of engaging in what prosecutors described as a “circle of greed” that generated millions in illegal gains.

More broadly, though, the court essentially narrowed the definition of what counts as insider trading. Its decision, legal experts say, could mean the reversal of additional convictions, and more importantly, limit the kinds of cases that can be brought in the future.

The central question in the Chiasson and Newman case was what does a trader need to know in order to be found guilty of insider trading? The laws around the practice are notoriously murky, but a landmark ruling from the Supreme Court in the 1983 case, Dirks v. the Security and Exchange Commission, found that to be convicted, a defendant must know that the corporate insider who leaked information was doing so in breach of duty to the company. A breach occurs, the court said, if the insider personally benefits from the leak. “Absent some personal gain, there has been no breach of duty.”

In the Chiasson/Newman case, however, Judge Richard J. Sullivan gave jurors a competing interpretation that relied on a lower burden of proof. The two men could be convicted, he said, if they simply knew the information was given away in breach of the tipper’s fiduciary duty to the company, and not necessarily in exchange for some form of compensation.

“The government is required to prove beyond a reasonable doubt that Newman and Chiasson knew that the insiders received a personal benefit in exchange for disclosing confidential information,” wrote Judge Barrington D. Parker in today’s ruling. But, he said, prosecutors “presented absolutely no testimony that Newman and Chiasson knew that they were trading from information obtained from insiders, or that those insiders received any benefit in exchange for such disclosures.”

The decision raises doubts about at least one other high-profile conviction — that of Michael Steinberg. In 2013, a jury convicted the former portfolio manager at SAC Capital Advisors on insider trading based on similar instructions from Judge Sullivan. Steinberg’s appeal, experts say, is only strengthened by the ruling.

The Steinberg conviction marked a milestone victory for the U.S. Attorney for the Southern District of New York, Preet Bharara. Before today’s ruling, his office has won 89 of 95 cases in an historic crackdown on insider trading. Just one case was acquitted, while five others are pending.

“Today’s decision by the Court of Appeals interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information,” Bharara’s office said in a statement. “We are still assessing the Court’s decision, which appears in our view to narrow what has constituted illegal insider trading, and are considering our options for further appellate review.”

Given the decision, the government’s run of success may be coming to an end. Moving forward, legal experts say, the decision in the Chiasson/Newman case will only make it more difficult for prosecutors to win insider trading cases, particularly for traders who are several jumps removed from the original source of confidential information.

“People may know there’s a breach, but this decision requires that they also know not only that the information was wrongfully released, but that it was released in return for some kind of financial benefit either paid or promised and that’s more specific than most of these conversations get,” said John C. Coffee Jr., a law professor at Columbia University.

“And frankly insider traders will learn from this decision. They’ll start saying I can do this as long as I know nothing about the following facts … ‘Tell me what you know, don’t tell me a thing about how you got it.'”

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