The federal appeals court that earlier this month overturned the insider-trading convictions of two Wall Streeters brought some clarity to some aspects of the crime.
It did not, however, reduce the risks around insider trading that compliance officers need to worry about one whit.
“It’s an important decision because there’s been very little clear guidance from the courts regarding what’s required in ‘tipping’ cases, in terms of a personal benefit to the tipper and the tippee’s knowledge of that personal benefit,” says Marc Elovitz, a partner at law firm Schulte Roth and Zabel.
Even so—and despite some accounts that suggest otherwise—most experts advise against relaxing any insider-trading policies and programs a company has. “A compliance officer would have to be out of his or her mind to tell the organization and its employees that there has been a lightening of standards regarding criminal or civil liability for insider trading,” says Richard Spinogatti, senior counsel with Proskauer Rose.
The decision in question centers around Todd Newman and Anthony Chiasson, Wall Street executives convicted in New York of insider trading in 2013. At the heart of the case was the application of “tippee liability,” when an individual outside a subject company receives material, non-public information and trades on the information, yet is several levels removed from the information’s source.
“It’s a very important decision because there’s been very little clear guidance from the courts regarding what’s required in ‘tipping’ cases, in terms of a personal benefit to the tipper and the tippee’s knowledge of that personal benefit.”
Marc Elovitz, Partner, Schulte Roth and Zabel
“The court is saying that for the ultimate user of the information, the trader, to be held criminally liable, [he or she] had to know or should have known the disclosure of the information involved a breach of fiduciary duty by the corporate insider, including the insider’s receipt of some form of personal benefit,” Spinogatti says. Moreover, the trader would have had to known this, yet traded anyway.
That scenario does not arise in insider trading every day.
That’s because the decision “dealt with a relatively narrow issue at the margins of insider-trading law,” says Russ Ryan, a partner with King & Spalding’s special matters and government investigations group in Washington, D.C.
Newman and Chiasson both were portfolio managers, although at different firms. The government alleged that analysts at various hedge funds and investment firms obtained insider information from employees at publicly traded technology companies, and passed that intel around until it ultimately reached the ears of portfolio managers at their firms. The government charged Newman and Chiasson with “willfully participating in this insider-trading scheme by trading in securities based on inside information illicitly obtained by this group of analysts.”
The 2nd Circuit Court of Appeals disagreed. The evidence showing any personal benefit received by the alleged insiders was insufficient to establish tipper liability, from which tippee liability is derived, the court said. What’s more, no evidence showed that Newman and Chiasson knew they were trading on information obtained from insiders in violation of their fiduciary duties.
“They were several steps removed from the corporate insiders and there was no evidence that either was aware of the source of the inside information,” the court said. That made it difficult to also prove either knew of any benefits the tippers might have received.
Despite the overturned criminal convictions, most compliance officers won’t want to relax their insider-trading policies; too much uncertainty surrounds the decision. For starters, the government may seek further appellate review by moving for a re-hearing or filing a certiorari petition with the Supreme Court, or both. “In that sense, it’s not a final decision,” Spinogatti says.
The language in the decision also leaves some uncertainty, Spinogatti says. It uses the terms “knew or should have known,” and “knowledge,” as seemingly interchangeable. “Knew or should have known,” however, has a broader meaning, as it can encompass concepts like willful blindness or duty to investigate.
The definition of “personal benefit” is likewise ambiguous. The benefits in this specific case were non-monetary and included providing career advice and occasional social gatherings. The appeals court didn’t see these as benefits—“If this was a benefit, practically anything would qualify,” the decision stated—yet the court never said what would be considered a benefit.
In addition, “prior decisions have suggested friendship alone might be enough of a personal benefit,” says Tanya Dmitronow, a partner with Proskauer. Given the various interpretations of “benefit” among this case and others, the definition will likely be narrowed as more cases make their way through the courts, she adds.
While the ruling may provide some defendants in insider-trading cases a new argument to use in their defense, “companies don’t want to be in the position of having to defend conduct that may look questionable in hindsight,” Dmitronow says.
Stay the Course
Rather than pull back from compliance programs focused on insider trading, compliance professionals would be better served by “reinforcing insider-trading rules and protocols, explaining that the decision doesn’t create a license to trade on insider information,” Spinogatti says.
For traders, investment professionals, and others in similar positions, the decision doesn’t change the fact that anyone who gets material non-public information should ask for guidance from legal and compliance departments, Elovitz says. “The law of insider trading is very nuanced.”
REASONS FOR THE REVERSAL
What follows is an excerpt from the Second Circuit Appelate Court’s recent reversal of insider-trading convictions against Todd Newman and Anthony Chiasson.
We agree that the jury instruction as erroneous because we conclude that, in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew than an insider disclosed confidential information and that he did so in exchange for a personal benefit. Moreover, we hold that the evidence was insufficient to sustain a guilty verdict against Neman and Chiasson for two reasons. First, the Government’s evidence of any personal benefit received by the alleged insiders was insufficient to establish the tipper liability from which defendants’ purported tippee liability would derive. Second, even assuming that the scant evidence offered on the issue of personal benefit was sufficient, which we conclude it was not, the Government presented no evidence that Newman and Chiasson knew that they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.
Accordingly, we reverse the convictions of Newman and Chiasson on all counts and remand with instructions to dismiss the indictment as it pertains to them with prejudice.
Source: 2nd Circuit Court of Appeals.
The decision didn’t state any use of material non-public information is restricted. To the contrary, it states: “[N]othing in the law requires symmetry of information in the nation’s securities markets.”
Elovitz provides an example in which asymmetrical information may be perfectly legal: an activist investor plans to invest in a company and is fairly certain his or her actions will affect the stock price. That doesn’t mean he or she can’t complete the trade. “They’d be restricted by themselves, and that doesn’t make any sense because there was no deception or breach of duty.”
To run afoul of the law, insider trading must include a breach of fiduciary duty, a benefit to the person who provides the inside tip, and the knowledge of both of these facts by the tippee. “You have to look very carefully at the specific facts in any situation and fit them into the legal framework,” Elovitz says.
At the same time, there’s a risk for financial firms that decide not to allow transactions that fall within what seems to be the wider berth discussed in the ruling, says Robert Heim, a lawyer with Meyers & Heim. To date, many firms have prohibited traders from trading on any material non-public information. That’s a wider scope than knowingly trading on information that was obtained via a breach of fiduciary duty in exchange for a benefit, which is the standard put forth in this decision.
Firms that don’t change their policies, yet whose employees engage in transactions falling within the criteria discussed in the ruling—that is, they use material non-public information that doesn’t appear to have been obtained in breach of fiduciary duty or for benefit—could face regulatory trouble. That’s because the trades, even if legal, still would be in violation of the companies’ own policies. That could prompt sanctions if the firm is reviewed by a regulator, Heim says.
As a result, the decision may spur compliance professionals at financial services firms to re-examine policies regarding how trades are made and documented, Heim says. It may also prompt them to renew their focus on their sources of information to ensure employees aren’t obtaining information in violation of an individual’s fiduciary duty to the company.
At the same time, since the ruling may not be final, some firms may want to take a wait-and-see approach before making changes, Heim adds.
Aside from this ruling, other considerations come into play when insider information is leaked. One is Regulation Fair Disclosure (Reg FD), which requires that an issuer who discloses material non-public information to certain individuals or entities also discloses the information publicly. In addition, most companies want to keep non-public information confidential for competitive, as well as regulatory reasons, Dmitronow says.
“The decision represents a possible defense to be asserted after the fact, if a case is brought by the Securities and Exchange Commission or Department of Justice,” Dmitronow says. “But does this mean companies can go back to the drawing board and excise portions of their insider-trading policy? Absolutely not.”