[This story previously appeared in Securities Regulation Daily.]
By Anne Sherry, J.D.
Criticizing last month’s opinion by a Second Circuit panel overturning two insider trading convictions based on a lack of personal benefit to the tippers, the government is asking for rehearing and rehearing en banc. The government’s petition argues that the opinion is counter to Supreme Court precedent and absolves “deliberate, corrupt, and formerly criminal insider trading” (U.S. v. Newman, January 23, 2015).
The Second Circuit last month vacated the convictions of two hedge fund portfolio managers in the absence of evidence that they knew they were trading on insider information or that the insiders received a personal benefit in exchange for the tips. But the government was denied an opportunity to retry its case under the “newly announced knowledge requirement,” the petition argues. The government maintains that the panel’s personal benefit definition conflicts with prior decisions, including by the Supreme Court, and that its evidence was sufficient to establish a personal benefit and knowledge or conscious avoidance of that benefit.
Narrow benefit requirement. The Second Circuit, following the Supreme Court’s opinion in Dirks v. SEC, previously defined personal benefit broadly to include “not only pecuniary gain, but also the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend.” The panel qualified this line of reasoning, stating that prior precedent did “not suggest that the Government may prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature.” Instead, the panel held, the benefit received in exchange for confidential information must be of some consequence. Furthermore, the government also needed to prove that the defendants knew that such a personal benefit had been conferred on an insider.
According to the petition, the panel replaced part of the Dirks benefit test with a new test, none of whose components, such as a “meaningfully close” personal relationship, have a familiar meaning in this or any analogous area of law. “To the extent the Panel sought to set clear guidelines for Wall Street professionals and prosecutors, the test it adopted will do just the opposite,” the government maintains.
Threat to securities markets. That the case was wrongly decided, in the government’s position, is especially problematic considering it is one of the most significant developments in insider trading law in a generation. The Second Circuit’s “preeminence in the field of securities regulation, and its jurisdiction over the financial capital of the world, serve to underline the opinion’s importance nationally and, consequently, magnify the harm that will result from its errors.” These harms include, the petition maintains, a perception by individuals that “cozy relationships” allow insiders and elite traders to exploit nonpublic information for personal gain. This outcome contravenes the basic objective of the securities laws to ensure honest markets and promote investor confidence, the government concludes.
The case is No. 13-1837.