U.S. Asks Justices to Review ‘Newman' Insider Case

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By Phyllis Diamond

July 30 — U.S. Solicitor General Donald Verrilli has asked the U.S. Supreme Court to take up the Second Circuit's controversial Newman decision vacating the insider trading convictions of two former hedge fund executives.

“In an unprecedented ruling, the court of appeals broke with this Court's decision” in Dirks v. SEC, 463 U.S. 646 (1983) regarding what it means when an insider “personally benefits” by providing confidential information to a trading friend or relative, Verrilli said in a July 30 certiorari petition.

Solicitor General

The court won't decide whether to review the case until it reconvenes Oct. 5 for its 2015-2016 term. Historically, however, the justices have granted a far higher percentage of the SG's cert petitions than those of other litigants and at least one Washington securities lawyer thinks they will do so here.

“It is highly likely that the Supreme Court will grant cert,” Eugene Goldman, McDermott Will & Emery LLP, told Bloomberg BNA. In an e-mail, he said the Solicitor General “petitions in the most important cases, and the petition here emphasizes that the meaning of the Court’s own decision in Dirks is center stage: whether Newman went too far in holding that the requisite personal benefit to the tipper under Dirks' gifting principles requires something akin to a quid pro quo.”

Goldman also suggested that the SG “picked his shots,” because the petition doesn't ask whether the Second Circuit erred by requiring proof that a remote tippee knew that the upstream tipper obtained a personal benefit.

“Many insider trading cases involve personal relationships,” Goldman said. He posited that if the court grants cert, it will “provide clarifying principles for insider trading enforcement on the scope of personal benefit when a gift of inside information is made to a friend or relative.”

Personal Benefit

In United States v. Newman, the U.S. Court of Appeals for the Second Circuit concluded that the government didn't prove beyond a reasonable doubt that defendants Anthony Chiasson and Todd Newman—both downstream tippees—knew that information was disclosed by an insider in exchange for a personal benefit.

The ruling represented a major defeat for U.S. Attorney Preet Bharara, who has won more than 80 convictions in his crackdown on insider trading on Wall Street. Bharara, who unsuccessfully petitioned the Second Circuit to reconsider its ruling, reportedly pressed Verrilli to seek high court review. Through a spokesperson, his office declined to comment and said it wouldn't be issuing a statement regarding the petition.

Through a spokesman, the Securities and Exchange Commission said it agreed with the Justice Department that the Second Circuit’s decision “cannot be reconciled with controlling Supreme Court precedent.”

Earlier this year, SEC Enforcement Director Andrew Ceresney said the commission would continue to bring insider trading cases despite the judicial setback.

In a statement, Chiasson's lawyer Gregory Morvillo, Morvillo LLP, New York, said that regardless of the definition of personal benefit, the appeals court acquitted his client “because there was no evidence that he had knowledge of any benefit provided to any corporate insider.”

“Mr. Chiasson remains confident that the carefully reasoned analysis of the 2nd Circuit is well grounded in the facts and the law and will withstand Supreme Court review.”

Risky Move.

Verrilli's move ended months of speculation as prosecutors pondered whether to ask the high court to review the ruling, at one point seeking an extension of the time in which to file a certiorari petition.

Although Newman makes it harder for the government to prove insider trading, seeking high court review isn't without risk. If the justices accept the certiorari petition, they could issue a ruling imposing an even more onerous burden on federal enforcers. A Supreme Court decision also would be binding on all U.S. courts, not just those in the Second Circuit.

On the other hand, a decision that undermines the Second Circuit's reasoning could complicate matters for other insider defendants who brought successful Newman-based challenges. In January, Bharara asked a federal district court to dismiss his case against five men who allegedly traded on inside information about a 2009 IBM Corp. acquisition, saying the prosecution couldn't meet Newman's “novel evidentiary bar”. 

In February, an SEC administrative law judge reserved judgment on competing summary judgment motions in the agency's case against two former Wells Fargo employees who allegedly traded on inside information about a ratings change. He said that while the Enforcement Division had a “slight edge” on the “exceedingly close” question of whether the respondent received a personal benefit for tipping his colleague, he wanted to hear more testimony on the personal benefit issue.

In April, the Second Circuit allowed former SAC Capital Advisors LP fund manager Michael Steinberg to challenge his insider-trading conviction on much the same evidence as the Newman defendants.

Newman wasn't as availing for other defendants, however, including Raj Rajaratnam cohort Rajat Gupta or former hedge fund owner Doug Whitman. Judge Jed Rakoff of the U.S. District Court for the Southern District of New York rejected Newman-based challenges in allowing both men's insider trading convictions to stand.

In a July 30 PLI webinar, Rakoff also said Congress, not the courts, should define unlawful insider trading.

Novel Test

In the certiorari petition, the SG disputed the Second Circuit's conclusion that to show that an insider personally benefited from conveying a tip, the prosecution must prove “a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

“That holding cannot be reconciled with Dirks, which did not require an `exchange' to find liability for a gift of inside information and did not impose amorphous standards for the relationships that can support liability,” the SG wrote.

“The Second Circuit's novel test has also created a conflict with circuits that have faithfully applied Dirks,” the cert petition said. The “effect of the new rule will be to hurt market participants, disadvantage scrupulous market analysts, and impair the government's ability to protect the fairness and integrity of the securities markets.”

“Those harmful consequences warrant this Court's review and reversal of the court of appeals' effort to rewrite this Court's decision in Dirks,” the government wrote.

`Real Threat'

The facts in Newman don't “make it the strongest or most attractive case” to put the personal-benefit issue before the justices, Boston lawyer Roberto Braceras, Goodwin Procter LLP, told Bloomberg BNA. In an e-mail, he said the Justice Department runs the risk that the high court could affirm—or even broaden—the Second Circuit's decision.

“But the Department is obviously willing to take that risk,” Braceras, a former federal prosecutor, said. “This shows that the government views Newman as a real threat,” probably because so many insider trading cases are brought in New York, and because of the Second Circuit's “importance and influence” throughout the U.S.

“Interestingly,” Braceras added, the Second Circuit's influence “apparently was not sufficient to convince” Rakoff, “who refused to follow his own circuit’s reasoning when he sat by designation” in United States v. Salman.

In Salman, the Ninth Circuit affirmed the insider trading conviction of a remote tippee who argued that the source of the information didn't receive a “tangible benefit” for his tip. 

“To the extent Newman can be read to go so far, we decline to follow it” because doing so would require departing from the “clear holding” of Dirks, Rakoff wrote.

The government cited Salman in its certiorari petition to indicate a circuit split on the tangible-benefit issue.

Looser Standard

In other comments, Georgetown University law professor Donald Langevoort said the petition “stresses–sensibly enough–that the Second Circuit ignored key language in Dirks.”

The risk, however, is that the high court “may be troubled about the subjectivity of the looser personal benefit standard as applied in a criminal case, which Dirks was not,” Langevoort told Bloomberg BNA.

“If the Court sees the issue that way, it may look for greater clarity, which in turn could affect more than insider trading prosecutions.”

He pointed to a longstanding issue regarding what, if anything, the statutory requirement of willfulness for criminal securities law violations means if the government already has to show scienter—culpable intent.

“If the Court were to choose to see Newman in terms of whether the literal Dirks test is appropriate in a criminal case, it might opine on that issue,” Langevoort said.

To contact the reporter on this story: Phyllis Diamond in Washington at pdiamond@bna.com

To contact the editor responsible for this story: Susan Jenkins at sjenkins@bna.com

To see the petition, go to http://op.bna.com/srlr.nsf/r?Open=rtri-9ywkpl.