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U.S. appeals major insider trading case (UPDATED)

UPDATED Monday 6:14 p.m.   This case has been docketed as 15-137.


Seeking to overturn a major setback in its power to punish trading of stocks based on insider tips, the Obama administration on Thursday asked the Supreme Court to revive one of the highest-profile prosecutions in years on Wall Street.  The petition in the case of United States v. Newman was sent to the Court just days before a filing deadline.  (Attached to the government’s petition is the December ruling by the U.S. Court of Appeals for the Second Circuit.   That court refused a government rehearing plea in April.)

The case grew out of federal prosecutors’ broad investigation into suspected insider trading at hedge funds.  In the specific case now at the Court, two hedge fund managers, Todd Newman and Anthony Chiasson, were convicted of securities fraud after their trades in technology company stocks — allegedly based on a chain of tips containing insider information — resulted in gains totaling about $72 million for their funds.  The Second Circuit overturned their convictions, wiping out the charges against them.  Prosecutors in New York reportedly have been pressing Justice Department leaders to seek review in the Supreme Court.

The Second Circuit’s approach to illegal insider trading, the government petition contended, will “hurt market participants, disadvantage scrupulous market analysts, and impair the government’s ability to protect the fairness and integrity of the securities markets.”  The appeals court, it said, had issued “an unprecedented ruling” that conflicts directly with Supreme Court precedent, as well as with rulings by other federal appeals courts.

The case involves Section 10(b) of the Securities Exchange Act, the government’s main weapon against those who buy or sell securities by taking advantage of important information about a stock that is known only to company insiders at the time.   When such information becomes public, it often pushes stock prices up or down, so there is an advantage in using that information to trade before it reaches the investing public.  Under Section 10(b), it is illegal to trade in securities if an insider is relying upon “material, non-public information” about the firm.  Instead, an insider knowing such information is required by law either to disclose it publicly, or to avoid trading in the stock.

The government’s new petition relied heavily on a 1983 Supreme Court decision in Dirks v. Securities and Exchange Commission.  In that ruling, the Justices spelled out how insider trading law would apply to an insider’s disclosure of confidential company information to others who then exploit it for personal gain.  The Court declared there that an insider benefits personally from insider trading if that individual “makes a gift of confidential information to a trading relative or a friend” — that is, the person giving an insider tip (the “tipper”) benefits from relating the information to a “tippee.”  The Court’s view was that a tippee’s duty not to trade in such information flows out of the tipper’s duty not to disclose.   The core issue, it added, is whether the tipper will benefit, directly or indirectly, from sharing the tip.

The Second Circuit, the government complained, interpreted the Dirks standard to mean that there must be a “meaningfully close personal relationship” between the source of the insider tip and the person doing the trading, and that such a relationship must be “objective, consequential and represents at least a potential gain of a pecuniary or similarly valuable nature.”  A jury in a case involving charges against a tippee, the court of appeals held, must be instructed that the government must prove beyond a reasonable doubt that the tippee knew that the insider had disclosed non-public information and did so in order to gain a personal benefit.

The prosecutors’ case targeted Newman as a portfolio manager at Diamondback Capital Management and Chiasson as a portfolio manager at Level Global Investors.   They were charged with participating in a round robin of tips emanating from inside the corporate staffs of two major technology companies — Dell Inc. and NVIDIA Inc.  After they were found guilty of illegally trading on those tips, Newman was sentenced to fifty-four months in prison and Chiasson to seventy-eight months.   Newman also was fined $1 million and ordered to forfeit $737,724.  Chiasson was fined $5 million and ordered to forfeit up to $2 million.

The prosecutors’ basic theory was that Newman and Chiasson were part of a scheme in which a group of market analysts repeatedly obtained insider information from employees of companies, including Dell and NVIDIA, and shared that with each other and with their superiors.  That information then was relayed on to Newman and Chiasson — who, prosecutors charged, traded on it.  Much of that inside data related to quarterly earnings reports not yet released publicly.

This trading produced $4 million for Newman’s hedge fund and $68 million for Chiasson’s fund, according to the government.

In the petition for Supreme Court review, government lawyers argued that a case in which an insider passes on inside information to a trading friend or relative will not meet the Second Circuit’s new standard unless there is evidence that the tipper and tippee had a “meaningfully close” relationship and that the insider stood to gain either money or something else of value in exchange for the tip.  “Such evidence will not always exist,” the filing said. So, the Second Circuit ruling will create “an obvious roadmap for unscrupulous insiders and tippees.”

The Court is unlikely to consider the case until it returns from its summer recess in late September.  The two Wall Streeters will have a chance to file a brief opposing Supreme Court review.



Recommended Citation: Lyle Denniston, U.S. appeals major insider trading case (UPDATED), SCOTUSblog (Jul. 30, 2015, 2:12 PM),