Federal Prosecutors Face New Challenges Following Second District Court’s Insider Trader Ruling

Reversing the trend of federal trial courts allowance of the prosecutorial broadening of the definition of what constitutes benefiting from insider trading, the Second Circuit Court overturned two high profile insider trading convictions of the semi-celebrity prosecutor Preet Bharara.

The court raised the bar, increasing the burden which federal prosecutors must prove when seeking insider trading convictions against individuals. Prior to the court’s ruling, the vague definition of benefits derived from insider trading resulted in vague and even arguably illusory benefits tying the benefits of the individual providing the insider tip to the individual who received the information tip.

Definition of Insider Training

Insider trading is broad terminology which covers any type of trade made by or based upon the privileged information which a corporate insider possesses. There are many insider trades which are perfectly legal.

Insider trading becomes illegal when there has been a breach of a fiduciary duty, trust or confidence, while the individual in possession of the non-public information executes either a buy or sell trade.

The SEC states that illegal insider trading also occurs when non-public information results in securities trades made by the person receiving the tip, following knowledge of securities trading by those persons classified as insiders for security trading purposes who have unlawfully caused their insider information to be disclosed.

Persons whom the SEC defines as insiders for these purposes include:

• • • • • • Officers, directors and employees of the corporation

• • • • • • family member’s, friends and those who have business dealings with the above group

• • • • • • bank employees, associated brokers, government employees and law firm employees associated with the corporation

• • • • • • more broadly: any other person who acquired privileged insider information from their employer

The Newman Case

The Second Circuit’s decision in United States v. Newman substantially narrowed the definition of those who may be prosecuted for executing a trade on an insider tip, by holding that the tip recipient cannot be prosecuted unless the he “knows of the personal benefit received by the insider in exchange for the (insider-privileged) disclosure.” Newman further defines that the “personal benefit” received by the person providing the tip “must be of some consequence” and must be expressible as true material exchange, rejecting the former vague notion under which previous convictions were allowed.

In their appeal, Todd Newman and Anthony Chiasson argued that the district trial court erred when it failed to instruct the jury that the Government must prove that they possessed knowledge of the personal benefit of the tip provider, and argued convincingly that there was a lack of necessary evidence to support the personal benefits the NVIDIA and Dell tip providers received.

Following the blowing reversal by the Second District Court, the SEC and prosecutor petitioned the Second Circuit Court unsuccessfully to be re-heard en banc. In further developments, the government’s petition to the United States Supreme Court was summarily denied as well.

The Aftermath
The Obama Administration, the SEC and Preet Bharara himself have released statements criticizing the ruling as providing a road map for illegal trading activity to occur and as a result undermines the integrity of the securities markets.

Shortly afterwards, in actions supporting the difficulty the new prosecutorial burden presents, Bharara announced that the government was dropping all of its charges against portfolio manager Michael Steinberg and six additional related prosecutions, whom the prosecutor felt were going to win [their] appeal(s) anyway.

Financial proponents have praised the ruling as requiring that the government may no longer conviction insider tipping cases which are not clear cut, but rather based upon far removed prosecutor conjectures allowed under the law before the successful appeal.

Prosecutor Preet Bharara was featured on the February 2012 cover of Time magazine entitled “This Man is Busting Wall Street” following his high profile convictions of wall street insiders.