ATTORNEY: H. ADAM PRUSSIN
Pomerantz Monitor, July/August 2013
Although it has had mixed results, at best, in cases related to the financial crisis of 2008, the government has done quite well in pursuing claims of criminal insider trading. For example, the U.S. Attorney in Manhattan has filed criminal charges against 81 defendants since he took office in 2009, and convicted 73 of them. Among them is former Galleon hedge fund boss Raj Rajaratnam, whose conviction and lengthy sentence were upheld by the Second Circuit in June.
Insider trading may sound simple, but it isn’t. The federal courts have been struggling for decades to decide what inside information is, who may trade on it, and who can’t. If an investor or analyst calls someone up to ask how his company is doing, that can be legitimate information gathering, or it can be a violation. It all depends.
One well-established element of an insider trading violation is that the tippee must know that the information is being disclosed in violation of the insider’s fiduciary duty. In one famous case, for example, someone disclosed that the company had received a takeover offer that had not yet been publicly disclosed. That kind of information is vital to the company; people working for the company cannot divulge it without breaching their fiduciary duties.
More recently, though, courts have been struggling with the question of whether the tippee also has to know that the person disclosing the information (the “tipper”) is receiving a “personal benefit” for disclosing it. If the tippee does know this, the Supreme Court held 30 years ago that he is liable; but the question now is, does the tippee have to know this in order to be liable? If the tippee is not paying for this information, he or she may not be aware that the tipper will benefit from the disclosure in some other way.
This issue is coming to a head in a case now pending in the Second Circuit, which is hearing an appeal of an insider trading conviction involving two hedge fund managers. They did not pay for the information, and maintain that they did not know that the insiders were profiting from their disclosures in other ways. The trial court did not believe that this was a required element of the crime, and refused to instruct the jury on it. Defendants appealed on that issue. Defendants asked that they be granted bail pending their appeal. The trial court denied it, but the defendants appealed that decision as well.
In late June, the Second Circuit granted their bail request. This has sent tongues wagging, because it may mean that the court is about to overturn the convictions and impose a “personal benefit” knowledge requirement for insider trading claims.
This is happening just as the government is zeroing in on the biggest fish in the insider trading pond, Steve Cohen of SAC Capital Advisors. Several of his underlings have already pleaded guilty to insider trading charges, and SAC recently paid more than $600 million in a “no admit, no deny” settlement of insider trading charges with the SEC. Yet somehow, Cohen authorized this hefty settlement without obtaining an agreement from the feds that they would not seek additional punishments or remedies against either himself or the company.
Perhaps he thought that, because it may be next to impossible for the feds to prove beyond a reasonable doubt that he had personal knowledge of the tippers’ motivation for revealing insider information, the would not pursue criminal charges against him. In this respect he is probably right. With the five year statute of limitations bearing down, the feds have reportedly given up on the idea of prosecuting Cohen on criminal charges.
But he is not exactly getting a free pass. On July 19 the SEC brought an administrative action against him, seeking to bar him from the securities industry for life. The complaint alleges that Cohen ignored “red flags” of illegal insider trading by employees and allowed it to go on, violating his duty to supervise.
And then, just before our press time, the feds announced that SAC Capital has been indicted. When and if that happens, it is all over. On Wall Street, an indictment is a death sentence.