Morrison Foester annual review of the insider trading laws for 2014.
Looking Back
2014 will be remembered as the year that the Department of Justice’s (“DOJ”) winning streak in insider trading cases came to an end. The last few years have been punctuated by the government’s aggressive – and highly successful – enforcement of criminal insider trading laws. Since 2009, the U.S. Attorney’s Office for the Southern District of New York (“S.D.N.Y.”) had enjoyed a perfect trial record in insider trading cases. With the high-profile trial conviction of Mathew Martoma, 2014 was poised to be another banner year. However, in July 2014 the perfect record came to an end when a jury acquitted Rajarengan (Rengan) Rajaratnam of insider trading charges. Rengan’s acquittal not only ended the government’s seemingly endless winning streak, but also signified the end of the longrunning “Perfect Hedge” investigation that initially ensnarled his brother, Raj Rajaratnam, and brought down most of the insider trading defendants over the last few years.
To close out 2014, the United States Court of Appeals for the Second Circuit issued the highly anticipated decision overturning the insider trading convictions of Todd Newman and Anthony Chiasson. The blockbuster opinion cast doubt on countless other convictions and guilty pleas secured over the past several years. The early effects of the decision have already been felt in the first few weeks of 2015, with a number of associated guilty pleas by downstream tippees having been vacated. The U.S. Attorney’s Office for the S.D.N.Y. is not going quietly; instead, it filed a blistering petition for rehearing and suggestion for rehearing en banc, arguing that the panel not only got it wrong, but also “threaten[ed] the integrity of the securities markets.” The viability of the panel opinion and its ripple effects are among the central events to watch in insider trading law in 2015.
Our Reviews in recent years have focused on the benefits that cooperators have received in the form of reduced prison sentences and civil penalties. But the calculus changed in 2014. With the Second Circuit’s groundbreaking Newman decision, the acquittal of Rengan Rajaratnam, and more cooperators getting prison sentences, it is now less clear just how much benefit a guilty plea plus cooperation actually buys.
DOJ is not the only one that suffered setbacks in 2014. The Securities and Exchange Commission’s (“SEC”) losing streak in civil trials continued in 2014. Defendants prevailed at trial in eight cases brought by the SEC. It is apparently no coincidence that, as the SEC’s losing streak at trial continued, the trend for the SEC to bring more insider trading cases as administrative proceedings picked up steam in the last year.
Morrison Foester: Overview Of Insider Trading Law
“Insider trading” is an ambiguous and over-inclusive term. Trading by insiders includes both legal and illegal conduct. The legal version occurs when certain corporate insiders – including officers, directors and employees – buy and sell the stock of their own company and disclose such transactions to the SEC. Legal trading also includes, for example, someone trading on information he or she overheard from a conversation between strangers sitting on a train or obtained through a non-confidential business relationship. The illegal version – although not defined in the federal securities laws – occurs when a person buys or sells a security while knowingly in possession of material nonpublic information that was obtained in breach of a fiduciary duty or relationship of trust.
Despite renewed attention in recent years, insider trading is an old crime. Two primary theories of insider trading have emerged over time. First, under the “classical” theory, the Securities Exchange Act of 1934’s (“Exchange Act”) anti-fraud provisions – Section 10(b) and Rule 10b-5 ? apply to prevent corporate “insiders” from trading on nonpublic information obtained from the company in violation of the insiders’ fiduciary duty to the company and its shareholders.1 Second, the “misappropriation” theory applies to prevent trading by a person who misappropriates information from a party to whom he or she owes a fiduciary duty – such as the duty owed by a lawyer to a client.2
Under either theory, the law imposes liability for insider trading on any person who obtains material nonpublic information and then trades while in possession of such information in violation of a fiduciary duty. Also, under either theory, until 2012, the law held liable any “tippee” – that is, someone with whom that person, the “tipper,” shares the information – as long as the tippee also knew that the information was obtained in breach of a duty.
In 2012, a decision by the Court of Appeals for the Second Circuit in SEC v. Obus arguably expanded tippee/tipper liability – at least in SEC civil enforcement actions – to encompass cases where neither the tipper nor the tippee has actual knowledge that the inside information was disclosed in breach of a duty of confidentiality.3 Rather, a tipper’s liability could flow from recklessly disregarding the nature of the confidential or nonpublic information, and a tippee’s liability could arise in cases where the sophisticated investor tippee should have known that the information was likely disclosed in violation of a duty of confidentiality.4
The holding in Obus was narrowed in 2014 by the Second Circuit’s opinion in United States v. Newman.5 In Newman, the Second Circuit held that downstream tippees in criminal cases can be convicted of insider trading only if (1) the tippee knew of a personal benefit received by the insider in exchange for his or her breach of fiduciary duty and (2) the personal benefit was more than mere friendship, and was instead “objective” and “consequential.”6 It remains to be seen whether the Newman decision will be followed in other circuits and whether it will stand after DOJ continues to attack it in the Second Circuit and perhaps the Supreme Court of the United States.
While the interpretation of the scope and applicability of Section 10(b) and Rule 10b-5 to insider trading is evolving, the anti-fraud provisions provide powerful and flexible tools to address efforts to capitalize on material nonpublic information.
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