Is the SEC’s Shadow Trading Win Proof That There is a Federal Common Law of Crime After All?

Last week, the U.S. Securities and Exchange Commission‘s Director of Enforcement celebrated a jury verdict in its insider trading case against Matthew Panuwat:

As we’ve said all along, there was nothing novel about this matter, and the jury agreed: this was insider trading, pure and simple. Defendant used highly confidential information about an impending announcement of the acquisition of biopharmaceutical company Medivation, Inc., the company where he worked, by Pfizer Inc. to trade ahead of the news for his own enrichment. Rather than buying the securities of Medivation, however, Panuwat used his employer’s confidential information to acquire a large stake in call options of another comparable public company, Incyte Corporation, whose share price increased materially on the important news.”

I disagree, many have described the SEC’s theory of shadow trading as “novel”. More importantly, you won’t find it in Section 10(b) or Rule 10b-5, the ostensible bases for insider trading prosecutions. I have long decried the “make it up as you go along” aspect of insider trading jurisprudence:

Notably, Rule 10b-5 itself doesn’t explicitly mention insider trading. It would be more than a half century before the SEC finally adopted a rule, Rule 10b5-1 defining just one element of insider trading – when a purchase or sale constitutes trading “on the basis of” material non public information. It is no surprise then that federal courts have struggled to define who can be guilty of insider trading and why. The result is that the crime of insider trading has a decidedly “make it up as you go along” quality. Individuals don’t know where the lines are until the courts draw them and then convict. Consequently, people have gone to prison even as courts have adopted the theories for their convictions. The fact that the U.S. Supreme Court is still defining the crime more than seven decades after Mr. Freeman cobbled together Rule 10b-5 suggests that the definition of insider trading has been too inchoate to support criminal convictions. However “well tuned to an animating principle” a theory might be, I simply don’t think due process exists when a crime is only defined after a conviction.

If Congress truly believes that insider trading should be a crime, it should define the exact elements of the crime rather than leave it to the courts to make up the rules as they send people to prison. The California legislature has in fact done just that in Corporations Code Section 25402. For more on Section 25402, see my article, California’s Unique Approach to Insider Trading Regulation, 17 Insights 21 (July 2003).

Why Bassam Salman Should Not Have Been Convicted.

The willingness of federal courts to send people to prison based on a crime that isn’t expressed, much less defined, in any federal statute is at odds with the principle that only the people’s elected representatives in the legislature are authorized to make an act a crime. United States v. Hudson, 7 Cranch 32, 34, 11 U.S. 32, 3 L.Ed. 259 (1812). While the SEC’s case against Mr. Panuwat was civil, I expect that this novel theory will soon be applied in a criminal prosecution.

Changes to Conditions of SEC Rule 10b5-1 Obligations

New amendments to insider-trading regulations are about to go into effect. SEC Rule 10b5-1 has long provided an affirmative defense to insiders who trade under a written plan adopted in good faith and who lack material nonpublic information (MNPI).

Over the years, pundits have noticed that trades under Rule 10b5-1 plans have been unusually profitable, suggesting that some insiders might have misused these plans. As a result, in December 2022, the Securities and Exchange Commission announced amendments and new disclosure requirements to address perceived abuses. Below are the significant provisions that go into effect on February 27, 2023.

New Good-Faith Requirements

Companies have always had to act in good faith when they adopt a Rule 10b5-1 plan. The new amendments extend that obligation, requiring insiders to continue to act in good faith throughout the duration of the plan. See 17 C.F.R. § 10b5-1(c)(1)(ii)(A). This means that insiders not only need to act in good faith when creating a plan but also have an obligation to avoid opportunistic trades or timing disclosures that coincide with trades under the plan.

While this is a heightened requirement, it is not clear who will bear the burden of pleading good faith during any ensuing litigation. The regulation is framed as an affirmative defense, but at least one court had previously interpreted the old regulation as placing the burden on the plaintiff to plead facts specifying that a plan was not entered into in good faith or was part of a plan to evade the regulations. [1] It is not clear how courts will interpret the new regulation and whether they will require a pleading of scienter or bad faith for this new obligation.

Director and Officer Certifications

Directors and officers must now certify that (1) they are unaware of any material nonpublic information about the security or issuer and (2) they are adopting the plan in good faith and not as a part of a plan or scheme to evade the regulations.

Cooling-Off Periods

The amendments impose various “cooling-off periods” for trades under Rule 10b5-1 plans, which could vary based on the identity of the trader. These “cooling-off periods” start when a company adopts a new plan or modifies a plan to alter the sale or purchase price, the ranges, the amount of securities sold or purchased, or the time of the trades.

Directors or officers cannot trade under a plan until the later of (a) 90 days after the plan’s adoption or after certain modifications or (b) two business days after filing a Form 10–Q or Form 10–K [2] that discloses the financial results of a quarter in which the plan was adopted or modified (subject to no more than 120 days). Anyone else (non-officers or non-directors) faces a 30-day cooling-off period after any adoption or modification of a plan. [3]

Multiple or Overlapping Plans

A Rule 10b5-1 defense will not be available to anyone who enters multiple or overlapping plans at the same time. This prohibition includes three exceptions:

First, a series of separate contracts with different broker-dealers acting on behalf of a non-issuer may be treated as a single plan if the plans, taken together, meet the regulation’s other conditions.

Second, a non-issuer may enter into one subsequent plan for the purchase or sale of any security of the issuer on the open market. But trading cannot begin until after all trades under the earlier starting plan are completed or expired, pending the effective cooling-off period.

Third, eligible sell-to-cover transactions will not be considered outstanding or additional plans under this section. The SEC defines an eligible sell-to-cover transaction as a contract, instruction, or plan that “authorizes an agent to sell only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award, such as restricted stock or stock appreciation rights, and the insider does not otherwise exercise control over the timing of such sales.”

Single-Trade Plans

The final condition imposed by the amendment is the addition of § 10b5-1(c)(1)(ii)(E), which limits the affirmative defense for non-issuers to one single-trade plan designed to affect the open-market purchase or sale of the total amount of securities as a single transaction during a twelve-month period. As with the prior condition, this regulation does exclude eligible sell-to-cover transactions.

Takeaways

Companies, directors, and officers who intend to use a Rule 10b5-1 plan to insulate themselves from accusations of insider trading need to revisit their plans. They need to ensure that the plan articulates a cooling-off period and that the plan includes the director-officer certification. Participants in the plan need to ensure they are conducting themselves in good faith, that they are not joining multiple competing plans during the same period, and that they are abiding by the new restrictions on single-trade plans. Rule 10b5-1 is a powerful tool to insulate insiders from liability, and it is imperative to align these plans with the new regulations.

Copyright © 2023 Robinson & Cole LLP. All rights reserved.

For more Financial, Securities & Banking legal news, click here to visit the National Law Review.


ENDNOTES

[1] Arkansas Pub. Emps. Ret. Sys. v. Bristol-Myers Squibb Co., 28 F.4th 343, 356 n.4 (2d Cir. 2022).

[2] Foreign issuers, Form 20-F or Form 6-K.

[3] The SEC did not impose cooling-off periods on issuers but has suggested that it is investigating whether such a period is appropriate.

Government Brings First Cryptocurrency Insider Trading Charges

In a series of parallel actions announced on July 21, 2022, the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) initiated criminal and civil charges against three defendants in the first cryptocurrency insider trading case.

According to the criminal indictment, DOJ alleges that a former employee of a prominent cryptocurrency exchange used his position at the exchange to obtain confidential information about at least 25 future cryptocurrency listings, then tipped his brother and a friend who traded the digital assets in advance of the listing announcements, realizing gains of approximately $1.5 million. The indictment further alleges that the trio used various means to conceal their trading, and that one defendant attempted to flee the United States when their trading was discovered. The Government charged the three with wire fraud and wire fraud conspiracy. Notably, and like the Government’s recently announced case involving insider trading in nonfungible tokens, criminal prosecutors did not charge the defendants with securities or commodities fraud.

In its press release announcing the charges, US Attorney for the Southern District of New York Damian Williams said: “Today’s charges are a further reminder that Web3 is not a law-free zone. Just last month, I announced the first ever insider trading case involving NFTs, and today I announce the first ever insider trading case involving cryptocurrency markets. Our message with these charges is clear: fraud is fraud is fraud, whether it occurs on the blockchain or on Wall Street. And the Southern District of New York will continue to be relentless in bringing fraudsters to justice, wherever we may find them.”

Based on these facts, the SEC also announced charges against the three men in a civil complaint alleging securities fraud. In order to assert jurisdiction over the matter, the SEC alleges that at least nine of the cryptocurrencies involved in the alleged insider trading were securities, and the compliant traces through the Howey analysis for each. The SEC has not announced charges against the exchange itself, though in the past it has charged at least one cryptocurrency exchange that listed securities tokens for failure to register as a securities exchange. Perhaps coincidentally, on July 21 the exchange involved in the latest DOJ and SEC cases filed a rulemaking petition with the SEC urging it to “propose and adopt rules to govern the regulation of securities that are offered and traded via digitally native methods, including potential rules to identify which digital assets are securities.”

In an unusual move, Commissioner Caroline Pham of the Commodity Futures Trading Commission (CFTC) released a public statement criticizing the charges. Citing the Federalist Papers, Commissioner Pham described the cases as “a striking example of ‘regulation by enforcement.’” She noted that “the SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together.” Commissioner Pham continued, “Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input—through notice-and-comment rulemaking pursuant to the Administrative Procedure Act.” She concluded by stating that, “Regulatory clarity comes from being out in the open, not in the dark.” The CFTC is not directly involved in either case, and it is atypical for a regulator to chide a sister agency on an enforcement matter in this fashion. On the same day, another CFTC Commissioner, Kristin Johnson, issued her own carefully-worded statement that seemed to support the Government’s actions.

Copyright © 2022, Hunton Andrews Kurth LLP. All Rights Reserved.

A Fool in Idaho; SEC Sues Idahoans for Insider Trading Scheme

In July 1993 two brothers, David and Tom Gardner, and a friend, Erik Rydholm, founded a private investment advisory firm in Alexandria, Virginia. They named that firm Motley Fool after the court jester in “As You Like It,” a play written by William Shakespeare (it is believed in 1599). The Motley Fool, or Touchstone as he is known in the play, was the only character who could speak the truth to Duke Frederick without having his head cut off. Similarly, Motley Fool, the advisory firm, sought to give investors accurate advice, even if it flew in the face of received wisdom. For example, in advance of April Fool’s Day 1994, Motley Fool issued a series of online messages promoting a non-existent sewage-disposal company. The April Fool’s Day prank was intended to teach investors a lesson about penny stock companies. The messages gained widespread attention including an article in The Wall Street Journal.

Over time Motley Fool grew into a worldwide subscription stock recommendation service. It now releases new recommendations every Thursday, and subscribers receive them through computer interfaces provided by Motley Fool. The terms of service in a Motley Fool subscription agreement (in the words of the May 3, 2022 Complaint brought by the U.S. Securities and Exchange Commission [“SEC”] in the Federal Court for the Southern District of New York) “expressly prohibit unauthorized access to its systems.”  David Lee Stone of Nampa, Idaho (southwest of Boise), is a 36-year-old computer design and repair person with a degree in computer science.  Since June 2021, he and his wife have lived periodically in Romania, a fact cited in the Complaint, suggesting, perhaps, some involvement with Romania-based computer hackers. In any event, Stone is alleged in the Complaint to have used deceptive means beginning in November 2020 to obtain pre-release access to upcoming Motley Fool stock picks. Using that information, Stone and a co-defendant made aggressive investments, typically in options, which generated more than $12 million in gains. Stone, his codefendant, and his family and friends all benefited financially from knowing in advance the Motley Fool picks.

The SEC seeks injunctions against Stone and his co-defendant, as well as disgorgement with interest and civil penalties, for violating the antifraud provisions of federal law. The Commission also seeks disgorgement with interest from the family and friends. In addition, the U.S. Attorney for the Southern District of New York has filed criminal charges against Stone.

This case is in many ways reminiscent of the 1985 federal prosecution by the U.S. Attorney for the Southern District of New York (who happened to be Rudolph Giuliani at the time) of R. Foster Winans. Winans was, from 1982 to 1984, the co-author of “Heard on the Street,” a column in The Wall Street Journal. Winans leaked advance word of what would be in his column to a stockbroker who then invested with the benefit of that information, sharing some of the profits with Winans. Winans argued that his actions were unethical, but not criminal. He was found guilty of insider trading and wire fraud and was sentenced to 18 months in prison. He appealed his conviction all the way to the U.S. Supreme Court, which upheld the lower court rulings.

Attempting to profit on market sensitive information can be both a civil and a criminal offense. The SEC Enforcement Division and the relevant U.S. Attorney are prepared to introduce a perpetrator to those consequences.

©2022 Norris McLaughlin P.A., All Rights Reserved

SEC Investigating Cyberattacks Used to Find Secret Company Mergers

SEC Investigating Cyberattacks and Insider Trading

According to Reuters, the Securities and Exchange Commission (SEC) is investigating hacks of email accounts of associates and executives that reveal information on potential mergers. The hackers use a technique known as phishing where they craft emails that trick recipients into logging into malicious websites to steal their email logins. These hacks pose a threat because fraudsters can easily use the information to engage in insider trading.

The group, known as FIN4, allegedly targeted a list of 60 companies in biotechnology, medical instruments, hospital equipment, and drugs. Fireeye reported these cyberattacks in February 2014 and found that they were performed to “obtain an edge on the stock trading.” This will continue to be a problem as more businesses move over to cloud computing, which could lead to a significant increase in data breaches.

The SEC’s Office of Compliance Inspections and Examinations released a report on observations relating to cybersecurity and best practices by financial market participants. The observations are offered as guidelines for firms considering how to improve their cybersecurity preparedness and response procedures. The intent is to highlight specific examples of cybersecurity and operational resiliency practices and controls that firms are taking to safeguard against threats, and how they respond in the event of a breach. The SEC “encourages organizations to review their practices, policies, and procedures with respect to cybersecurity and operational resiliency.” Cybersecurity and Resiliency Observations report.

New Technology & Whistleblower Tips Root Out Insider Trading

The SEC relies on technological developments to accomplish its enforcement goals, including identifying and pursuing insider trading cases. In FY 2018, the SEC implemented a Consolidated Audit Trail, intended to enhance, centralize, and update the regulatory data infrastructure available to market regulators. Once fully implemented, the Consolidated Audit Trail will give regulators quicker access to all trade and order data, facilitating the detection of illegal trading practices, such as insider trading.

In addition to technology, the SEC has increasingly relied on whistleblower tips to identify and halt insider trading. Whistleblowers have been instrumental to expose fraud and expose insider trading secrets.

SEC Rewards Whistleblowers for Exposing Insider Trading 

Under the SEC Whistleblower Program, whistleblower are eligible to receive a reward if their original information about insider trading leads to a successful enforcement action with total monetary sanctions of more than $1 million. A whistleblower may receive an award of between 10 to 30 percent of the total monetary sanctions collected. If represented by counsel, a whistleblower may submit a tip anonymously to the SEC.


© 2020 Zuckerman Law

For more on SEC Insider Trading enforcement, see the National Law Review Criminal Law and Business Crimes section.

Multi-Level Tipping: Insider Trading Cartoon Series, Vol. XI [VIDEO]

In this Presidential transition season, we bring you a very special episode of the Insider Trading Cartoon Series.

David Smyth has a wide-ranging enforcement and litigation practice that focuses on representation of individuals and corporations facing action by federal and state authorities.


Part 1 – The Insider Trading Cartoon Series Vol. I — Classical Theory

Part 2 – Insider Trading Cartoon Series, Vol. II — Temporary Insiders

Part 3 – The Insider Trading Cartoon Series, Vol. III — Very Temporary Insiders

Part 4 – Insider Trading Cartoon Series, Vol. IV — Rank-and-File Employees [VIDEO]

Part 5 – Insider Trading Cartoon Series, Vol. V — Misappropriation Theory [VIDEO]

Part 6 – Insider Trading Cartoon Series, Vol. VI — Misappropriation (Part Deux) [VIDEO]

Part 7 – Insider Trading Cartoon Series, Vol. VII — Misappropriation Theory (Part the Third)

Part 8 – Negligence Based Charges – The Insider Trading Cartoon Series, Vol. VIII [VIDEO]

Part 9 – Tender Offers – The Insider Trading Cartoon Series, Vol. IX [VIDEO]

Part 10 – Tipping (Pre-Newman): Insider Trading Cartoon Series, Vol. X

Salman Decision: Supreme Court Weighs in on Insider Trading

insider trading law Supreme CourtSignificant decision comes after nearly two decades of silence. For the first time in nearly 20 years, the US Supreme Court has weighed in on insider trading law and handed a victory to the government and its insider trading enforcement efforts. In Salman v. United States,[1] the Court put to bed confusion generated by the US Court of Appeals for the Second Circuit’s decision in United States v. Newman.[2] In Newman, the Second Circuit held that to be guilty of insider trading, (i) a tippee must know that the insider/tipper breached a duty of confidentiality in exchange for a “personal benefit” and (ii) the personal benefit must be an “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similar valuable nature.”

The second part of this holding posed more questions than it answered because it appeared to conflict with the Supreme Court’s 1983 decision in Dirks v. SEC.[3] The Court in Dirks found that an insider/tipper may be liable for insider trading, and a tippee derivative liable, only if the insider disclosed confidential information in exchange for a personal benefit. And this “personal benefit,” Dirks found, can be shown when an insider “makes a gift of confidential information to a trading relative or friend.” But in 2014, Newman injected a pecuniary-gain element into the personal-benefit test, leaving the government and defense counsel to wonder what is required when a tipper gifts information to a relative or friend who then trades on the information. As discussed below, Salman has dispelled this confusion by following Dirks in holding that an insider’s gift of confidential information to a trading relative is a sufficient personal benefit.

The Newman Case

In Newman, defendants Todd Newman and Anthony Chiasson were “remote” or “downstream” tippees charged with trading on material nonpublic information (MNPI) that they received from other tippees concerning earnings information at two prominent technology companies.

At trial, Newman and Chiasson urged the court to adopt jury instructions that predicated guilt upon a showing that they knew the insiders tipped the MNPI in exchange for a personal benefit. US District Judge Richard J. Sullivan found that although such an instruction could be supported by Dirks, he was obliged to follow the Second Circuit’s decision in SEC v. Obus,[4] which, arguably, only required a showing that the tippee knew of a tipper’s breach of duty to establish scienter.[5] Newman and Chiasson were convicted at trial.

On appeal, the Second Circuit reversed both convictions. The court held that a tippee only knows of the tipper’s breach of fiduciary duty if “he knew the information was confidential and divulged for personal benefit.”[6] In other words, the court agreed with defendants that knowledge of a tipper’s breach of fiduciary duty required knowledge that the confidential tip was made in exchange for a personal benefit.[7] But the court further held that a personal benefit cannot be inferred “by the mere fact of a friendship”; rather, it must be established through “proof of a meaningfully close relationship that generates an exchange that is objective, consequential, and that represents at least a potential gain of a pecuniary or similarly valuable nature.”[8] The government appealed the Second Circuit’s decision, but the Supreme Court declined to hear the case.

The Salman Case

In the summer of 2015, the US Court of Appeals for the Ninth Circuit decided United States v. Salman,[9] in which defendant Bassam Yacoub Salman, a remote tippee, had received and traded on MNPI from his brother-in-law Michael Kara, who in turn had obtained the information from his older brother Maher Kara, an investment banker at a large bank. Evidence showed that Salman was aware that the MNPI originated with Maher, and that from 2004 to 2007, Salman and Michael had profited from trading in securities issued by the bank’s clients just before major transactions were announced, but there was no evidence that Maher received any pecuniary benefit for his tips. Salman was convicted at trial.

On appeal, Salman argued that under Newman, the evidence was insufficient to show that Maher had tipped the information to his brother in exchange for a pecuniary benefit or that Salman knew of any such benefit. The court dismissed this argument as a strained misreading of Newman, holding that Newman did not seek to undermine Dirks’s crucial observation that a tipper may obtain a personal benefit when (s)he “makes a gift of confidential information to a trading relative or friend.” Otherwise, as the court noted, “a corporate insider . . . would be free to disclose [MNPI] to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return.” Notably, the Ninth Circuit held that Newman’s personal-benefit language must be interpreted in a narrower way than others might attempt to use it, and that to the extent Newman cannot be interpreted so narrowly, the Ninth Circuit would “decline to follow it.”[10] Salman appealed the Ninth Circuit’s holding, and the Supreme Court granted certiorari.

The Supreme Court’s Decision

In Salman v. United States,[11] the Court unanimously affirmed the Ninth Circuit’s holding. The Court squarely rejected Salman’s argument that an insider must receive a pecuniary quid pro quo from a tippee for there to be a sufficient personal benefit. The Court found that Dirks made clear that a tipper breaches a fiduciary duty—and receives a personal benefit—by making a gift of confidential information to a “trading relative or friend,” which clearly happened in this case. Notably, the Court declined to adopt the government’s broader argument that “a tipper personally benefits whenever the tipper discloses confidential trading information for a noncorporate purpose.”[12] Rather, the Court found that Dirks “easily resolves the narrow issue presented here.”[13] In applying Dirks, the Court found that “Maher, a tipper, provided inside information to a close relative, his brother Michael. Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative,’ and that rule is sufficient to resolve the case at hand.”[14]

Regarding the Second Circuit’s holding in Newman, the Court found that “[t]o the extent the Second Circuit held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends, Newman, 773 F.3d, at 452, we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.”[15] The Court held that Salman’s jury was properly instructed that a personal benefit includes the benefit one would obtain from simply making a gift of confidential information to a trading relative, and, accordingly, upheld the Ninth Circuit’s judgment.

The Supreme Court’s decision is extremely significant. Salman resolves confusion raised by Newman by specifically rejecting—as inconsistent with Dirks—the Second Circuit’s requirement that the tipper must receive something of a “pecuniary or similarly valuable nature” in exchange for the information and that a gift to family or friends was insufficient. In so doing, and on the issue of what constitutes a “personal benefit,” the Salman decision essentially turns back the clock on the law of tipper liability to its status pre-Newman, which had partially derailed the government’s insider trading enforcement efforts. Thus, it appears that Salman is a boon to the government’s ability to get its insider trading efforts back on track.

Copyright © 2016 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

[1] 580 U.S. __ (2016).

[2] 773 F.3d 438, 450 (2d Cir. 2014).

[3] 463 U.S. 646 (1983).

[4] 693 F.3d 276 (2d Cir. 2012).

[5] See United States v. Newman, 1:12-cr-00121-RJS-2, Docket No. 215, pp. 3594-3605 (S.D.N.Y. Dec. 10, 2012).

[6] 773 F.3d 438, 450 (2d Cir. 2014) (emphasis added).

[7] Newman, 773 F.3d at 447-49 (“[W]e conclude that a tippee’s knowledge of the insider’s breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit.”).

[8] Id., 773 F.3d at 452.

[9] 792 F.3d 1087 (9th Cir. 2015).

[10] Id., 2015 WL 4068903 at *6.

[11] 580 U.S. __ (2016).

[12] Slip op., at 7.

[13] Slip op., at 8.

[14] Slip op., at 9.

[15] Slip op., at 10.

Second Circuit Dismisses Suit Over FBI’s Wiretapping of Marital Conversations in Securities Fraud Investigation

Federal Bureau of Investigation (FBI) wiretapping played an important role in the wide-ranging insider trading investigation and subsequent trials of Galleon Group LLC principals and traders. During his criminal prosecution, former Galleon trader, Craig Drimal, unsuccessfully moved to suppress evidence obtained via an authorized wiretap of his cell phone because of a failure to minimize interception of calls with his wife. His wife, Arlene Villamia Drimal, is now pursuing civil claims against FBI agents for wiretapping her personal telephone conversations with her husband, but her claims have thus far been unsuccessful. On May, 15, the US Court of Appeals for the Second Circuit dismissed Ms. Drimal’s complaint without prejudice to repleading, finding that her conclusory pleading failed to state a claim under Title III of the Omnibus Crime Control and Safe Streets Act of 1968, which requires the government to “minimize the interception of communications not otherwise subject to interception.” The Second Circuit also found fault with the lower court’s assessment of the agents’ qualified immunity defense.

In connection with a federal criminal investigation, the US District Court for the Southern District of New York authorized a wiretap of Mr. Drimal’s cell phone, but stressed that monitoring must “immediately terminate when it is determined that the conversation is unrelated [to criminal matters].” FBI agents also were instructed to “discontinue monitoring if you discover that you are intercepting a personal communication solely between husband and wife.” Despite these instructions, agents allegedly monitored approximately 180 private marital calls between the Drimals that were unrelated to the investigation. Although the district court denied Mr. Drimal’s suppression motion in his criminal matter, it identified 18 calls that were “potentially violative” and observed that the agents’ failure to minimize monitoring of private calls was “inexcusable and disturbing.” Ms. Drimal brought her separate civil lawsuit following the conclusion of her husband’s criminal case with his entry of a guilty plea and subsequent sentencing.

At the district court level, the FBI agents unsuccessfully moved to dismiss Ms. Drimal’s complaint for failure to state a claim and on qualified immunity grounds. The Second Circuit reversed that decision, holding that Ms. Drimal’s complaint was insufficient because it merely stated, in a conclusory fashion, that the interception of marital calls violated Title III, without reference to a duty to minimize. The Second Circuit noted that Title III does not prohibit outright the monitoring of privileged calls. With respect to the agents’ qualified immunity defense, the court of appeals held that the district court should have evaluated each agent’s minimization efforts under an “objective reasonableness” standard based on the particular circumstances, rather than as a group. The Second Circuit vacated the lower court decision and directed dismissal of the complaint with leave to replead, stating that amending the complaint would not be futile.

Drimal v. Makol, Nos. 13-2963 and 13-2965 (2d Cir. 2015)

©2015 Katten Muchin Rosenman LLP

“Hello, Newman" Government Continues to Litigate Reversed Insider Trading Convictions

Barnes & Thornburg LLP Law Firm

The U.S. Attorney for the Southern District of New York, Preet Bharara, has decided not to go down without a fight. Following a Second Circuit panel’s reversal of Bharara’s signature achievement, the insider-trading convictions of former hedge fund managers Todd Newman and Anthony Chiasson, the U.S. Attorney’s office has petitioned the court for rehearing and rehearing en banc. The Securities and Exchange Commission has also weighed in on the U.S. Attorney’s side, arguing in an amicus brief that the panel seriously erred in its decision. Meanwhile, in other cases, particularly outside the Second Circuit, the Justice Department, and the SEC have argued strenuously that the Second Circuit’s panel decision should not be followed.

In the Second Circuit, the battle lines are being drawn. Bharara’s office has asked both the panel and the full Second Circuit to rehear the case. The US Attorney’s office has argued that the panel erred by imposing two requirements that are purportedly contrary to law– first, that a tipper act for a “personal benefit” of financial consideration, or something at least akin to monetary gain; and second, that the tippee know that the tipper supplying the inside information acted for such a benefit. The SEC has concurred with this assessment, elaborating on Newman’s conclusion that evidence of friendship between tipper and tippee is insufficient to prove the “personal benefit” necessary for tipping liability. The Commission contends that this contradicts Dirks v. SEC, the Supreme Court’s seminal insider trading decision. Both the U.S. Attorney and the SEC contend that, if Newmanremains the law, it will seriously threaten the integrity of the securities markets, and government regulators will be dramatically limited in their ability to prosecute “some of the most common, culpable, and market-threatening forms of insider trading.”

In opposition, Newman and Chiasson, along with various law professors, the criminal defense bar, and even Marc Cuban, have argued that the Second Circuit panel got it right when it imposed an important, objective outer bound to an otherwise amorphous illegal activity. The defendants even engaged in ad hominem criticism of Bharara, analogizing him to a “Chicken Little” complaining that the sky is falling, or more precisely, a “petulant rooster whose dominion has been disturbed.” Those supporting the opinion assert that any perceived difficulty created by the decision can, and should, be rectified by Congress.

Even as the Newman case continues forward, its repercussions are being felt within the Second Circuit and beyond. In the Southern District alone, at least a dozen defendants, who were convicted or pleaded guilty underpre-Newman law, have argued that their cases need to be revisited in light of Newman. No court yet has agreed with that argument, but most of these motions remain pending.

Outside the Second Circuit, the Government is looking to ring-fence the Newman decision and limit its applicability elsewhere. Federal prosecutors, for example in North Carolina, have argued that Newman is not the law in the Fourth Circuit and therefore should not be followed. Meanwhile, defendants in other jurisdictions are invokingNewman in pending, and even resolved, insider trading matters, both civil and criminal.

Defendants are even arguing Newman’s applicability within the SEC’s administrative courts – with success. In In re Peixoto, an SEC administrative proceeding related to Herbalife, the Commission voluntarily dropped its case against Peixoto after Newman. Other cases in the agency’s courts (including against SAC founder Steven Cohen) remain on holding pending final resolution of Newman. And in In re Ruggieri, the administrative law judge said that he would require the SEC to demonstrate the Newman standard of “personal benefit.”

Clearly, the Newman saga has not reached its conclusion, but the fall-out already demonstrates what a momentous decision the Second Circuit panel made.

ARTICLE BY

OF

“Hello, Newman” Government Continues to Litigate Reversed Insider Trading Convictions

Barnes & Thornburg LLP Law Firm

The U.S. Attorney for the Southern District of New York, Preet Bharara, has decided not to go down without a fight. Following a Second Circuit panel’s reversal of Bharara’s signature achievement, the insider-trading convictions of former hedge fund managers Todd Newman and Anthony Chiasson, the U.S. Attorney’s office has petitioned the court for rehearing and rehearing en banc. The Securities and Exchange Commission has also weighed in on the U.S. Attorney’s side, arguing in an amicus brief that the panel seriously erred in its decision. Meanwhile, in other cases, particularly outside the Second Circuit, the Justice Department, and the SEC have argued strenuously that the Second Circuit’s panel decision should not be followed.

In the Second Circuit, the battle lines are being drawn. Bharara’s office has asked both the panel and the full Second Circuit to rehear the case. The US Attorney’s office has argued that the panel erred by imposing two requirements that are purportedly contrary to law– first, that a tipper act for a “personal benefit” of financial consideration, or something at least akin to monetary gain; and second, that the tippee know that the tipper supplying the inside information acted for such a benefit. The SEC has concurred with this assessment, elaborating on Newman’s conclusion that evidence of friendship between tipper and tippee is insufficient to prove the “personal benefit” necessary for tipping liability. The Commission contends that this contradicts Dirks v. SEC, the Supreme Court’s seminal insider trading decision. Both the U.S. Attorney and the SEC contend that, if Newmanremains the law, it will seriously threaten the integrity of the securities markets, and government regulators will be dramatically limited in their ability to prosecute “some of the most common, culpable, and market-threatening forms of insider trading.”

In opposition, Newman and Chiasson, along with various law professors, the criminal defense bar, and even Marc Cuban, have argued that the Second Circuit panel got it right when it imposed an important, objective outer bound to an otherwise amorphous illegal activity. The defendants even engaged in ad hominem criticism of Bharara, analogizing him to a “Chicken Little” complaining that the sky is falling, or more precisely, a “petulant rooster whose dominion has been disturbed.” Those supporting the opinion assert that any perceived difficulty created by the decision can, and should, be rectified by Congress.

Even as the Newman case continues forward, its repercussions are being felt within the Second Circuit and beyond. In the Southern District alone, at least a dozen defendants, who were convicted or pleaded guilty underpre-Newman law, have argued that their cases need to be revisited in light of Newman. No court yet has agreed with that argument, but most of these motions remain pending.

Outside the Second Circuit, the Government is looking to ring-fence the Newman decision and limit its applicability elsewhere. Federal prosecutors, for example in North Carolina, have argued that Newman is not the law in the Fourth Circuit and therefore should not be followed. Meanwhile, defendants in other jurisdictions are invokingNewman in pending, and even resolved, insider trading matters, both civil and criminal.

Defendants are even arguing Newman’s applicability within the SEC’s administrative courts – with success. In In re Peixoto, an SEC administrative proceeding related to Herbalife, the Commission voluntarily dropped its case against Peixoto after Newman. Other cases in the agency’s courts (including against SAC founder Steven Cohen) remain on holding pending final resolution of Newman. And in In re Ruggieri, the administrative law judge said that he would require the SEC to demonstrate the Newman standard of “personal benefit.”

Clearly, the Newman saga has not reached its conclusion, but the fall-out already demonstrates what a momentous decision the Second Circuit panel made.

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