Securities Regulation Daily Cert petition claims 2nd Circuit has expanded reach of insider trading
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Thursday, February 25, 2021

Cert petition claims 2nd Circuit has expanded reach of insider trading

By Rodney F. Tonkovic, J.D.

A cardiologist convicted of insider trading asks the Court to get to the heart of what established a duty of "trust and confidence."

A petition for certiorari asks the Supreme Court to address the Second Circuit's standard for determining the existence of a fiduciary relationship in the insider trading context. In this case, a doctor who participated in a drug trial was convicted of insider trading after profiting from trades made after he—but before the public—learned that the trial would be halted. At its heart, the petition argues that a mere promise of confidentiality does not by itself establish fiduciary status or trust. In holding that there was a fiduciary relationship in this case, the petition says, the Second Circuit has expanded, without a clear standard, the reach of insider trading to ensnare nonfraudulent conduct. A response is due on March 25, 2021 (Kosinski v. U.S., February 19, 2021).

Confidential information. In 2014, Dr. Edward Kosinski, a cardiologist, served as a principal investigator in a clinical trial conducted by Regado Biosciences. Kosinski recruited 20 of his patients to take the drug, which was designed to prevent blood clotting during heart procedures, and monitored their response to the experimental medication; for this he was paid $80,000. In late 2013, prior to the study, Kosinski signed a Confidential Disclosure Agreement requiring that he keep the trial information confidential and not exploit it for his own benefit. When he agreed to participate, Kosinski signed a second agreement called a Clinical Study and Research Agreement (CSRA)—which he says expressly superseded the CDA—that specified that he was an "independent contractor" and in no way an agent or partner of Regado. Under the second agreement, Kosinski agreed to maintain "strict confidence," but this agreement had no restrictions on Kosinski's use of the confidential information.

Kosinski began purchasing Regado stock in late 2013 and eventually amassed 40,000 shares worth around $210,000. On June 29, 2014, Kosinski and the other investigators received advance notice that patient enrollment in the trial was being suspended due to allergic reactions. The next day, Kosinski sold all of his shares. On July 2, 2014, Regado publicly announced that enrollment had been suspended. Kosinski avoided a loss of approximately $160,000 by selling before the announcement and subsequent drop in share price. Later that month, Kosinski learned that enrollment in the drug trial would likely be permanently halted because a patient had died. When Regado announced the end of the trial in August 2014, Kosinski earned $3,300 after exercising put options purchased in late July.

Heartbreaking defeat. In August 2016, the U.S. Attorney's Office for the District of Connecticut announced criminal charges against Kosinski, and the SEC similarly charged him with two counts of securities fraud. After a jury trial, in late November 2017, Kosinski was convicted of two counts of securities fraud-insider trading, which potentially carries a maximum of 20 years in prison on each count.

The Second Circuit upheld Kosinski's conviction. On appeal, Kosinski maintained that he kept the information confidential, but that his trading on the basis of that information was not a breach of his agreement. According to the court, Kosinski was a "temporary insider" with a fiduciary duty of "trust and confidence" not to trade Regado's securities on the basis of confidential information he obtained during the drug study. Kosinski would not have been hired if he did not agree to keep the information confidential, the court said. Moreover, by using inside information to trade his shares, Kosinski's financial interest became aligned with the outcome of the study, thus undermining the study's integrity. The contract also required Kosinski to inform Regado if the value of his shares in that company exceeded $50,000, which he failed to do. The court went on to find that the remainder of Kosinski's arguments were without merit, pointing out that independent contractors can serve as fiduciaries and that the lack of an express prohibition on insider trading was not fatal, especially in light of a merger clause in the CSRA.

Need for both "trust" and "confidence." The petition asks two questions concerning the duty of "trust and confidence": (1) whether a simple agreement to keep information confidential establishes a fiduciary relationship; and (2) whether the Second Circuit's case-by-case approach to the duty element of insider trading fraud is unconstitutionally vague. The Court, the petition remarks, has repeatedly held that only a fiduciary relationship creates a duty to refrain from trading on material nonpublic information, but the Second Circuit's decision has now muddied the law.

First, Kosinski argues, the Second Circuit has now held that a mere promise of "confidentiality" establishes a duty of "trust and confidence" even in the absence of other indicia of fiduciary status or trust. The Supreme Court, however, has never even suggested that just an agreement to maintain information in confidence suffices to establish such a relationship, and permitting this obligation to substitute for the requisite duty would broaden the reach of insider trading to ensnare nonfraudulent conduct. The Second Circuit has excised the integral concept of "trust" from the duty of "trust and confidence," the petition says. This conflicts with the Fifth Circuit's approach in SEC v. Cuban (2010), finding an "essential understanding" not to trade that is absent in this case.

Next, the petition posits that the Second Circuit has not articulated a clear standard for determining when a fiduciary relationship exists. Many of the factors discussed by the appellate court, and how they were applied, could as easily apply to non-fiduciary relationships, Kosinski says. The resulting "smorgasbord" of formulae and case-by-case approach creates uncertainty in "an area of the law that demands clarity" and deprives investors of fair notice as to when they can trade on information they have obtained. Here, the petition points to the holding in Skilling v. U.S. (2010) in which, in the context of the "honest services fraud" statute, the Court cabined the offense to cases in which the existence of a fiduciary relationship is "beyond dispute." In contrast, the Second Circuit in this case "expanded the duty (and the crime) to reach an indeterminate and boundless range of relationships."

Finally, the petition takes issue with the district court's instruction to the jury to find a duty of trust and confidence if there is proof of a confidentiality agreement. The Second Circuit held that this error was harmless, and the petition accuses the court of basing this on "its own notions" without actually conducting the proper review. According to the petition, the appellate court used its own factual findings relating to theories of fiduciary duty that were never presented to the jury. In doing so, the court violated Kosinski's Sixth Amendments rights, the petition argues.

The petition is No. 20-1161.

Attorneys: Daniel J. O’Neill (Shapiro Arato Bach LLP) for Edward J. Kosinski. Elizabeth B. Prelogar, United States Department of Justice, for the U.S.

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