Several panels of private practitioners and current and former federal prosecutors along with regulators from both the SEC and CFTC tackled the myriad issues posed by the Second Circuit’s Newman decision and by the similar Salman case, of which the latter will be argued before the Supreme Court later this year. The discussion, part of the Practising Law Institute’s program Insider Trading Law 2016: Salman, Newman, and the Road Ahead, mulled Newman’s impact on insider trading cases while examining best practices for avoiding liability that can arise in the remote tippee setting and from using expert networks.
Now what? While the Supreme Court prepares to hear the Salman case, which raises some of the same issues the Second Circuit dealt with in Newman, panelists mostly said Newman has had a muted impact outside of the Second Circuit. Eugene Ingoglia of Morvillo LLP said the SEC has tried to keep some post-Newman cases alive by alleging every possible pecuniary benefit, but that the primary strategy for regulators and prosecutors will be to shorten the tipping chain in hopes of making their cases a bit easier to prove, even if that means losing their bid to hold an upstream tipper liable. Ingoglia also said prosecutors may turn to other criminal statutes such as those for wire fraud.
Antonia M. Apps, a partner at Milbank, Tweed, Hadley & McCloy LLP, told panelists in reply to a question from event moderator David I. Miller of Morgan, Lewis & Bockius LLP about whether Newman was a "sea change" that she thought it was not because many appeals courts had so far ignored the decision. Apps said the Newman panel’s citation to the Second Circuit’s Jiau decision regarding intent to benefit undermined the seemingly more restrictive language in Newman. Apps later explained that U.S. insider trading law is still very different from most other countries, which ban trading on all material nonpublic information.
According to Alexandra A.E. Shapiro of Shapiro Arato LLP, counsel for the petitioner in Salman, U.S. insider trading law poses a constitutional problem because there can be no common law crimes, and yet insider trading is premised on vague civil laws and judicial opinions. Shapiro also said Newman is consistent with the Supreme Court’s Dirks opinion, which famously posed the scenario of a trading relative or friend, because the word "gift" in Dirks cannot mean no pecuniary gain.
Moderator Miller’s fellow Morgan, Lewis partner Kenneth I. Schacter called Dirks an "unusual" case. Schacter explained that the defendant in Dirks was a tipper who did not seek a personal benefit or a benefit for anyone else.
Expert network best practices. In a later panel on trends in insider trading cases, Joon H. Kim, Deputy U.S. Attorney in the Southern District of New York, noted that the recent so-called "push" of insider cases was less of a push (prosecutions cover a range of frauds) than it was a collection of cases with many "overlaps" that happened to arise from hedge funds’ use of expert networks. Miller noted on the earlier compliance panel that expert networks are not illegal, but that people get into trouble when they talk informally instead of through a formal network.
Zachary Feingold, Coatue Management, LLC, suggested some best practices: (1) the compliance function should "own" the program and be involved in selecting networks; (2) disallow unscheduled contacts between experts and analysts; (3) avoid contacts with people who have public company ties; and (4) make sure that people at privately-held companies are authorized to share information. Feingold also said good documentation of expert networks can help the compliance function gain insight into the workings of networks and that Newman would have little impact for his clients, who he said have no desire to get close to the insider trading line.
Miller added that best practices for expert networks would include having a good monitoring system. These efforts might focus on: (1) training; (2) usage reports; (3) logs kept by a firm’s CCO; (4) scripts for analysts to use with contacts; (5) getting both the legal and compliance functions involved in monitoring activities; (6) use of a telephone portal instead of in-person contacts; and (7) being careful not to overuse consultants.
The road to Newman and Salman. The speakers at the PLI event mentioned several landmark cases on the long road from the enactment of Exchange Act Section 10(b), the main statutory provision used in securities-based insider trading cases, to Newman and Salman. A key theme to watch going forward is how the Supreme Court and the lower courts explain not just Dirks, but also O’Hagan, Chiarella, and Carpenter. Moreover, look at the Newman panels’ references to the Second Circuit’s Jiau decision.
Here is a mini-primer listing some of the more recent court opinions (and a few other documents) that highlight key questions that led to Newman and Salman:
- Salman v. U.S. (related unpublished opinion)—Supreme Court to hear case during October 2016 term; Salman petition for a writ of certiorari.
- U.S. v. Conradt—Early district court opinion applying Newman to pending case; See also, Government’s view on application of Newman to classical and misappropriation theory cases in U.S. v. Durant.
- U.S. v. Newman—Supreme Court declined to hear government’s appeal; Newman’s opposition; Chiasson’s opposition.
- U.S. v. Jiau—Pre-Newman Second Circuit opinion.
- SEC v. Obus—Pre-Newman Second Circuit opinion.
- U.S. v. O’Hagan—Clarifying misappropriation theory; See the Motazedi administrative order for the CFTC’s invocation of O’Hagan in support of its expanded insider trading authorities under the Dodd-Frank Act.
- U.S. v. Dirks—In reading Newman and Salman, look for how the courts are either consistent with, or deviate from, the Supreme Court’s language inDirks, especially regarding an insider’s "gift of confidential information to a trading relative or friend."
Congressional solution? Several bills in Congress would clarify insider trading liability, although prior bids for a legislative fix have faltered. The Financial CHOICE Act (House Financial Services Committee documents webpage), to be introduced by House Republicans, would increase insider trading penalties. But House Democrats have panned other parts of the bill as an effort to gut the Dodd-Frank Act reforms.
Other bills would do more to define the contours of insider trading. Representative Jim Himes (D-Conn) introduced the Insider Trading Prohibition Act (H.R. 1625). This is the most comprehensive of the several bills and has bipartisan support. The Stop Illegal Insider Trading Act (S. 702), introduced by Sen. Jack Reed (D-RI), and the Ban Insider Trading Act of 2015 (H.R. 1173), introduced by Rep. Stephen F. Lynch (D-Mass), also would spell out what it means to trade on material inside information.
Many commentators have noted over the years that Exchange Act Section 10(b) does not explicitly mention insider trading and that some outsiders to a corporation can be pulled within its grasp. But Exchange Act Sections 20A and 21A do address contemporaneous traders and penalties for insider trading. And Exchange Act Rules 10b5-1 and 10b5-2 deal with trading "on the basis of" material nonpublic information and misappropriation theory. The SEC’s early attempt to define insider trading is contained in Cady, Roberts & Co. and has informed many court decisions (See also former SEC Chairman Ray Garrett, Jr.’s speech on Rule 10b-5 and the history of Cady, Roberts & Co., and former SEC general counsel Philip A. Loomis, Jr.’s speech on the non-exhaustive list of "insiders" with reference to Cady, Roberts & Co.).
If the Supreme Court does clarify insider trading law in Salman, especially the personal benefit component, it is plausible that Congress will forgo a legislative solution. But even in a post-Salman world, there may be renewed calls for a statutory definition of insider trading. In any event, given that the timing of theSalman decision is unpredictable, it seems possible that the several bills already in circulation will need to be re-introduced in a new Congress following this year’s general election.
Attorneys: David I. Miller and Kenneth I. Schacter (Morgan, Lewis & Bockius LLP). Anjan Sahni (Wilmer Cutler Pickering Hale and Dorr LLP). Antonia M. Apps (Milbank, Tweed, Hadley & McCloy LLP). Eugene Ingoglia (Morvillo LLP). John J. O'Donnell (Herbert Smith Freehills). Ryan Poscablo (Riley Safer Holmes & Cancila LLP). Alexandra A.E. Shapiro (Shapiro Arato LLP). John T. Zach (Boies Schiller & Flexner LLP).
Companies: Coatue Management, LLC
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