Securities Regulation Daily Temporary insider had fiduciary duty to not trade on drug trial data
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Tuesday, September 22, 2020

Temporary insider had fiduciary duty to not trade on drug trial data

By Mark S. Nelson, J.D.

The court upheld the conviction of a medical doctor for insider trading where the doctor acted as a principal investigator responsible for keeping information about a drug study confidential while also recruiting patients into the drug study.

The Second Circuit upheld the conviction of Edward Kosinski on charges of insider trading related to his role as a principal investigator of a new drug candidate during clinical trials in advance of a decision by the FDA on whether to approve the drug. The court concluded that Kosinski was a temporary insider of a company with a fiduciary duty not to trade the drug company’s securities on the basis of confidential information he obtained from the drug study. The court upheld the conviction against Kosinski’s challenges to the fiduciary standards applied to him and to the sufficiency of the evidence (U.S. v. Kosinski, September 22, 2020, Korman, E.).

Regado Biosciences, Inc. paid Kosinski $80,000 for recruiting 20 of his patients to a study of Regado’s drug, which was designed to lessen the risk of blood clots during certain heart procedures. Kosinski signed two agreements with Regado in various capacities. A Confidential Disclosure Agreement (CDA) included terms that limited the disclosure and use of study data. A subsequent agreement, titled the Clinical Study and Research Agreement (CSRA) required Kosinski to hold study data in "strict confidence" and to disclosure his Regado’s holdings over $50,000. Kosinski, an experienced stock trader with a trading account of $11 million, secretly acquired $250,000 of Regado stock. Upon learning the drug trial would be suspended, Kosinski sold Regado stock and avoided a loss of $160,000. Upon learning the drug trial would end due to safety concerns, Kosinski shorted Regado stock by purchasing put options at a net profit of $3,300. Kosinski was convicted of two counts of insider trading and sentenced to six months in prison and fined $500,000.

Temporary insider status. The court began its analysis with a discussion of Justice Ginsburg’s explanation in U.S. v. O’Hagan of the classical and misappropriation theories of insider trading, both of which the court concluded could apply to Kosinski because of how the theories can overlap. Specifically, the court said Kosinski was, as a result of his role as a principal investigator, a temporary insider of Regado who had received information "integral[]" to the safety of the drug study from Regado that he agreed to keep confidential. Kosinski was even subject to a requirement that he disclose his Regado holdings above a stated threshold. As a result, Kosinski breached a duty to the source of the information and that failure satisfied the "deceit" required to be shown by Exchange Act Section 10(b) and Rule 10b-5.

Fiduciary-like relationship. Kosinski had disputed that he acted in a fiduciary role. However, the court observed that upon joining the Regado study, Kosinski agreed via contract to keep Regado’s study-related information confidential and that he would report his holdings of Regado stock if they grew above $50,000.

The court reasoned that this was sufficient to imbue Kosinski’s relationship with Regado with the fiduciary-like status because Kosinski, in exchange for keeping study information confidential, would be trusted by Regado to administer the trial drug to patients and to report on the safety and efficacy of the drug. The court explained that when Kosinski decided to focus on his personal financial gain by trading Regado securities, he jeopardized his ability to independently evaluate the drug candidate for purposes of Regado’s attempt to obtain FDA approval. Put another way, the court said Kosinski had aligned his personal interest with the study’s outcome and, thus, acquired a motive to potentially shade study results in favor of his personal financial interest.

The court also rejected numerous arguments offered by Kosinski, albeit in the context of a broader discussion of the Second Circuit’s Chestman factors. Kosinski, for example, had claimed that he did not disclose information acquired by him as a principal investigator, but the court said the merger clause in the CSRA supplanted the prior CDA, which had explicitly banned use of such information. The court also rejected Kosinski’s assertion that he was an independent contractor because independent contractors can be fiduciaries and private contract language related to this issue cannot supplant contrary pubic policy expressed in the federal securities laws. Likewise, Kosinski’s conception of his relationship with Regado as one of arms-length dealings elided the trust and confidence with which that relationship had been imbued. Lastly, Kosinski argued that his relationship with Regado lacked confidence on one side and superiority/influence on the other; the court answered that Kosinski’s argument missed the mark because Regado trusted Kosinski and Kosinski exercised superior skill in getting his patients to join the drug study.

The court also rejected Kosinski’s argument that a jury instruction to the effect that "a person has a requisite duty of trust and confidence whenever a person agrees to maintain information in confidence" was erroneous because his agreement to the CSRA would lead the jury inevitably to conviction. The court said there was "overwhelming[]" evidence of Kosinski’s guilt and any resulting error from the jury instruction was harmless.

In a footnote, the court declined to address the government’s theory that Exchange Act Rule 10b5-2 applied because the court had already found that there was sufficient evidence to convict Kosinski. This provision states a non-exclusive definition of the phrase "duties of trust or confidence" in the context of the misappropriation theory of insider trading. The government in Kosinski’s case had posited that of the three stated theories in the rule, the one providing that "[w]henever a person agrees to maintain information in confidence" could apply to Kosinski.

Willfulness instruction. Exchange Act Section 32(a) requires that to be convicted of securities fraud the government must prove that the defendant acted willfully. The court here noted that Kosinski endorsed the charge and, in any event, a securities defendant need only have general awareness of the unlawfulness of his actions. The court then cited numerous factors that supported a conclusion that the evidence of willfulness was sufficient to convict Kosinski.

Statements by Kosinski. Kosinski argued that two statements he made to an FBI agent should have been admitted at trial under the rule of completeness or as excited utterances. The court said Kosinski’s statement that he had not retained counsel, made before being told he had been indicted, was not an excited utterance because he still did not know of the indictment and it was not a startling event because Kosinski had previously spoken to FBI agents. Once Kosinski had been told of the indictment, he told the FBI agent "I can’t believe this is happening." The court, however, said neither it nor the district court could completely evaluate that statement because of a stipulation by the parties to avoid a "hearsay fight." The court could not conclude that that the trial court’s exclusion of the statement was "manifestly erroneous," but the statement also was not needed for completeness purposes. As result, the district court did not abuse its discretion.

The case is No. 18-3065.

Attorneys: Alexandra A.E. Shapiro (Shapiro Arato Bach LLP) for Edward Kosinski. Heather L. Cherry, U.S. Attorney for the District of Connecticut, for the U.S.

Companies: Regado Biosciences, Inc.

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