In U.S Obama Administration Gambles on Supreme Court Review of Insider-Trading Case

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The Obama administration has asked the U.S. Supreme Court to reverse an appeals-court decision that seriously weakened the ability of the government to prosecute insider-trading cases.

The U.S. Solicitor General, in certiorari, asked the high court to review the Second Circuit Court of Appeals decision last December that overturned the 2013 insider-trading convictions of Todd Newman and Anthony Chiasson. In that decision, the influential New York court held that prosecutors must prove not only that the men traded on material, non-public information but that they knew the source of the information received some kind of gain for sharing it.

By appealing the case, the government is taking a calculated risk the Supreme Court will cement the Second Circuit understands of the law across the country. The government argues the opposite, of course: It says the appeals court “reinterpreted” the most important precedent for insider trading, Driks v.SEC, to require proof of a “close personal relationship” between tipper and tippee that results in the tipper receiving an “objective, consequential” benefit.

The Second Circuit’s holding conflicts with the law in other circuits, Solicitor General Donald Verrilli wrote, and “the effect of the new rule will be to hurt market participants, disadvantage scrupulous market analysts, and impair the government’s ability to protect the fairness and integrity of the securities markets.”

Critics of insider-trading prosecutions point to the ever-widening spread of supposedly illegal activity to traders who don’t even know the source of the information they are profiting from, let alone paying anybody for it. The government’s position is insider trading is a plague on public markets because it allows knowledgeable investors to profit at the expense of less sophisticated ones and undermines confidence in capital markets. The Supreme Court has allowed the prosecution of insiders who share information with family members and close friends, but has specified that liability stems from the tipper’s breach of a duty to his employer and other shareholders, and not the mere use of insider information.

The breach is usually cemented by receiving some sort of benefit, such as cash or even the gratitude of a family member. In this case benefit was more amorphous, in one case advice on how to get a job as a financial analyst. And since the tipper and tippee were several steps removed from each other, the government couldn’t prove a direct chain of liability passing from one to the other.

In last December’s decision, the Second Circuit said “although the Government might like the law to be different, nothing in the law requires symmetry of information in the nation’s securities markets.” The court went on to criticize the “doctrinal novelty” of the government’s “recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders.”

The government’s 85-page request for Supreme Court review contains an unusually long description of the cases against Newman and Chiasson, who were accused of accepting insider information on quarterly earnings at Dell and NVIDIA. When an acquaintance asked Chiasson how he had “checks” on Dell’s gross margin before a scheduled earnings release, he allegedly wrote: “Not your concern. I just do.” But neither Chiasson nor Newman admitted to knowing the identities of the tippers, and the tippers weren’t prosecuted.

“This cert petition is a risk for the government,” said John Donovan, a partner with Ropes & Gray in Boston, in e-mailed comments. “They risk the Supreme Court affirming the Second Circuit decision, and tightening the elastic way in which prosecutors have been able to apply the `personal benefit’ test.” “But a decision not to petition the Court could be worse.  It would leave the Second Circuit decision as it is. The government’s petition is a bet that they can improve on that worst case scenario – even if the Supreme Court clarifies the law by adopting a middle ground.”