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From Securities Regulation Daily, April 3, 2015

Appeals court will not rehear Newman; will Supreme Court or Congress take up insider liability?

By Mark S. Nelson, J.D.

Manhattan U.S. Attorney Preet Bharara has nearly run out of options for getting the blockbuster Newman insider trading decision reheard by the Second Circuit. The panel’s December 2014 opinion relied heavily on Supreme Court precedent while limiting some types of insider trading cases that involve remote tippees. The appeals court panel that decided Newman, and the full Second Circuit, both declined to rehear the case today. That leaves Bharara’s office with few options in the circuit court, but a Supreme Court appeal is at least possible, and Congress has recently shown interest in defining insider trading liability (U.S. v. Newman, April 3, 2015).

Mere friendship not enough. In Newman, the Second Circuit reversed criminal insider trading convictions and told the district court judge there to dismiss the indictment with prejudice on remand because of a defective jury instruction and weak evidence. The court said the government failed to prove beyond a reasonable doubt that the tippees knew an insider disclosed confidential information in exchange for a personal benefit. The court also explained that, despite other Second Circuit cases applying the Supreme Court’s Dirks opinion, “the personal benefit received in exchange for confidential information must be of some consequence.”

The government had asked the Newman panel and the full circuit court to rehear the decision because it believed the panel went too far in limiting the types of insider trading cases the government can bring. The SEC, in an amicus brief, sided with Bharara’s office in urging the appeals court to take a second look atNewman.

The Newman opinion prompted some judges to act quickly in ruling on pre-Newman plea agreements. In one case, four individuals who pleaded guilty to criminal insider trading won a reprieve when federal Judge Andrew L. Carter, Jr. vacated their earlier pleas and instead entered pleas of not guilty. Judge Carter said in a three-page order that he was “swayed” by what some may call dicta in the Newman opinion, which he said implied that tipping liability is governed by the same standards no matter if it is based on the classical or misappropriation theories of insider trading. Bharara’s office had urged the judge not to extend Newman to misappropriation cases.

Legislative options. While an appeal of Newman to the Supreme Court seems possible, it may be Congress that steps in to reply to calls to statutorily define insider trading. The first two bills introduced this session by Sen. Jack Reed (D-RI) (S. 702) and Rep. Stephen F. Lynch (D-Mass) (H.R. 1173) seek to define insider trading in a manner that would roll back some of the limits imposed by Newman.

But the latest bill, introduced just over a week ago by Rep. Jim Himes (D-Conn), contains the most detailed approach to insider trading offered to date. The Insider Trading Prohibition Act (H.R. 1625) would explicitly ban insider trading in a new Exchange Act Section 16A. The bill would clarify the knowledge requirement and spell out derivative liability. The bill also would give the SEC authority to exempt some transactions.

Representative Himes said in a press release announcing his bill that the existing mix of judicially defined insider trading standards is ill-suited to penalizing those who flaunt the law, while hindering legitimate traders who fear criminal prosecution or civil enforcement actions.

The prospect of the Second Circuit rehearing the Newman case spurred legal academics and celebrities alike to weigh in on the definition (or lack of one) for insider trading. Mark Cuban, who won a jury verdict in an insider trading case the SEC brought against him, told the Second Circuit not to rehear the case.

Cuban’s amicus brief emphasized that the absence of a clear statutory definition of insider trading can lead to a situation where persons who believe they are lawfully trading securities can be charged civilly and/or criminally for acts they could not have known may run afoul of the law. Cuban’s brief also noted the many legislative misfires over the years in which Congress failed to take action to clarify what constitutes insider trading.

Law professors Stephen M. Bainbridge, M. Todd Henderson, and Jonathan R. Macey  also urged against rehearing of Newman in an amicus brief because they believe the greatest threat to the integrity of securities markets comes from the government’s (and by extension, the SEC’s) disdain for the Supreme Court’s Dirks opinion. They focused on Newman’s observation that while the personal benefit test is “permissive,” that standard rejects proof of the “mere fact of a friendship, particularly of a casual or social nature” because this level of proof could render the test a “nullity.” According to the professors, a lessening of the Newman standard could jeopardize the useful role securities analysts play in markets.

Likewise, the defense bar view, pressed by amici National Association of Criminal Defense Lawyers and the New York Council of Defense Lawyers, viewedNewman as a “long-overdue clarification of existing law” whose definition of personal benefit is “faithful” to the Supreme Court’s Dirks opinion. Although the defense bar amici said the Newman panel correctly applied Dirks, they said the panel that decided the case could have opted to rehear it in order to clarify who must get the potential gain from a relationship.

The case is Nos. 13-1837 and 13-1917.

Attorneys: Michael A. Levy, United States Attorney’s Office for the USA. Stephen Fishbein, Esq. (Shearman & Sterling) for Todd Newman.

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