Two men share securities regulation news

Breaking news and expert analysis on legal and compliance issues

[Back To Home][Back To Archives]

From Securities Regulation Daily, February 26, 2015

Law profs, defense bar tell appeals court to leave Newman alone

By Mark S. Nelson, J.D.

A pair of amicus briefs filed yesterday in the Newman insider trading case urge the Second Circuit panel that limited prosecutions in these cases last December to rebuff the government’s effort to have it (or the full appeals court) rethink the opinion. One of the briefs gives the view of three prominent law professors, while the other one recites the defense bar’s position. Just last week, the case gained a celebrity hue when Mark Cuban filed an amicus brief backing theNewman panel (U.S. v. Newman, December 10, 2014, Parker, B.).

It is much too soon to tell if the Newman case could reach the Supreme Court, but the high court has several times in the past few years taken on the issue of prosecutorial overreach—a theme that pervades the Newman debate. Yesterday’s  decision in the Sarbanes-Oxley Act “fish” case, and last year’s case about the use of a chemical weapons law, ended up limiting prosecutors’ options; both cases gave rise to somewhat bruising battles among the justices over statutory interpretation.

Still, the Newman case brings renewed national attention to what until now has been a highly successful insider trading strategy pursued by Manhattan U.S. Attorney Preet Bharara, whose office vigorously objects to the Newman panel’s outcome. The SEC also has urged the Second Circuit to upend the Newmanpanel’s opinion.

Unlimited insider liability. Amicus briefs filed by law professors got an unexpected boost when Supreme Court Justice Anthony Kennedy put a spotlight on the “law prof” brief (“the midway position”) during oral argument in Halliburton II last year. Likewise, will it be a “law prof” brief that grabs the Second Circuit’s attention as a panel of that court decides if  it will rehear its December 2014 Newman insider trading opinion limiting prosecutions in cases with remote tippees?

The law professors here are Stephen M. Bainbridge, M. Todd Henderson, and Jonathan R. Macey. They said the greatest threat to the integrity of security markets comes from the government’s (and by extension, the SEC’s) disdain for the Supreme Court’s Dirks opinion. Their amicus brief focuses on Newman’s observation that while the personal benefit test is “permissive,” that standard would reject proof showing 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.  Dirks, they said, backs the idea that analysts can provide a check on the accuracy of statements made by corporate insiders; analysts could even detect fraud at a company. Analysts also use this information to achieve better capital markets pricing and their work aids the optimal allocation of capital. But while objecting to Newman, the professors acknowledge that analyst-insider communications should be curbed by other anti-insider trading precepts.

Newman, the professors said, stands for the proposition that a test based solely on friendship (without some improper motive shown by a personal benefit) can expose analysts to nearly unlimited insider trading liability. In a footnote, the professors cite as an example the SEC’s Regulation FD (Fair Disclosure), in which the Commission admitted in its own footnote to its adopting release the “in terrorem” shock that could result if it pursued insider trading charges based on selective disclosures rather than follow the “measured” limits imposed by Regulation FD.

The professors argue that Dirks strikes the right balance between the government’s and the SEC’s pursuit of fraudulent insider trading and letting key industry participants engage in what should be lawful and beneficial activities that aid capital markets. They said the Second Circuit panel or the full court should uphold the Newman opinion as a bulwark against overzealous insider trading prosecutions.

In a parting shot, the last sentence of the professors’ brief urged the government and the SEC to ask Congress to clear up insider trading law by explicitly legislating on whether the receipt of inside information without a “provable personal benefit” is unlawful. The brief filed last week by Mark Cuban made a similar point by noting that Congress has tried, but failed, to explicitly define insider trading.

Professor Bainbridge is UCLA’s William D. Warren Distinguished Professor of Law and a prolific blogger on securities law. Professor Henderson, the Michael J. Marks Professor of Law and Aaron Director Teaching Scholar, teaches at the University of Chicago Law School.

Professor Macey recently engaged in a back-and-forth with others over the propriety of sitting SEC Commissioner Daniel M. Gallagher’s and Professor Joseph Grundfest’s paper that seemed to accuse the Shareholder Rights Project of violating securities laws. (This dustup has quieted during the past few weeks, however.) Macey is the Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale Law School (Macey is on leave during Spring 2015).

Who must get the benefit? Much as the law professors see Newman as properly reigning-in overbroad prosecutorial discretion, the defense bar amici also view Newman as a “long-overdue clarification of existing law” whose definition of personal benefit is “faithful” to the Supreme Court’s Dirks opinion. The defense bar is view is being pressed by the National Association of Criminal Defense Lawyers and the New York Council of Defense Lawyers.

Although the defense bar amici said the Newman panel correctly applied Dirks, they said the panel that decided the case might think about clarifying who must get the potential gain from a relationship. This request came in a footnote to a section of their brief where they observed that the definition of “friendship” is “infinitely malleable.”

According to the defense bar, the highlighted text in the this passage from the Newman opinion is problematic: “… we hold that such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

The defense amici noted that Dirks contemplated scenarios in which either insider or the trading relative/friend could get the financial benefit. But they point out that the Newman panel “presum[ably]” intended to follow Dirks.

Moreover, the defense bar amici said the government’s “mere friendship” test runs afoul of due process by failing to give fair warning of what conduct is unlawful; the government’s view also runs counter to the principle of lenity. The defense bar also cautioned that the judge-made character of insider trading law can raise the issue of separation of powers because Congress typically must enact a law defining a crime.

The case is No. 13-1837(L) and No. 13-1917(CON).

Attorneys: Jonathan P. Bach (Cooley LLP) for Stephen M. Bainbridge, M. Todd Henderson and Jonathan R. Macey. Ira M. Feinberg (Hogan Lovells US LLP) for National Association of Criminal Defense Lawyers and New York Council of Defense Lawyers.

Companies: National Association of Criminal Defense Lawyers; New York Council of Defense Lawyers

MainStory: TopStory FraudManipulation ConnecticutNews NewYorkNews VermontNews 

Securities Regulation Daily

Introducing Wolters Kluwer Securities Regulation Daily — a daily reporting service created by attorneys, for attorneys — providing same-day coverage of breaking news, court decisions, legislation, and regulatory activity.

A complete daily report of the news that affects your world

  • View full summaries of federal and state court decisions.
  • Access full text of legislative and regulatory developments.
  • Customize your daily email by topic and/or jurisdiction.
  • Search archives for stories of interest.

Not just news — the right news

  • Get expert analysis written by subject matter specialists—created by attorneys for attorneys.
  • Track law firms and organizations in the headlines with our new “Who’s in the News” feature.
  • Promote your firm with our new reprint policy.

24/7 access for a 24/7 world

  • Forward information with special copyright permissions, encouraging collaboration between counsel and colleagues.
  • Save time with mobile apps for your BlackBerry, iPhone, iPad, Android, or Kindle.
  • Access all links from any mobile device without being prompted for user name and password.