Will Congress, Supreme Court Define Insider Trading?

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The Second Circuit has denied the U.S. Government’s reconsideration request on a key December ruling limiting the definition of insider trading.  The Supreme Court and/or Congress are up next for the U.S. Government to undo the decision the U.S. Attorney’s office in the Southern District of New York has said would “dramatically limit” the prosecution of some of the most common cases of misconduct.

The opinion in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), reh’g denied, Nos. 13-1837, 13-1917 (2d Cir. Apr. 3, 2015) requires insiders leaking information to receive a personal benefit, something of some consequence, in order to convict them for insider trading.  In the case, the information passed through several hedge funds before the traders the government prosecuted received the information.  The Second Circuit also concluded that they didn’t have the requisite intent to violate the law because they weren’t aware of any benefit provided to the insiders for the information.  The Second Circuit also said that it was insufficient to prove a violation of the law for an insider passing on confidential information to receive an intangible “friendship.”

There are now three options open to the government.

The Government can appeal the decision to the Supreme Court.  There has been speculation that the Court would not agree to take the appeal at this juncture.  The Supreme Court takes a very low percentage of the cases where it is petitioned to review.  There’s also been speculation that a Supreme Court appeal could lead to a more unfavorable ruling, making it difficult to prosecute insider trading in scenarios not touched by the Second Circuit decision.

The Obama administration could also take the case to Congress.  There is currently no federal law defining insider trading. There have already been three bills introduced into the legislative branch to remedy the problem since the Second Circuit announced its decision.  However, the Republican-controlled Congress would probably be hostile to the request at a time when it is already seeking to overturn key aspects of the Wall Street regulations imposed by Dodd-Frank.

The third strategy involves a wait-and-see approach.  The SEC and Justice Department could continue to bring cases and watch how the doctrine develops in the judicial system.  An opinion by U.S. District Judge Rakoff applying the ruling suggests that there may not have been a monumental change in the application of the law.  See Securities and Exchange Commission v. Payton et al, No. 1:2014-cv-04644 (S.D.N.Y. April 6, 2015).

The courts seem to be increasingly hoping to put the ball back in Congress’ arena, however.  In his opinion, Judge Rakoff suggests that Congress is the appropriate body to adequately define insider trading and that the case-by-case approach caused by criminal and civil enforcement of insider trading laws has created tensions.

Supreme Court Justice Antonin Scalia has also implied that it is time for Congress to act to clarify the ambiguity of the prohibition on insider trading.  In the Supreme Court’s denial of an appeal by Douglas Whitman last year, Justice Scalia indicated he would be open to considering an appeal of a criminal conviction for insider trading based on the issue of whether ambiguous criminal legislation can be clarified by an administrative agency or the courts.

The SEC had made insider trading enforcement a priority since 2009.  Before recent losses, U.S. Attorney Preet Brahara had an impressive record of 79-0 in these cases.  Defendants in some of those cases are now preparing to challenge their convictions based on the Second Circuit decision.

It remains to be seen how aggressively the SEC will pursue insider trading cases following the decision, and it could have an effect on some whistleblowers.  There have been more than 400 tips concerning insider trading since Dodd-Frank created the SEC whistleblower program.  Prior to the Dodd-Frank whistleblower program, the SEC had a discretionary program for incentivizing securities whistleblowers in insider trading.