Court Overturns Insider-Trading Convictions, a Blow to Justice Department


Judges Narrow Definition of Insider Trading, Say Prosecutors Took Too Broad a View in Wall Street Crackdown



Updated Dec. 10, 2014 7:18 p.m. ET

In a blow to the Justice Department’s Wall Street crackdown, a federal appeals court overturned two insider-trading convictions and ruled it isn’t always illegal to buy or sell stocks using inside information.

The ruling raised the bar for prosecutors on a crime that is already hard to prove, and it will likely limit the types of cases the government can pursue.

Specifically, the three-judge panel of the Second U.S. Circuit Court of Appeals said prosecutors must prove traders knew that the person who provided an inside tip gained some sort of tangible reward for doing so. The judges also said it may be legal to trade on inside information, even if it gives an investor an unfair advantage in the markets, as long as the tipper didn’t commit an illegal breach of his or her duty.

Judge Barrington D. Parker said the Supreme Court had rejected the notion that insider-trading law prohibits all trading using confidential information, writing that, “although the government might like the law to be different,” not every instance of financial unfairness constitutes fraud.

The ruling is a disappointing denouement for prosecutors winding down their recent run of insider-trading cases, a closely watched effort that has featured charges against high-level traders at some of the country’s biggest hedge funds. The push sent a chill through Wall Street trading rooms and landed Manhattan U.S. Attorney Preet Bharara on the cover of Time magazine.

The unanimous decision overturned the December 2012 convictions of former hedge-fund traders Todd Newman and Anthony Chiasson in New York federal court. The judges said prosecutors have been too aggressive in their interpretation of the law.

Marc Powers, a partner at law firm Baker & Hostetler LLP, said the U.S. attorney and the Securities and Exchange Commission “have been pushing the boundaries of the law and the facts in insider-trading cases, beyond fairness and reason.”

“The Second Circuit appears now to be setting the government straight,” he said. Baker & Hostetler wasn’t involved in the matter before the court.

In the case at hand, jurors deliberated for two days before finding Messrs. Newman and Chiasson guilty of using confidential information to make $72 million trading on stock in technology companies Dell Inc. and Nvidia Corp. The pair hadn’t received the information directly. Instead, the tips they got were passed through a network of investor-relations representatives and analysts before reaching analysts who worked for the two men.

The appeals-court panel ruled that, in order to be found guilty of insider trading, a defendant must know a tip was illegally disclosed in exchange for a reward of “some consequence.” The court also dismissed prosecutors’ contention that career advice or friendship constituted a reward, saying that, under that logic, “practically anything would qualify.”

The U.S. attorney’s office had planned to retry the cases if they lost the appeal, according to people familiar with the matter. But the court dismissed the indictments altogether, which prevents a retrial. In a statement, Mr. Bharara said his office was considering options for further appeals.

“Today’s decision by the Court of Appeals interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information,” Mr. Bharara said.

A common view of insider trading is of a plugged-in trader using a confidential tip to make lucrative trades. But the legal reality is more nuanced. Courts have long held that tippers must violate a duty of some sort in disclosing material nonpublic information, and the trader needs to know that that’s the case.

At issue in the appeal was whether the trial judge made an error in telling the jurors in Messrs. Newman and Chiasson’s trial that it was enough for the government to show that the men knew the information was disclosed in breach of a fiduciary duty and not necessarily in exchange for a reward.

The appeals court said that instruction was wrong, clarifying that the trader also needs to know that the tipper benefited tangibly from breaching the duty, something that might not apply to a person who trades on a tip from an old classmate, for instance.

On Wednesday, a lawyer for Mr. Chiasson praised the opinion. “Today’s decision is a resounding victory for the rule of law and for Anthony Chiasson personally,” Gregory Morvillo said in a statement. Stephen Fishbein and John Nathanson, lawyers for Mr. Newman, said the “vindication comes after four years of unnecessary prosecution including a trial in which the Second Circuit held that the wrong legal standard was applied.”

The office of Judge Richard J. Sullivan, who presided over the trial, declined to comment.

Legal observers said the decision could also provide grounds to overturn the marquee conviction of a former SAC Capital portfolio manager Michael Steinberg. The confidant of SAC founder Steven A. Cohen was found guilty of trading using confidential information that reached him via a chain of analysts and traders, and he plans to appeal his conviction on similar grounds. A spokesman for SAC Capital, now known as Point72 Asset Management, declined to comment.

The ruling won’t affect the overwhelming majority of insider-trading convictions in the past five years. Prosecutors relied on a handful of cooperators to testify against Messrs. Newman and Chiasson. Legal experts said the cooperators, who all pleaded guilty, could seek to withdraw their pleas in the wake of the ruling but would face a steep climb in doing so.

Lawyers also don’t expect the highest-profile convictions by Mr. Bharara’s office—including the convictions of Raj Rajaratnam, former Galleon Group hedge-fund manager; or Rajat Gupta, the former Goldman Sachs Group Inc. director who provided Mr. Rajaratnam with information—to be jeopardized by the decision.

“We note that the government has not cited, nor have we found, a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading,” Judge Parker wrote.

David Ganek, who co-founded the hedge fund Level Global with Mr. Chiasson, said Wednesday’s opinion called into question the government’s entire probe into the fund, which shut down after 2010 raids by the Federal Bureau of Investigation. Mr. Newman’s hedge fund, Diamondback Capital, was also raided and wound down operations in 2012.

This isn’t the first time the courts have rebuked prosecutors for overreaching in insider-trading cases. Rudolph Giuliani was criticized by lawyers and some on Wall Street for pushing the boundaries of insider-trading cases in the late 1980s, after two Kidder Peabody employees were arrested only to see the charges dropped. Later, the Second Circuit court threw out the conviction by Mr. Giuliani’s office of investment manager John Mulheren, who was accused of a stock-manipulation scheme.

David Miller, a former New York federal prosecutor who handled multiple insider-trading cases, said the most significant consequence of the ruling is that it will make it particularly difficult to go after people who allegedly traded using inside information but were one or more layers removed from the source. Messrs. Newman, Chiasson and Steinberg fall under that category.

“The bottom line is this is going to have a major effect on downstream tippee investigations and prosecutions,” said Mr. Miller, who is now a partner at Morgan, Lewis & Bockius LLP. “If the tippee doesn’t even know of the tipper, how can you prove they knew there was a benefit?”

Mr. Bharara’s team had enjoyed a nearly untarnished winning streak since he took office in 2009, securing 89 convictions.

The appeals court not-so-subtly suggested that the Justice Department has strayed too far from the real villains. “Recent insider trading prosecutions,” the Second Circuit said, “are increasingly targeted at remote tippees many levels removed from corporate insiders.”

—Michael Rothfeld and Susan Pulliam contributed to this article

Write to Christopher M. Matthews at


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