U.S. Government Appeals Landmark Insider Trading Decision to the Supreme Court

This guest post was authored by our colleague Rimma Tsvasman, an associate in the firm’s Litigation Department in New York. Rimma concentrates her practice on corporate and securities transactions, investment management and commercial litigation. She can be reached at rtsvasman@mmwr.com or 212-867-9500. 

In a highly anticipated move following a denied request for a rehearing, the Government has petitioned the Supreme Court for a writ of certiorari requesting the high court to overturn the Second Circuit’s landmark insider trading decision in U.S. v. Newman.

Although the Newman decision has not reached far beyond New York’s borders, as noted by MMWR partner Lathrop Nelson in this recent Bloomberg article, there is no denying that the decision is a prominent one coming from what Supreme Court Justice Harry Blackmun has called the “Mother Court” for securities law.  Indeed, if the Supreme Court decides not to hear the case or if the decision is left to stand, it would represent a big change to the securities law landscape – both in New York and in other jurisdictions which historically have deferred to the Second Circuit on securities law matters – and a blow to U.S. Attorney Preet Bharara’s legacy in aggressively policing Wall Street in the area of insider trading.

The Government itself has conceded that the Newman decision will dramatically limit its ability to prosecute some of the most common forms of insider trading which involves downstream tipping to individuals two or three steps removed from the so-called insider.  As noted by MMWR partner Mark Sheppard in an earlier post reporting on the Newman decision, many of the Government’s highest profile cases have been built upon the cooperation of those “downstream” traders who would be more empowered to resist the government’s efforts to secure that cooperation.  And although Newman is a criminal case, the Second Circuit did not limit its holding to such cases.  Therefore, civil enforcement cases stand to be impacted as well.

Already, the change caused by Newman is palpable as industry professionals hold their breath to see what the Supreme Court will do.  In just several months following the decision, defendants – including S.A.C. Capital Advisors’s Mathew Martoma and Michael Steinberg – have begun to file appeals to overturn their convictions in reliance on Newman.    And some defendants have already had their guilty pleas vacatedJust over a month after the Newman case was decided, the District Court for the Southern District of New York applied the case to vacate four guilty pleas in an insider trading action involving tips about a 2009 acquisition by IBM.  In that case, United States v. Conradt, No. 12 CR 887 (ALC), 2015 WL 480419 (S.D.N.Y. Jan. 22, 2015), the court expanded Newman’s application to cases based on the misappropriation theory, which imposes liability on third parties – such as lawyers – who are entrusted with confidential information as part of their work and break that trust by divulging the confidential information to others.

Decided on December 10, 2014, the Newman court put the brakes on aggressive insider trading prosecutions by holding that the Government must prove that the defendant knew the insiders disclosed confidential information in exchange for a personal benefit, and that the benefit was consequential and represented at least a potential gain of a pecuniary nature.  In other words, under Newman, friendly tips are no longer actionable.

In its petition to the Supreme Court, the Government argues that the Newman decision is at odds with the Supreme Court’s decision in Dirks v. SEC, which sets forth the personal-benefit standard, as well as other appeals court rulings, and has troubling implications for the Government’s ability to police insider trading.

The Supreme Court begins its new term in October, and will likely decide this Fall whether to consider the Government’s appeal.  We will be sure to keep you posted.

Landmark $1.375 Billion Settlement in S&P Case Highlights DOJ’s FIRREA Civil Enforcement

Just two years after the ink dried on the Department of Justice’s civil complaint against McGraw-Hill Financial, Inc. and its wholly owned subsidiary Standard and Poor’s Financial Services LLC and almost a decade after S&P was alleged to have misled investors by promoting all-star grades of residential-mortgage bonds as independent and objective, S&P settled prosecutions being conducted by the DOJ, the District of Columbia, and nineteen states for over $1.375 billion, the largest record settlement involving a credit rating firm in history. The settlement agreement requires S&P to pay the DOJ $687,500,000 as well as pay similar amounts to the nineteen states and the District of Columbia.

The DOJ initiated suit against S&P on the basis that it violated the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), a previously underutilized statute that, as we discussed on White Collar Alert, has been rejuvenated by the DOJ in recent years. As detailed in the government’s complaint, S&P was alleged to have knowingly misled investors by overrating residential mortgage backed securities (“RMBS”) and collateralized debt obligations (“CDOs”) during the onset of the 2007 financial crisis. The complaint asserts that S&P’s conduct was fueled by its desire to maintain business relationships with and profit from the banks and companies that issued the RMBS and CDOs. When the housing market collapsed, S&P’s ratings turned out to be inaccurate and in many instances, based on mortgage packages that S&P knew were likely to default. As Attorney General Eric Holder summarized:

On more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised. … While this strategy may have helped S&P avoid disappointing its clients, it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.

Although the settlement agreement and its sixteen-point statement of facts did not require an explicit admission of wrongdoing by either S&P or McGraw Hill, it did require S&P to retract its earlier assertion that the DOJ’s prosecution was political retaliation for the firm’s 2011 downgrade of the United States’ credit rating.

What this historical settlement signals is the increased (and successful) use of FIRREA by the DOJ. The statute has been around for over twenty years without a significant track record, but the DOJ has started to feature it more prominently in civil enforcement actions against financial services and securities companies. Not only does it have a longer statute of limitations, but a civil enforcement action under FIRREA has a lower standard of proof than a criminal enforcement action and provides for the recovery of significant monetary penalties. Although the S&P prosecution is the first enforcement action of its kind against a rating agency, we wouldn’t be surprised to see the government dip its toe into the cool FIRREA waters more frequently in the future.

DOJ Hopes to Prosecute More Criminal Cases Arising Out of False Claims Acts

On Wednesday, Assistant Attorney General for the Criminal Division Leslie R. Caldwell spoke at the Taxpayers Against Fraud Education Fund annual conference in Washington D.C., and announced that the DOJ is closely examining civil False Claims Act lawsuits in order to find possible criminal cases. The DOJ published Caldwell’s remarks from the conference, run by a well-known nonprofit. If you represent government contractors, hospitals, other health care industry individuals and entities, or others involved in government programs, take note of this development and advise your clients accordingly.

Ms. Caldwell said that:

Today, I want to announce that we will be stepping up our use of one tool, and that is the fine work done by all of you in investigating and filing cases under the False Claims Act.

Through our Fraud Section, we will be committing more resources to this vital area, so that we can move swiftly and effectively to combat major fraud involving government programs.

(emphasis added).

She asked the audience, mostly members of the Plaintiff’s bar, to contact DOJ Criminal Division “[w]hen you are thinking of filing a qui tam case that alleges conduct that potentially could be criminal, I encourage you to consider reaching out to criminal authorities, just as you now do with our civil counterparts in the department and the U.S. Attorney’s Offices.” She noted that the DOJ Criminal Division has “unparalleled experience prosecuting health care fraud, procurement fraud, and financial fraud” and that they “will bring that expertise to bear by increasing our commitment to criminal investigations and prosecutions that stem from allegations in False Claims Act lawsuits.”

Ms. Caldwell emphasized all of the resources available to criminal prosecutors that might not be available to other enforcement agencies, including search warrants and wiretaps, consensual recordings, confidential informants.”

The announcement of the DOJ’s goal combined with attempts to streamline the referral process internally has many possible ramifications for white collar practitioners. First and foremost, if your client is facing exposure under the False Claims Act, be aware that the DOJ may be combing through the relators complaint to see if the alleged conduct raises criminal concerns or even working directly with the qui tam plaintiff’s lawyer who filed the civil suit. And if the DOJ Criminal Division does take notice and start investigating, the negotiations will inevitably shift from minimizing the financial penalties to avoiding criminal charges at all. The bottom line is that the DOJ has effectively upped its ability to collect much more in fines with the new threat of criminal prosecutions.

Justice Department’s Integrity Section Scores a Win in McDonnell Case: Gov. McDonnell Should Have Accepted the Plea Deal Because the Broken Marriage Defense Didn’t Work

More than two years after the Justice Department Public Integrity Section’s embarrassing fumble in the campaign finance trial that didn’t result in a conviction against former U.S. Senator John Edwards, the section successfully prosecuted former Virginia Gov. Bob McDonnell (a onetime Republican rising star who was considered for the 2012 vice-presidential nomination) and wife Maureen McDonnell. The Edwards trial was one of many missteps that led to a wave of bad publicity for the DOJ Section. But yesterday, a jury found former governor Bob McDonnell guilty of 11 corruption-related counts, and his wife of 8 corruption-related counts and one count of an obstruction of justice in a case that arose from accepting gifts from a wealthy businessman. He was acquitted of lying on loan documents, and she was acquitted of falsifying a bank record.

We’ve previously blogged about the trial here. At trial, lawyers for the McDonnells argued that their marriage was too broken for them to conspire. This simply wasn’t enough for the jury. The prosecutors vigorously attacked this defense (at one point showing pictures of the McDonnells arriving at court holding hands earlier this year to the jury) and paraded the evidence of all the lavish presents received by the couple.

Now that we have all become familiar with the dysfunctional marital dynamics of the couple, and both face years in jail, I’m sure the former governor is ruing his decision to reject what now seems like an incredibly good deal: plead guilty to one felony fraud charge that had nothing to do with corruption in office and his wife would not be charged at all. However, the cliché that hindsight is 20/20 is usually appropriate with decisions to reject plea deals and go to trial. Because sometimes, even when it seems as though all evidence points to guilty, a jury will not convict. 

Insider Trading Probe a Bogey for Mickelson?

On Friday, the Wall Street Journal and New York Times reported that federal authorities are investigating investor Carl Icahn, gambler William Walters and golf champion Phil Mickelson for insider trading. Investigators are examining a series of successful trades by Walters and Mickelson of shares of Clorox in 2011 shortly before Icahn announced an unsolicited (and ultimately unpursued) take-over bid for the company. FBI agents first questioned Mickelson about the trades a year ago, pulling him off a plane in New Jersey, then again last Thursday following his first round at the Memorial Tournament. Mickelson and Icahn both have denied even knowing each other. However, both know Walters and he may have been the link between the two.

Full disclosure: I’m a Phil Mickelson fan. Whether it’s his swashbuckling, go-for-broke style or the fact that we’ve eagled the same par four (mine was a fluke; his was Phil being Phil). He’s a risk-taker and with his aggressive game on the course comes both the good (think pine straw in 2010) and the bad (think Winged Foot in 2006). Perhaps that risk-taking has now gotten him into the deep rough with the SEC and DOJ.

Maybe, but maybe not. Even if Icahn passed information to Walters, who then passed it along to Mickelson, who then made a series of successful trades, liability is far from clear, particularly for a “downstream tippee” like Mickelson.

For there to be any insider trading liability, the tipper – Icahn – must have breached a fiduciary duty. Although Rule 14e-3 prohibits certain persons from disclosing or trading on information in connection with a tender offer, the rule applies only where the person making the offer has taken “substantial step” in making it. Icahn, who has no affiliation with Clorox, never made the offer. Icahn may have had a duty to his own investors to keep the proposed offer confidential, but the basis of such a duty is unclear and would likely turn on any non-disclosure requirements Icahn had with his investors.

But there are additional challenges in attaching liability to Mickelson. Even assuming that Icahn had a duty to his own investors, the government would need to demonstrate that “Phil the Thrill” knew or should have known that Icahn was breaching a fiduciary duty by making the a disclosure of non-public, material information. In addition, as we have blogged about previously, the government may also be required to demonstrate that Mickelson also knew or should have known that Icahn received a personal benefit from making the tip (also assuming that Icahn, in fact, received a personal benefit, an assumption that is far from clear).

That’s a lot of assumptions. So, ultimately, while Phil didn’t have the greatest week (or season) on the course, the government has an uphill fight in reaching him as a downstream tippee. In the meantime, Mickelson will chase that elusive U.S. Open victory at Pinehurst while the SEC and the DOJ continue to shoot for the pin as they aggressively pursue insider trading.

Chinese Government Outraged Over DOJ Indictment, Calling Charges “Ungrounded” and “Absurd”

Yesterday, the Department of Justice unsealed a 31 count indictment against five members of the Chinese People’s Liberation Army: Wang Dong, Sun Kailiang, Wen Xinyu, Huang Zhenyu, and Gu Chunhui. The five men were indicted on May 1st by a federal grand jury in the Western District of Pennsylvania and are charged with conspiracy to commit computer fraud, intentionally accessing and obtaining information from a protected computer, intentional damage to a protected computer, aggravated identity theft, economic espionage, and theft of trade secrets. Attorney General Eric Holder stated that the members engaged in hacking American businesses including U. S. Steel Corporation, Westinghouse, Alcoa, Allegheny Technologies, the United Steel Workers Union, and SolarWorld. These charges are the first ever brought against a foreign nation for cyber spying, and mark the beginning of an assertive position by the U.S. government. At a news conference yesterday, Holder said the U.S. “will not tolerate actions by any nation that seeks to illegally sabotage American companies and undermine the integrity of fair competition in the operation of the free market.”

Since the indictment was unsealed, the Chinese government has vigorously denounced the charges, lashed out at the U.S., and taken public steps to defend against the allegations. In a statement, Chinese Foreign Ministry spokesman Qin Gang said:

The United States fabricated facts in an indictment of five officers for so-called cybertheft by China, a move that seriously violates basic norms of international relations and damages Sino-U.S. cooperation and mutual trust. China has lodged a protest with the United States, urged the U.S. to correct the error immediately and withdraw its so-called prosecution.

Moreover, he proclaimed that “China is steadfast in upholding cybersecurity,” and that “[t]he Chinese government, the Chinese military and their relevant personnel have never engaged or participated in cyber-theft of trade secrets. The U.S. accusation against Chinese personnel is purely ungrounded and absurd.”

Chinese state-run Xinhua News Agency also reported that Chinese Assistant Foreign Minister Zheng Zeguang summoned Ambassador Max Baucus on Monday night to make a formal complaint about the charges. Additionally, new statistics were published by China’s internet controllers yesterday that essentially accused the U.S. of hypocrisy, suggesting that cyber-attacks on China came from United States and “target[ed] Chinese leaders, ordinary citizens and anyone with a mobile phone.” China also decided to suspend participation in the Sino-US Cyber Working Group.

While the Chinese government has invoked the “outrageous” defense, the significance of the U.S. government’s action cannot be understated. Cyber threats and data breaches are very serious problems for all business throughout all sectors of the economy, including, as alleged in yesterday’s indictment, major U.S. manufacturing companies. Indeed, just this month, Target Corp. ousted its CEO, in part, as a result of the significant data breach last year that compromised personal data of millions of its customers. Yesterday’s indictment marks the first step by the Department of Justice to address cyber spying against a foreign government and reveals a new front on attacking the cyber-attackers.