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.

Bharara’s Fire Dies Out: Cohen Remains Uncharged And Turns His Losses Into Gains

As the chapter closes on the decade-long insider trading investigation of SAC Capital Advisors, our question has finally been answered—at least for now: billionaire hedge fund guru Steven A. Cohen has dodged criminal charges for his role in managing the company now convicted of systemic insider trading. It seems, after all, that Manhattan U.S. Attorney Preet Bharara did not have enough fuel in his fire to engulf Cohen.

What is undisputedly the largest insider trading prosecution in American history, the United States of America v. S.A.C. Capital Advisors, L.P., et al. drew to a close April 10, 2014, as U.S. District Judge Laura Taylor Swain accepted SAC’s guilty plea. SAC will pay an unprecedented $1.8 billion in penalties, serve a probation sentence of five years, wind down its business affairs as an investment advisor for third parties, and retain a compliance consultant to evaluate and report on insider trading compliance procedures.

With a sentence like that, one would think that SAC’s days are numbered. But Cohen has been quick to reinvent himself and christen Point72 Asset Management as the legal successor to SAC, a family office that will assume the reins of Cohen’s investing, trading, and portfolio management. Perhaps in an attempt to get out from under the SEC’s watchful eye, Point72 was specifically founded as a “family office,” a wealth management office that will not be subject to SEC regulation as other investment advisors, such as SAC, are. 17 C.F.R. § 275.202(a)(11)(G)–1. Just how wide a net can a family office cast when soliciting clients, you ask? Point72 will be permitted to invest and manage the money of Cohen’s family members, key employees, certain non-profit organizations, estates, and trusts, and any company owned and operated for the benefit of family clients. Id. And what’s more, key employees include Point72’s executive officers, directors, trustees, and general partners, not to mention employees who have participated in Point72’s investment activities for the past twelve months. Id. Does Point72 sound like a revamped version of SAC? Perhaps, but then again, Cohen’s uncanny ability to turn such massive losses somehow into entrepreneurial opportunities are conceivably the reason behind his seemingly endless success.

To those critics who think that SAC walked away essentially unscathed, the terms of the plea were unequivocally supported by SAC and the Government alike. As the Government wrote in its sentencing memorandum of April 3, 2014:

The $900 million fine imposed on the SAC Entity Defendants pursuant to the Plea Agreement is, to the Government’s knowledge, the largest criminal fine ever imposed in an insider trading case. When combined with the $900 million judgment in the Forfeiture Action, it represents an amount that is several times larger than the illicit gains and avoided losses resulting from the insider trading alleged in the Indictment. This financial penalty, together with the non-financial penalties and considerations set forth in the Plea Agreement, is an appropriate punishment for the criminal conduct at SAC Capital – where eight employees to date have been convicted of insider trading – and provides a strong message of deterrence to other institutions…

Gov’t Sentencing Mem. at 2, United States of America v. S.A.C. Capital Advisors, L.P., et al. (2nd Cir. 2014) (13-CR-00541-LTS).

But alas, prosecutors have left themselves wiggle room. The executed plea agreement unambiguously reserves the right to investigate and pursue charges against other individuals—i.e. Cohen. Id. at 7. So perhaps I spoke too soon, perhaps the question still remains: Will Bharara ever have enough fuel to fire the indictment of Cohen?

Bharara’s Infernal Region Expanded By One: Martoma Convicted

For those of us following the prosecutions of SAC Capital Advisors LP, today marked another milestone in U.S. Attorney Preet Bharara’s quest against insider-trading.  Mathew Martoma, ex-SAC fund manager and pharmaceutical-industry analyst, was found guilty this afternoon of one count of conspiracy and two counts of securities fraud.  He became the seventy-ninth consecutive individual to have pled guilty or to have been convicted by the U.S. Attorney’s Office in the federal government’s recent crackdown on insider-trading.

After deliberating for two days, federal jurors concluded that Martoma received insider information regarding Alzheimer’s disease drug trials and manipulated the information to trade large blocks of Elan Corp. and Wyeth shares.  Ultimately, Martoma made profits for SAC amounting to $276 million.

And yet, despite seven consecutive convictions of SAC fund managers, the million dollar question remains: will Martoma’s conviction add enough fuel to Bharara’s fire to motivate the U.S. Attorney’s Office to pursue a prosecution against SAC kingpin Steven Cohen?

Bharara’s Insider Trading Inferno Engulfs Its Next Victim: Former SAC Portfolio Manager Steinberg Convicted

Yesterday – seemingly before the ink even dried on SAC Capital Advisor’s unprecedented billion dollar plea agreement – U.S. Attorney Preet Bharara’s office secured the conviction of former SAC portfolio manager Michael Steinberg.

As recently reported by White Collar Alert editor Carrie Sarhangi, Steinberg was indicted for insider trading in March, and the government contended that he traded on financial figures he obtained from professionals with ties to computer mogul Dell and technology company Nvidia. “He allegedly made about $1.4 million in trades [executed] ahead of some of the companies’ quarterly earnings reports in 2008 and 2009.”  Richard Vanderford, SAC’s Steinberg Guilty of Insider Trading, Law360 (Dec. 18, 2013).

During the month-long trial, which began on November 18th, prosecutors did not present the incontrovertible evidence that we have become accustomed to seeing in insider trading cases brought by Bharara’s office.  As noted this morning by The New York Times, “Prosecutors lacked the incriminating wiretaps …. The emails pointed to no smoking gun.  And the government’s star witness, a felon who testified to avoid prison time, fumbled his way through five days of cross-examination.”  Ben Protess, Matthew Goldstein and Alexandra Stevenson, Former SAC Trader Is Convicted of Insider Trading, The New York Time’s DealB%k (Dec. 18, 2013).  Indeed, the government had previously conceded “that the case was not a slam dunk,” as Steinberg “was at the end of a five-person chain of information that started with an insider … and wound its way to … [him].”  Id.

Yet, after two days of deliberations, the federal jury completed its “fact-finding,” id., and delivered the guilty verdict.  In a press release issued yesterday, Bharara stated:

The jury has found what the Government contended from the outset; in search of an edge, Michael Steinberg crossed the line into criminal insider trading.  Like many other traders before him who, blinded by profits, lost their sense of right and wrong, Steinberg now stands convicted of federal crimes and faces the prospect of losing his liberty.

Statement of Manhattan U.S. Attorney Preet Bharara On The Conviction of Michael Steinberg (Dec. 18, 2013).  Indeed, while Steinberg is free on bail until his April 25th sentencing, he faces up to 85 years in prison.

The conviction of Mr. Steinberg is just the latest victory by the United States Attorney’s Office in Manhattan in its campaign to root out illegal conduct on Wall Street.  Over the past four years, more than 80 individuals and entities have been charged with insider trading in the Southern District of New York.  The office has secured 76 convictions without losing a single trial.  And just last week, Richard Zabel, Bharara’s Deputy U.S. Attorney, noted at a conference that insider trading remains one his office’s focuses.

According to one recent survey, financial services professionals feel that there may be plenty of Wall Streeters for Bharara’s office to target.  This survey, entitled “Wall Street in Crisis:  A Perfect Storm Looming,” revealed the following:

  • 52% of financial services professionals felt it was likely that their competitors have engaged in unethical or illegal activity to engage in the market;
  • 24% felt employees at their own company have likely engaged in misconduct to get ahead;
  • 23% of respondents indicated that they have observed or had firsthand knowledge of wrongdoing;
  • 24% of financial service professionals likely would engaged in insider trading to make $10 million if they could get away with it; and
  • 29% of those surveyed believed that the rules may have to be broken in order to be successful.

Yet the question still remains whether SAC’s founder, Steven A. Cohen, falls into one of these categories of professionals prone to illegal activity, and/or whether he will be the next victim of Bharara insider trading inferno.

Bharara’s Insider Trading Inferno – SAC Pleads Guilty and Agrees to Pay Unprecedented $1.8 Billion Penalty. Will Cohen Also Go Down in Flames?

Billionaire Steven A. Cohen’s SAC Capital Advisors, L.P., a hedge fund accused of engaging in rampant insider trading, has agreed to plead guilty and pay an unparalleled $1.8 billion in penalties.  In response to the indictment issued by Manhattan U.S. Attorney Preet Bharara on July 25th of this year, SAC will plead guilty to all five counts alleged– four counts of securities fraud (one for each of the four SAC units that were charged) and one count of wire fraud.  The indictment, which primarily targeted SAC for creating a corporate culture that encouraged employees to obtain proprietary information and make investments on the basis of it, also alluded to Cohen’s criminal conduct, specifically identifying his failure to question employees about suspicious information and outlining his questionable recruiting practices of individuals alleged to have access to inside information.  Indictment at 17-19 can be found here.

Because SAC’s own employees were pleading guilty to the very conduct SAC was accused of, SAC had “no defense,” opined Richard Scheff, Montgomery McCracken chairman on The Wall Street Journal’s MarketWatch blog. Thus, the government was able to exert massive control over the future of SAC in its proposed plea agreement, forcing the wind down of the company’s investment advisory business and requiring it to retain a compliance consultant to keep a watchful eye on Cohen’s remaining business ventures.

Described by Bharara as a “fair but steep” resolution, SAC has agreed to pay $900 million in criminal fines and $900 million in civil fines, amounting to a total penalty of $1.8 billion, a penalty unmatched by other federal insider trading prosecutions.  Should the pact be approved, SAC shall receive a $616 million credit for civil settlements it previously reached with the Securities and Exchange Commission in March involving alleged insider trading at two SAC affiliates, thus resulting in an outstanding $1.184 billion dollar penalty.  In his Monday press conference, Bharara was explicit in mandating that the financial burden is to be paid by those conspirators participating in the scheme and not to fall upon third party investors.  A representative of SAC will plead guilty on its behalf in Manhattan federal court on November 8.

While Bharara may describe the punishment as appropriate, defense attorneys forewarn that this case exhibits just how unforgiving the government can be when it comes to insider trading.  “No matter how you slice it, it’s awful [for SAC],” said Scheff, and “it certainly demonstrates that that government is watching… it’s [insider trading is] a focus of the government and it will continue to be a focus.”  Occurring on the heels of the prosecutions of Galleon Group hedge-fund founder and billionaire Raj Rajaratnam, who is now incarcerated, and his friend Rajat K. Gupta, a former Goldman Sachs board member who was found guilty of divulging boardroom secrets to Rajaratnam, this prosecution marks the climax of the Bharara administration’s efforts to target Wall Street insider trading.

The question remains, is SAC’s pact with the government going to satisfy prosecutors’ hunger for Wall Street’s insider trading moguls?  The proposed plea agreement unambiguously reserves the right to investigate and pursue charges against other individuals – i.e. Cohen.  And in a related SEC investigation, Cohen remains a target of potential charges for failing to supervise Michael Steinberg and Mathew Martoma, two ex-SAC employees who are slated to go to trial in November and January respectively on charges of insider trading.  Only time will tell if SAC’s plea negotiation quells the insider trading prosecutorial fire or if it is simply a catalyst for the inferno to come.