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.

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.

The “Effects” of Fraud that “Affect” a Financial Institution

The Department of Justice has recently dusted off the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) – enacted following the savings and loan crisis of the 1980s to protect financial institutions from fraud – as an offensive weapon against financial institutions themselves.

Much has been made of a trio of recent cases from the Southern District of New York in which the courts have interpreted FIRREA to expand civil liability of financial institutions where they are the alleged malfeasants, not the victims, of the alleged fraudulent conduct.  See United States v. Wells Fargo Bank, N.A., No. 12 Civ. 7527 (JMF), 2013 WL 5312564 (S.D.N.Y. Sept. 24, 2013); United States v. Countrywide Financial Corporation, No. 12 Civ. 1422 (JSR), 2013 WL 4437232 (S.D.N.Y. Aug. 16, 2013); United States v. Bank of New York Mellon, No. 11 Civ. 6969 (LAK), 2013 WL 1748418 (S.D.N.Y. Apr. 24, 2013).  Indeed, on October 23, 2013, a jury returned a verdict in Countrywide holding Bank of America liable for mortgage fraud under this theory.

Lest one think that this Alex P. Keaton-era legislation is limited to civil litigation brought by the DOJ, a pair of recent decisions filed just a day apart show the government’s use of the FIRREA amendments in criminal prosecutions.  These FIRREA provisions increase maximum penalties from 20 to 30 years for mail and wire fraud and also extend the statute of limitations from five to ten years for fraudulent conduct that “affects a financial institution.”  See 18 U.S.C. §§ 1341, 1343 (increasing maximum penalties to 30 years for mail and wire fraud); 18 U.S.C. § 3293 (increasing statute of limitations for certain financial offenses).

On October 17, 2013, the Ninth Circuit issued its opinion in United States v. Stargell, No. 11-50392, 2013 WL 5645171 (9th Cir. Oct. 17, 2013), which affirmed the conviction of a defendant who prepared fraudulent tax returns to obtain refund anticipation loans.  Although only one of the four charged fraudulent returns resulted in a loan default and a corresponding actual loss to a financial institution, the court held that the other false returns resulted in an “increase risk of loss” for the banks that issued the loans.

Just one day earlier, in United States v. Murphy, No. 12-CR-235, 2013 WL 5636710 (W.D.N.C. Oct. 16, 2013), the district court for the Western District of North Carolina similarly addressed the type of conduct that “affects a financial institution” for purposes of extending the statute of limitations from five to ten years.  The defendant in Murphy is a former employee of Bank of America, a co-conspirator, who is alleged to have participated in a municipal bond bid-rigging scheme.  The court held that the defendant’s conduct (from 1998 to 2002) caused Bank of America to be “susceptible to substantial risk of loss” and, in fact, ultimately resulted in the bank paying restitution to federal and state authorities.  The court rejected the defendant’s arguments that Bank of America must have been a “victim” of the fraud.

Ultimately, the DOJ can’t tack on five more years to prosecute an individual or corporation under heightened penalties because a financial institution happens to play some extraneous role in the alleged fraudulent conduct.  At some point, the relationship “becomes so attenuated, so remote, so indirect that it cannot trigger the ten-year period.”  United States v. Mullins, 613 F.3d 1273, 1278 (10th Cir. 2010).  For example, alleged fraudulent conduct does not “affect a financial institution” if the scheme involves the “mere utilization of the financial institution in the transfer of funds.” United States v. Ubakanma, 215 F.3d 421, 426 (4th Cir. 2000).

Nevertheless, those counseling individuals and financial institutions need to keep the eye on “financial institution” ball in any alleged fraudulent scheme.  The effects of conduct that “affects” a financial institution can be significant.