Mickelson Seeks Relief from Insider Trading Hazard

Almost two years ago, the Wall Street Journal and New York Times first reported an insider trading investigation involving sports gambler William “Billy” Walters and pro golfer Phil Mickelson.  At the time, the investigation appeared to focus on trading activity surrounding a potential take-over bid of Clorox.  We didn’t think much of potential claims against Mickelson arising out of the Clorox investigation.  Yet, buried in both articles was a reference to a second investigation involving trading in Dean Foods.  Today, the Dean Foods investigation shot up the leaderboard with the announcement of criminal insider trading charges against Walters and former Dean Foods Chairman Thomas Davis.  The SEC also brought civil charges against the pair and has named Mickelson as a “relief defendant,” asserting that Mickelson profited from trading in Dean Foods stock based upon non-public information received from Walters.

As a relief defendant, Mickelson is not accused of any wrongdoing. Rather, a relief defendant may be ordered to repay funds when that person has received ill-gotten gains and does not have a legitimate claim to those funds.  SEC v. Cavanagh, 155 F.3d 129, 136 (2d Cir. 1988).  In this case, the SEC alleges that Walters gave Mickelson, who at the time owed Walters for a gambling debt, inside information regarding Dean Foods (which Walters had received from Davis).  Mickelson then used that information to earn a $931,000 profit in just over a week from his $2.4 million position in the company.  That sure beats the $500 he made off of Mike Weir for betting that Jim Furyk would sink a bunker shot, a bet that put him in hot water for violating PGA Tour policy that provides that “player shall not have any financial interest, either direct or indirect, in the performance or the winnings of another player.”  In any event, the “ill-gotten” nature of Mickelson’s Dean Foods’ profit was not alleged to be the result of Mickelson’s conduct, but rather, Walters’.

It is not uncommon for the SEC to pursue disgorgement from individuals who are downstream tippees – traders who are a step or two distant from the insider who breached his or her fiduciary duty in disclosing material, non-public information.  See, e.g., SEC v. McGee, 895 F.Supp.2d 669, 686-689 (E.D. Pa. 2012).  By naming Mickelson as a relief defendant, not charging him civilly or criminally, the government need not prove that Mickelson knew that the insider – here, Davis – received a benefit from the immediate tippee – Walters – in exchange for the inside information. As tipees get further down the chain from the insider, the government faces an increasingly difficult task in proving the requisite knowledge of this benefit, particularly in light of the Second Circuit’s decision clarifying this requirement in United States v. Newman.  See our discussion of Newman here, here, and here.

As for Walters, he is a gambling man, and he’s now facing the gamble of his life.  He faces a federal indictment that alleges gains (and avoided losses) of more than $40 million.  Further, the government has announced that the corporate insider, Davis, has already pleaded guilty to conspiracy, securities fraud, wire fraud, obstruction of justice, and perjury, and is cooperating with the government.

For Mickelson, as the SEC announced today, he has agreed to repay the full disgorgement of his trading profits of $931,738.12 plus interest of $105,291.69.  He has neither admitted nor denied the allegations.  In a statement, Mickelson noted the return of the funds and said that he had “no desire to benefit from any transaction that the SEC sees as questionable.”  Mickelson appears to be identified in Walters’ indictment as “Individual-2” and may well play an ongoing role as a witness in any civil or criminal trial arising out of the SEC’s complaint or the criminal case against Walters.

Second Circuit Accepts Rajat Gupta’s Insider Trading Appeal

This week I spoke with Fox Business reporter Serena Elavia about the Second Circuit’s decision to grant a certificate of appealability in the Rajat Gupta insider trading prosecution.  Gupta is the high-profile former McKinsey & Co. Managing Director and Goldman Sachs board member who was prosecuted and convicted for providing insider information to former Galleon Group hedge fund manager Raj Rajaratnam.

Gupta, who was first convicted in 2012 and whose direct appeal was denied in 2014, received another bite at the apple earlier this month.  He now has an opportunity for the Second Circuit to determine whether his conviction should be vacated because the jury was erroneously instructed and whether any procedural default may be excused for cause and prejudice or actual innocence.  This opportunity flows directly from the Second Circuit’s United States v. Newman decision, which altered the proof needed for the “personal benefit” to the insider that is required under Dirks v. S.E.C., 463 U.S. 646 (1983).

Newman held that merely “maintaining a good relationship” is not enough to prove the required “personal benefit.”  Instead, the insider must be the beneficiary of “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”  Yet, at the time that Gupta was convicted, the district court instructed the jury that the benefit received did “not need to be financial or to be tangible in nature.  It could include, for example, maintaining a good relationship with a frequent business partner, or obtaining future financial benefits.”  Gupta did not object at the time to the instruction (Newman had not been decided).  Gupta and others, including Bassam Salman, whose petition for certiorari the Supreme Court just granted, have argued that Newman did, in fact, change the personal benefit test and thus their convictions under the less stringent “relationship” test should be vacated.

For Gupta personally, the Second Circuit’s order agreeing to hear the appeal is a significant step, although, procedurally, the Second Circuit may have accepted the appeal to put it in a holding pattern.  The Supreme Court will have the final say on this issue as it addresses Salman’s petition on the question of whether the personal benefit:

requires proof of “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature,” as the Second Circuit held in United States v. Newman, or whether it is enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case.

Salman’s Supreme Court brief is due in May.

 

 

Supreme Court Takes on Insider Trading “Personal Benefit” After All

Just when the Supreme Court appeared to be turning its collective attention away from the standard for insider trading convictions by denying the writ for certiorari in United States v. Newman, the Court today granted cert. in Salman v. United States, which addresses the “personal benefit” that a tipper must receive in an insider trading case.  (And speaking of recent cert. grants:  kudos to my colleague, Charles Casper, who, along with others, obtained a grant of certiorari in Microsoft Corporation v. Baker, No. 15-457, on behalf of Microsoft, in a case raising a class action jurisdictional challenge).

Back to insider trading.  The Court will now take up the following question, as posed by the petitioner in Salman:

Does the personal benefit to the insider that is necessary to establish insider trading under Dirks v. SEC, 463 U.S. 636 (1983), require proof of an “exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature,” as the Second Circuit held in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), cert. denied, No. 15-137 (U.S. Oct. 5, 2015), or is it enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case?

In Salman, the remote-tippee defendant (Salman) received and traded on information received from the brother (Michael) of a Citigroup investment banker-insider (Maher).  Maher testified that he provided the information to his brother Michael to “get him off his back.”  Michael then provided the information to Salman.  The petitioner argued that, under the standard set by Newman, Maher, the insider, gained “nothing” – or at the very least nothing that was “objective” or “consequential” or that represented “a potential gain of a pecuniary or similarly valuable nature.”  Maher, it seems, was – like Spaulding Smails in Caddyshack – that family member whose relative was content to declare:  “you’ll get nothing and like it!”

The Ninth Circuit, however, explicitly rejected the approach in Newman and determined that it was sufficient that the government proved that the insider “made a gift of confidential information to a trading relative or friend.”  Because the government had established that link, the Ninth Circuit (Southern District of New York Judge Jed Rakoff, sitting by designation) concluded that the government satisfied its “personal benefit” burden.

But why did the Supreme Court pick Salman rather than weigh in on Newman?  While it is, of course, reading tea leaves, it nonetheless appears that the Court was persuaded by the petitioners’ argument (adopting the Justice Department’s arguments from the Newman petition) that the conflict generated by Newman and widened by Salman creates “uneven enforcement” of the securities laws and that Supreme Court review is necessary to “restore certainty and order” to the law of insider trading.

Moreover, petitioner argued that, unlike in Newman, where the Second Circuit based its decision on a second ground (the defendant’s lack of knowledge of any personal benefit), the “personal benefit” test here was outcome-determinative:  apply Newman, judgment reversed; require merely a gift to a family member, judgment affirmed.

As we argued previously in the context of Newman, we think that Newman got it right (or, at least, put us on the right path) by providing clarity as to the level of personal benefit required of a tipper in an insider trading prosecution.  What the Court does with Newman and Salman will surely be debated going forward, but in the meantime, there appears to be at least a final word on the subject coming shortly from One First Street.

Supreme Court Denies Review of Second Circuit’s Newman Insider Trading Decision

We’ve taken a summer (early fall?) recess here at White Collar Alert but have been jolted back into the blogosphere with the news of the Supreme Court’s denial of certiorari in United States v. Newman. We’ve written and blogged repeatedly (and here, too) about the Second Circuit’s decision in Newman, including the Government’s petition for a writ of certiorari to the Supreme Court. Yesterday, the Court denied the government’s petition, meaning the Second Circuit’s opinion remains binding precedent in the Second Circuit.

What exactly does this mean? For starters, the Second Circuit’s holding stands: the government must prove that an insider disclosed confidential, non-public information for a personal benefit, which must be “of some consequence” resembling “a relationship between the insider and the recipient that suggests a quid pro quo” or an intention to confer a future benefit. Further, the Second Circuit’s other holding in Newman – that a downstream tippee must know that the corporate insider-tipper received a personal benefit from the tip – was not subject to the petition for writ of certiorari and further remains binding in the Second Circuit.

What is left is to determine what the implications are for existing and future insider trading prosecutions. Already, U.S. Attorney for the Southern District of New York Preet Bharara forecasted in a press conference following the high court’s denial that executives and traders will have a “bonanza for friends and family of rich people who have access to material nonpublic information.” Bharara’s “bonanza” rhetoric appears, to put it mildly, over the top, as he acknowledged that 90% of the cases he’s brought are not implicated by the Circuit’s decision.

As for the other 10%? We at White Collar Alert will continue to stand by to monitor how the courts – and the nation’s prosecutors – approach insider trading cases in light of the Second Circuit’s now final decision. From our perspective, however, having more clearly defined standards for what is a “personal benefit” and what the government is required to prove a defendant knew before trading in a security promotes a more fair and just application of the securities laws, which are designed to protect against breaches of fiduciary duties by insiders. For now, at least, the precedential value of the Second Circuit’s decision is secure.

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.

Former Oriole Swinging for the Fences in Insider Trading Prosecution

The fallout from the Second Circuit’s decision in United States v. Newman continues and threatens to affect not just future enforcement actions, but pending prosecutions. As we have noted before, the Second Circuit in Newman required that a trader / tippee know that an insider disclosed confidential, non-public information and that the insider did so in exchange for a personal benefit. The benefit must be “of some consequence” and more than mere friendship.doug_decinces_autograph

Just a week after the Second Circuit’s ruling, in an insider trading prosecution involving tips relating to a 2009 acquisition by IBM, a court questioned whether there was a sufficient factual basis for guilty pleas that were entered prior to the Second Circuit’s ruling. Others, including Michael Steinberg of SAC Capital Advisors, who was sentenced to three and half years for insider trading (see our coverage here and here) and who received the same flawed jury instruction that the Second Circuit criticized in Newman, may also benefit from the Second Circuit’s decision.

And that’s not all. The decision may touch upon one of the most high-profile insider trading investigations to reach Major League Baseball, the prosecution of former Oriole All-Star third baseman Doug DeCinces and several others. You may recall DeCinces from his two-out, ninth inning walk-off home run from the 1979 season that gave rise to “Orioles Magic.” Or maybe you recall his 1975 Topps rookie baseball card in which he shared real estate with the great Manny Trillo, the second baseman for the 1980 World Champion Phillies.

In any event, the government has alleged that DeCinces received material, non-public information from James Mazzo, the former CEO of Advanced Medical Optics, regarding that company’s pending acquisition by Abbott Laboratories. Although DeCinces is the only MLB player that has been prosecuted from this scheme, the investigation reached the Pantheon of baseball immortality, ensnaring fellow Oriole and Hall of Famer Eddie Murray, who allegedly traded on a tip from DeCinces and ultimately settled with the SEC for over $350,000 (without admitting or denying the allegations). DeCinces similarly settled with the SEC – for $2.5 million – but that didn’t stop federal prosecutors for charging him criminally with insider trading. Continue reading

Government Swimming Upstream at Second Circuit Oral Argument on Downstream Insider Trading Liability

The Justice Department has been bullish over its rigorous enforcement of insider training over the past year, but on Tuesday a Second Circuit panel raised questions regarding the government’s theory of liability that led to the conviction of two “downstream” traders. Before the court was the issue of whether tippees – recipients of inside information – can be convicted if they did not know that the tipper received any personal benefit for disclosure of inside information. The case may implicate how far downstream from the insider prosecutors can go in prosecuting “remote tippees” for insider trading.

In United States v. Newman, two hedge fund managers were convicted for participating in an insider trading scheme. The fund managers received detailed inside information from a source, but did not know the identity of the original insider. Though not quite the level of six degrees of Kevin Bacon, the defendants contended that they were four degrees away from the original tipper and had no information regarding whether the tipper received any personal benefit. At trial, the judge instructed the jury that the defendants must have known that the material, nonpublic information upon which the defendants traded was disclosed by the insider in violation of a duty of confidentiality. The jury convicted both defendants under that standard.

At oral argument before the Second Circuit, both the defendants and the government sparred over the application of the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1993), to downstream tippee liability. In Dirks, the Court held that an insider tipper does not violate the securities laws unless he has disclosed information in breach of a duty, which the Court defined as whether “the insider personally will benefit directly or indirectly from his disclosure.” Id. at 662. The Court also addressed tippee liability, holding that the tippee cannot be liable unless he “knowingly participates with the fiduciary in such a breach.” Id. at 659. In Newman, the defense asserted that Dirks thus requires that the tippee know that the tipper provided inside information for a personal benefit. The prosecution argued that it needed to prove only that the information was provided in violation of a duty of confidentiality.

According to reports, the Second Circuit panel pushed back at oral argument against the government’s theory of liability. Judge Barrington Parker observed:

We sit in the financial capital of the world and the amorphous theory you have gives precious little guidance to all these financial institutions and all these hedge funds out there about a bright-line theory as to what they can and cannot do.

Of course, attempting to determine how a court will rule based upon comments or questioning at oral argument (or better yet, based on “downstream” information from media reports) can be a fool’s errand (just as downstream inside information about a hot stock tip can be both factually wrong and legally perilous). But reports of the argument suggest a healthy skepticism of the government’s theory of liability. Ultimately, we must wait for the Second Circuit’s decision for guidance on what knowledge is necessary for a remote tippee’s liability and how the Second Circuit’s decision – assuming it provides clarity – affects the Department of Justice’s active insider trading prosecutions. Stay tuned to White Collar Alert for the latest.