by Walt Pavlo
Since Congress has not specifically defined insider trading, courts have interpreted the Securities Exchange Act’s prohibition against manipulative or deceptive means to determine whether a violation has occurred. The imprecision of securities law has led many people to weigh in on what constitutes a criminal act. Recently, Antonia Apps wrote over 2,000 words on the Second Circuit’s recent insider trading decision, United States v. Martoma, 869 F.3d 58 (2d Cir. 2017), and Greg Morvillo wrote two posts to clarify his thoughts on that case. Can you imagine a crime that is so difficult to define that it continues to spark debate with each new decision from a court?
Prosecutors use these vagaries to get convictions in cases that should have never been pursued in the first place. For example, in 2013, U.S. District Judge Richard Sullivan was so certain that Anthony Chiasson and Todd Newman were guilty of insider trading that he denied their bail request pending appeal and ordered them to surrender to prison for 78 months and 54 months, respectively. Indeed, the case involved a typical story that the jury could comprehend: a pair of greedy Wall Street hedge fund managers trafficking in insider information. However, the Second Circuit overturned Chiasson and Newman’s convictions because the evidence used to convict was “nonexistent or so meager” that it gave “equal or nearly equal circumstantial support to a theory of guilt and a theory of innocence . . . .” United States v. Newman, 773 F.3d 438, 451 (2d Cir. 2014) (citations omitted). There was plenty more to question in the case than what “benefit” means in relationship between the tipper and tippee.
I looked back at a picture of Preet Bharara, then the U.S. Attorney for the Southern District of New York, announcing the arrests of Chiasson and Newman in January 2012. He was gesturing to a poster board showing a flow of information from Dell Computer, then a publicly traded company, through various analysts to Chiasson and Newman. Each box on the chart contained the name of an individual and the company where that person worked, except for the top box. That box contained “Dell Insider,” some unknown Dell employee who tipped off the chain of events that led to profitable trades.
Though they tried, the Assistant U.S. Attorneys from the Southern District of New York never prosecuted “Dell Insider,” and the Securities and Exchange Commission never filed a lawsuit against him (many know his name but let’s allow him to move on with life). In fact, the tipper in the case was never even called to testify at the trial of Newman and Chiasson. Yet, even without the person who started this chain of events, prosecutors were able to convince a jury that criminal insider trading violations had occurred. How can the U.S. Attorney’s Office charge those who eventually (allegedly) profited from inside information without charging the person who released the information in the first place? This case demonstrates not only how vague the law is but also how arbitrarily it is applied.
Insider trading cases are so difficult that it takes insights from legal scholars to figure out whether or not a crime has even occurred. Given this complexity, imagine what it must be like to be a defendant in one of these cases.
In United States v. Megalli, No. 13–cr–0442–RWS (N.D. Ga. Nov. 25, 2013), Mark Megalli pleaded guilty to insider trading charges related to information he received as a portfolio manager at Level Global (a hedge fund) on trades he made in children’s clothing manufacturer Carter’s Inc. Megalli was sentenced to prison for one year and a day, not a terribly long term compared to those who take similar cases to trial. Now, years after he was released from prison, he is asking the Northern District of Georgia to overturn his case based on judicial decisions made since his plea. Could it have been that the pre-Newman state of the law at the time, the potential for millions of dollars in legal expenses, and the prospect of a long prison term led Megalli to take a plea deal even though he never believed he was guilty? Consider that, post-Newman, another hedge fund manager who stood trial for similar charges in a related case was found not guilty.
Even after defendants are found guilty of insider trading, they remain steadfast that they did nothing wrong.
James Fleishman was a a salesman at a firm called Primary Global Research, where he paired industry experts with hedge fund analysts. The firm paid him a salary for his work, but he never personally traded in stocks and never received insider information. The firm eventually failed and its founders were never prosecuted. Fleishman took his case to trial in the Southern District of New York. In United States v. Fleishman, No. 11 CR. 32 JSR, 2011 WL 4000987 (S.D.N.Y. Aug. 31, 2011), he was found to have been a conduit of inside information and was subsequently sentenced to 30 months in prison. Having spoke to Fleishman a number of times, he still maintains his innocence.
Eric McPhail was a top amateur golfer when he received inside information from a golfing buddy about a publicly traded stock. He passed the information along to fellow country club members who made profitable trades. In a recent interview I conducted with McPhail, he claimed that he never traded in the stock nor did he receive any payment for passing along information about the company. He was indicted and found guilty after trial in the District of Massachusetts in United States v. McPhail, No. CRIM.A. 14-10201-DJC, 2015 WL 2226249 (D. Mass. May 12, 2015). He was sentenced to 18 months in prison. After he finished his sentence, he stated in an interview with me that he “never knowingly violated any security law.”
Sean Stewart, a former investment banker at JPMorgan Chase, is currently serving a three-year sentence and awaiting the appeal of his insider trading conviction in the Southern District of New York. At his sentencing, Stewart said, “In my heart and mind . . . I know I did not commit a crime.”
Then there is Martoma. Mathew Martoma, a former SAC Capital portfolio manager, recently lost his appeal on an insider trading conviction in the Southern District of New York that landed him in prison for nine years. He made profitable trades in shares of pharmaceutical companies based on scientific information he received from a University of Michigan doctor who was working on the clinical trials. In her dissent, U.S. Circuit Judge Rosemary S. Pooler wrote, “there is great wisdom in the Supreme Court’s limitations on broad rules, particularly when those rules might otherwise allow punishment of the absentminded in addition to persons with corrupt intentions.” Martoma, 869 F.3d at 91-92. One could substitute “absentminded” with “innocent.”
It is alarming that we are sending people to prison who are so confused about what, if anything, they have done wrong. As lawyers and courts debate what is insider trading and what is just good research, people are serving Draconian prison sentences. Moreover, these sentences are influenced by trade profits which did not accrue to the accused parties. If you are going to do the time, you should have at least profited from the crime!
Had they gone to prison, Todd Newman would have been nearing the end of his 54-month prison sentence and Anthony Chiasson would have about two years to go on his 78-month term. I, like many others, believe that the Second Circuit made the right decision in Newman and helped protect many hardworking people in the financial sector. While U.S. Attorneys may be applauding Martoma, those in the financial sector are just as uncertain as they were prior to Newman.
Walt Pavlo is President of Prisonology and co-author of “Stolen Without A Gun,” which he co-wrote with Neil Weinberg (Bloomberg).
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