2nd Circuit, Insider Trading, S.D.N.Y., Securities and Exchange Commission, U.S. Attorneys Offices, Wall Street, White-Collar Crime

The Trouble With Insider Trading Prosecutions

Time Magazine cover boy Preet Bharara

In the federal criminal world, there are certain cases where the government almost always wins.

Illegal reentry for a previously deported person, for example, is pretty close to a lock for a government win — all the government has to show is that the person isn’t a citizen, was previously deported, and is in the United States again. If the dude’s in the courtroom, the government is a third of the way there. For example, in the last fiscal year, there were 20,840 folks charged with illegal reentry.  Four of them were acquitted at trial.

Similarly, bank robbery is a high-percentage game for the government. These days, most banks have amazing technology that lets them record pretty much everyone inside. Last fiscal year, 896 people were charged with bank robbery. One lucky guy was acquitted.

These days, federal law enforcement is using wiretaps and, according to the Wall Street Journal, old-school sting operations, to go build white-collar cases (it’s a pretty cool article — very cloak and dagger). The strategies that got the federal government the conviction rate it has in drug and gun cases are being applied to investment fraud and insider trading cases.

This is one reason that insider trading cases have looked like as much of a layup as a bank robbery case. The U.S. Attorney’s Office in the Southern District of New York has secured a record of 85 convictions in either guilty pleas or trials without a single loss.

Until this week….

Raj Rajaratnam was the poster child for an insider trading conviction. The founder of Galleon Group was sentenced to 11 years in prison for insider trading.

His brother Rengan was tried for insider trading based on information he got from Raj and, on Tuesday, Rengan was acquitted.

The case is a fascinating study in what’s going on in this area of the law, and there’s a lot going on there. Just about everyone and their mother is writing about it (e.g., here and here (collecting links)).

Here’s the part I find most interesting — the law in this area is a little bit of a mess.

By way of illustration, it looks like the pending Second Circuit case in United States v. Newman — and the widespread reports of how the oral argument in that case didn’t go very well for the government — affected Rajaratnam’s case at trial and how the trial judge perceived the issues in the case.

Newman is an appeal from a criminal insider trading conviction (here’s a decent, though clunky, rundown of the issues in the case). Generally, in a classic case of insider trading, it’s not ok for a person who has confidential information to give it to someone he isn’t supposed to give it to (who then trades on it), and get something of benefit in return for the information. That’s a breach of the tipper’s fiduciary duties.

The question in Newman is whether the person who receives the information has to know that the person who gave up the information got something of value.

The second question of what counts as “something of value” is also not super clear — in Newman, the question is whether career advice is a thing of value. In my experience, career advice is most often worthless (e.g., “I want to say one word to you. Just one word…. ‘Plastics'”) and, in some cases, actually career detrimental (“Can’t decide what to do? Go to law school!”). But, really, whether career advice is actually good advice is a jury question? Seriously?

Here’s the awesome part — the issues in Newman aren’t settled questions of law by a country mile. As the awesome Judge Rakoff put it — on whether there has to be knowledge by a tippee that the tipper got something of value in exchange for information — the Second Circuit is “somewhat Delphic on this score.”

If that’s right — that exactly what has to be proven in order to prove insider trading in a case like this is unsettled law — then why is a case that presents this issue being brought as a criminal case?

I can see why the government may need to bring a prosecution in an unsettled area of law in some cases, perhaps, where there’s only criminal jurisdiction.

But where there’s a civil vehicle to clarify the law, and where it’s basically the same legal issues at play, why not let the SEC plow the field first, clarify the law when it’s a civil case, then, once the basic ground rules are clear, the government can bring cases based on a solid foundation of clearly articulated law.

In a civil case, as we all know from civil procedure, pure legal issues can be set up well in advance. Judges will hear motions to dismiss and motions for summary judgment. Pure legal questions can actually get decided without being encumbered by messy facts.

In a criminal case, by contrast, pure legal questions get pulled down into the muck of the facts of the trial.

Very few criminal cases are dismissed in motions, especially motions on pure questions of law. The pleading standards are just lower in criminal cases, and there’s a bias in criminal cases against resolving legal questions until after the government has put on its case at trial. And the standard for resolving those motions is incredibly low.

The result is that if the law is unclear, but the person who is on trial looks shady or unpopular, there’s a great incentive to convict, almost regardless of the law. And that’s especially true where the law is complex or hard for the lay person to understand.

At bottom, if you’re the government, and you’d like to have clear laws, you should opt for civil litigation — it presents options for pure legal argument and clear rulings.

On the other hand, if you’d prefer to put people who look like they may have done something wrong (regardless of whether they’ve actually violated the law as it should be properly construed) and you’re less interested in a clean resolution of the law, you should bring criminal cases.

One advantage of bringing these criminally is that there is a perception that the S.D.N.Y. U.S. Attorney’s office has more institutional competence than the SEC. See, e.g., this (another week, another trial loss for the SEC) and this (and many more, but, really, Google for yourself).

If only the SEC were more like the SEC.

Also, bringing these cases criminally scares a lot of people in an industry that may not be popular.

If you’d like to change the behavior of people without going through the trouble of changing — or clarifying — the law, prosecuting folks when the law is unclear is a pretty good way to do it, whether or not you should.

Plus you might get your picture on the cover of Time magazine.

U.S. District Courts—Criminal Defendants Disposed of, by Type of Disposition and Offense, During the 12-Month Period Ending September 30, 2013 [U.S. Courts]
Inside One of the U.S.’s Biggest-Ever Investment-Fraud Stings [Wall Street Journal]
Prosecutors’ Winning Streak on Insider Trading Cases Ends [Dealbook / New York Times]
‘Newman’ Addresses Divisive Insider Trading Question [New York Law Journal]

Earlier: Attempted Cannibalism and Furthering Jihad: Two Views of Intent in a Criminal Conspiracy
Law School Is Not A Stock: It’s A Very Expensive Lotto Ticket


Matt Kaiser is a partner at The Kaiser Law Firm PLLC, a boutique litigation firm in Washington DC, which handles government investigations, white-collar criminal cases, federal criminal appeals, and complex civil litigation. You can reach him by email at mattkaiser@thekaiserlawfirm, and you can follow him on Twitter: @mattkaiser.

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