Since Preet Bharara took over as U.S. Attorney for the Southern District of New York in 2009, that office has been almost completely consumed by the jihad against what they falsely call "insider trading." The label is false because the large majority of the defendants have not been insiders of the companies in question, but rather have been investment professionals of various sorts. As of about a week ago the SDNY prosecutors claimed a record of 85 straight convictions without a single loss. Last week they lost their first case, the prosecution of a guy named Rengan Rajaratnam. That may seem like a small thing -- now it's 85 - 1. But actually, the latest one is signaling that a good half of the prior 85 were baseless. The whole jihad could be about to unravel.
Lots of people try to make money in the stock market by coming up with a few tidbits of information about a company before others do, and then trading on that information. Is that OK? For many, many investment professionals on and off Wall Street, this is their job. People who do this have no sense that they are doing anything wrong. Some (including me) would say that this process is a big part of how the U.S. became a successful country. But our current government regime thinks that the whole enterprise is somehow wrong. Indeed a fair summary of their view is that anyone who makes money trading on advantageous market information, and by doing that makes more money than other people or more than seems "fair," therefore belongs in jail. Certainly this is an accurate statement of the view of the current federal criminal prosecutors, led by the SDNY, and of the SEC.
Is mere trading on advantageous market information, including information that originally came from a company insider, actually illegal? Here is the statute under which the federal criminal prosecutors and SEC go after the non-insiders for this so-called "insider trading." It is Section 10(b) of the Securities Exchange Act of 1934:
It shall be unlawful for any person . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance . . . .
OK, now that you've read that, can you kindly explain to me exactly what you can and can't do in trading on information that you have come upon that may or may not have come in the first instance from a corporate insider at some company? In the view of the feds, if you have any reason to suspect that any information about a company that seems valuable to you came from some source inside the company, then any trading by you in the stock of that company is a criminal act. Can you tease that out of the statute? I can't.
So how do they come to get a record of 85 straight convictions? First, almost all of them are guilty pleas, as opposed to convictions after trial before a jury. I can't find an exact statistic, but my best information is that approximately 6 of the 85 are convictions after a jury trial. This is an area where a minimally competent defense will cost at least $5 million, and some defenses have cost even $20 million or more. The feds have essentially infinite resources to pour into the prosecution. Almost nobody is in a position to defend unless they have an employer to back them, and the prosecutors then put pressure on the employers to pull the plug. And in the rare case where you have the resources to fight, you then also need unbelievable intestinal fortitude. Convictions after trial come with incredibly long prison sentences, often 5 or more years; guilty pleas can entail little or no jail time. While I obviously don't know the facts of every case, I strongly suspect that well over half of the 80 or so guilty pleaders did absolutely nothing wrong. And if your test of criminality moves from "seems wrong to me" to "clearly violates a criminal statute passed by Congress and signed by the President," then the percentage of innocent will move still higher.
The beginning of the end actually came before the recent acquittal of Rengan Rajaratnam, and goes back at least to April, when the Second Circuit heard the argument in the appeal of Messrs. Newman and Chiasson, non-insiders previously convicted of "insider trading" in the stock of Dell. The appeal has not yet been decided. In the Newman/Chiasson case, Dell's designated investor relations spokesperson, Rob Ray, allegedly gave some information he should not have to A, who passed it on to B, who passed it on to C, who passed it on to Newman and Chiasson. The Second Circuit panel expressed skepticism at the hearing as to how Newman and Chiasson had been convicted without a jury instruction requiring as an element of the crime proof that they knew that Ray had been improperly compensated for disclosing the information. (Ray, by the way, was never prosecuted, and currently holds a comparable investor relations position at another large public company. Others in the information chain pleaded guilty.)
In the Rengan Rajaratnam prosecution, the defendant was again a "remote tippee," who allegedly got information about companies passed on by his previously-convicted brother Raj. Judge Buchwald decided that she would require the prosecutors to prove that Rengan knew that the sources of the information had been improperly compensated; and when the prosecutors came up with nothing, she dismissed the two "fraud" counts against Rengan herself before sending one remaining conspiracy count to the jury. The jury took just a few hours to dispose of that one as well.
Assume for the moment that the Second Circuit reverses in Newman/Chiasson, as I believe they will. Another one of the SDNY's handful of trial convictions, Steinberg, also involves the same Dell information chain as Newman and Chiasson (actually Steinberg was yet one more level removed from the source), and Steinberg's trial was before the same judge with the same defective instructions. It's hard to see how Steinberg's conviction could survive the reversal of Newman/Chiasson. And suddenly half of Bharara's convictions after trial have gone up in smoke.
And what about those 80 +/- guilty pleas? According to an analysis by Reuters here, "roughly a third of the insider trader defendants charged by Manhattan U.S. Attorney Preet Bharara since 2009 are alleged so-called 'remote tippees.'" Of course, remote tippees are just one example of non-insider "insider trading" defendants who are unlikely to have been directly involved in any compensation of insiders.
Meanwhile over at the SEC, the civil branch of the non-insider insider trading jihad has been crumbling for months. In a high publicity trial ending in October 2013, Mark Cuban was cleared of alleged insider trading in the stock of Mamma.com. Subsequent SEC losses have gotten much less publicity. In February, there was the exoneration of four members of the Steffes family for alleged insider trading in the stock of Florida East Coast. Nelson Obus was cleared by a jury in May of alleged insider trading in a stock called SunSource after a ten-year battle reported to have cost him $9 million. In June came the exoneration of Manouchehr Moshayedi for alleged insider trading in the stock of STEC Inc.
Having secured his many guilty pleas, Mr. Bharara has no explicit legal obligation to go back to those wrongly coerced into a plea and offer them exoneration. On the other hand, this is a man who thinks that the power of the federal prosecutor extends to criminally convicting people in the absence of a clear federal statute and on the basis that their conduct offends his sense of right and wrong. Is there any chance that he himself will now do the right thing? Don't count on it.