Will There be a New Loophole For Insider Trading?

Insider trading laws may soon undergo changes that will allow creative professionals to avoid liability, even if they are caught.

A three-judge panel of the U.S. Court of Appeals for the Second Circuit recently heard arguments on whether to reverse the convictions of two hedge fund managers.

Todd Newman, a portfolio manager at Diamondback Capital Management, and Anthony Chiasson, a co-founder of Level Global Investors, were convicted of insider trading. The two hedge fund managers made millions of dollars trading on inside information in Dell Computer and Nvidia. They knew that the information came from company employees who breached their obligations to their employers in exchange for “things of value.”

The managers’ attorney described them as “remote tippees,” meaning they did not receive the information from the original sources. However, the evidence showed they wanted assurance that the tips came from insiders in a position to provide reliable information. The tips proved to be worthwhile, as demonstrated by the shares moving when the information became public.

Newman and Chiasson’s appeal was based on the fact that the federal district court judge refused to instruct the jury that they could not be convicted unless they knew the employees leaking the information had received a benefit when they violated their duty to their companies by providing the information.

The appellate panel focused on the Supreme Court holdings that trading on inside information is legal unless it is obtained from an individual who violates a duty to keep it confidential and receives something of value in return for the information.

Judge Barrington D. Parker promoted the need for a “bright line” to enable hedge fund managers to know whether they were violating the law when they traded on inside information. In other words, proving the information came from an insider and the trader was aware of the source will be irrelevant if the trader did not know about the payoff.

This leads to the question of why a hedge fund manager would ever want to know about the payoff? As long as the tip is reliable, the rest doesn’t matter to him/her. Additionally, the standard for meeting the “something of value” requirement is extremely low. Even friendship has been deemed sufficient.

In short, if the court overturns the convictions of Mr. Newman and Mr. Chiasson, it will make it difficult for prosecutors to ever win convictions. The message to traders will be to never discuss or be aware of the payoffs to sources.

If you have any questions about insider trading or would like to discuss other corporate, securities and investment banking matters, please contact me or the Scarinci Hollenbeck attorney with whom you work.