Bill Black: Second Circuit Decision Effectively Legalizes Insider Trading

Yves here. Bill Black is so ripshit about a Second Circuit court of appeals decision that effectively legalizes insider trading that he doesn’t unpack the workings until later his his important post. Let’s turn to Reuters (hat tip EM) for an overview:

A U.S. appeals court dealt federal prosecutors a blow in their crackdown on insider trading on Wall Street on Wednesday, overturning the convictions of two former hedge fund managers charged with making illegal trades in technology stocks.

The 2nd U.S. Circuit Court of Appeals in New York said prosecutors presented insufficient evidence to convict Todd Newman, a former portfolio manager at Diamondback Capital Management, and Anthony Chiasson, co-founder of Level Global Investors.

The court held that defendants can only be convicted of insider trading if the person trading on confidential information knew the original tipper disclosed it in exchange for a personal benefit.

What does this mean in practical terms? The court has just provided a very-easy-to-satisfy roadmap for engaging in insider trading legally. Don’t give the person who gave you the choice tidbit any explicit payoff. You can give him all sorts of buttering up before hand (fancy meals, hot women, illicit substances, box seats, whatever you think will induce cooperation and show your seriousness and ability to pay) and just engage in vague winks and nods. As long as you don’t pay the tipster for the trade in any crass or traceable way (and no communications that point to an explicit payoff), you are good to go. Compensation down the road, in hard dollar or soft forms is perfectly kosher.

Needless to say, the implications are terrible. Thanks to high frequency trading, way way too cozy a relationship between the Fed and its preferred banks, and years of suspicious trading patterns (markets too consistently not breaching technically significant price levels, with the trading looking decidedly not organic) has sapped the faith of retail and even smaller institutional investors in the integrity of markets. The Second Circuit has just announced open season on pervasive misuse of inside information.

And this decision pretty much puts the SEC out of the enforcement business, unless the agency gins up the nerve and skills to take on targets other than insider trading. The SEC had pretty much retreated to pursuing only insider trading cases; to the extent it does anything else, its policy is to (at most) file a claim and negotiate a settlement. But its targets know that the agency’s reluctance and presumed inability to go further makes it a paper tiger. That in turn leads to the widely ridiculed “virtually no admission of facts” settlements, which leaves courts (when asked to approve settlements) and the public in the dark as to whether the punishments were remotely adequate. It also deprives private plaintiffs to leverage the government case to seek restitution. Oh, there may be some remarkably stupid crooks who didn’t get the Second Circuit memo and will be fair game for the agency. But they are likely to be few in number and penny-ante in the scale of their activity.

By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Jointly published with New Economic Perspectives

We know that insider trading is an activity in which cheaters prosper. We know that Wall Street and the City of London are dominated by a fraudulent culture and we know that firm culture is set by the officers that control the firm. We know that the Department of Justice (DOJ) has allowed that to occur by refusing to prosecute any of the thousands of senior bank officers who became wealthy by leading the three most destructive financial fraud epidemics (appraisals, “liar’s” loans, and fraudulent sales of these fraudulently originated mortgages to the secondary market) in history. No one is surprised that Wall Street’s elites have also engaged in widespread efforts to rig the stock markets so that they can shoot fish in the barrel through insider trading. Unlike the three fraud epidemics, one DOJ office, the Southern District of New York, has brought a series of criminal prosecutions against these officers.

Wall Street’s court of appeals (the Second Circuit) has just issued an opinion not simply overturning guilty verdicts but making it impossible to retry the elite Wall Street defendants that grew wealthy through trading on insider information. Indeed, the opinion reads like a roadmap (or a script) that every corrupt Wall Street elite can follow to create a cynical system of cutouts (ala SAC) that will allow the most senior elites to profit by trading on insider information as a matter of routine with total impunity. The Second Circuit decision makes any moderately sophisticated insider trading scheme that uses cutouts to protect the elite traders a perfect crime. It is a perfect crime because (1) it is guaranteed to make the elite traders who trades on the basis of what he knows is secret, insider information wealthy absent successful prosecutions and (2) using the Second Circuit’s decision as a fraud roadmap, an elite trader can arrange the scheme with total impunity from the criminal laws. The Second Circuit ruling appears to make the financial version of “don’t ask; don’t tell” a complete defense to insider trading prosecutions. The Second Circuit does not simply make it harder to prosecute – they make it impossible to prosecute sophisticated insider fraud schemes in which the elites use junior cutouts to create (totally implausible) deniability.

The New York Times article on the decision was entitled “Two Insider Trading Convictions Are Overturned in Blow to Prosecutors.” The title is partially correct. The real blows, however, were to investors, the already crippled integrity of Wall Street, and every honest trader on Wall Street who cannot possibly compete with his rivals who cheat through the “sure thing” of insider trading now that the Second Circuit has written an opinion explaining how to corrupt the entire system with impunity from the criminal laws.

Wall Street’s most recent effort to rig the markets through insider trading is far larger and more audacious than any prior effort, including those by Michael Milken and Boesky. Wall Street elites sought to institutionalize the corruption of officers of a wide range of publicly traded corporations. The goal was to gain a corrupt advantage over honest investors in trillions of dollars in securities trades.

The Second Circuit decision admits that the prosecutors presented evidence established a massive conspiracy designed to allow Wall Street elites to profit by engaging in insider trading, a conspiracy that greatly enriched the defendants that were convicted in the case under appeal.

At trial, the Government presented evidence that a group of financial analysts exchanged information they obtained from company insiders, both directly and more often indirectly. Specifically, the Government alleged that these analysts received information from insiders at Dell and NVIDIA disclosing those companies’ earnings numbers before they were publicly released in Dell’s May 2008 and August 2008 earnings announcements and NVIDIA’s May 2008 earnings announcement. These analysts then passed the inside information to their portfolio managers, including Newman and Chiasson, who, in turn, executed trades in Dell and NVIDIA stock, earning approximately $4 million and $68 million, respectively, in profits for their respective funds.

The Second Circuit was not distressed that senior Wall Street officials received information that was clearly insider information that they knew they should not have access to. The insider information they were provided was the crown jewels – two major corporations’ soon to be announced “numbers” – at least one of which was sure to be a major surprise to the markets. A senior trader that knows “the number” in advance, particularly when he knows that the number will be a surprise, can shoot fish in a small barrel with a large shotgun. The insider information allows the senior trader to reduce the risk of loss to trivial levels while increasing the probability of gain to near certainty. The trader makes a fortune by cheating, not through any unusual skill. The senior trader knows that no employee of any publicly traded corporation is permitted to release such secret and proprietary insider information to investors.

The Second Circuit was not distressed that the senior Wall Street officials did not react to being provided what was clearly insider information by demanding to know how their analysts got the information and instructing them that their actions violated the firms’ ethical standards and would lead to their termination if it were ever repeated. The firm’s ethics manuals banned the senior traders from trading on the basis of insider information. Instead, of serving as ethical leaders in training the analysts not to engage in such behavior and instead of following their firm’s ban on trading on the basis of insider information, the senior officers engaged in a cynical financial version of “don’t ask; don’t tell.” The analysts and the senior officials that traded on the inside information understood the wisdom of the old line “ask me no questions and I’ll tell you know lies.” The senior officers proceeded to profit by exploiting this advantage over honest investors while minimizing the risk of a successful prosecution not by being ethical, but by consciously maintaining (not remotely) “plausible deniability.”

I recently wrote a column responding to an article in which a prominent criminal justice scholar was quoted as complaining, in response to the protests of the police killing of Eric Garner during their attempt to arrest him for selling “broken packs” of cigarettes on a NYC street, that politicians had a “responsibility” to explain to the public the necessity of “broken windows” policing strategies. The concept of “broken windows” is that is essential to take formal, aggressive enforcement actions against even minor transgressions in order to prevent a “criminogenic environment” from developing that will produce large numbers of major crime. The SEC is formally claiming to have adopted “broken windows” as its enforcement standards. Confusingly, “broken windows” has been rebranded by some academics as “quality-of-life enforcement.”

“Everyone is just demonizing the police,” said Maki Haberfeld, a professor of police studies at John Jay College of criminal justice. “But police follow orders and laws. Nobody talks about the responsibility of the politicians to explain to the community why quality-of-life enforcement is necessary.”

Garner’s profits from violating an obscure law on the sale of cigarettes in any given week probably amounted under $70. A few days of the defendants’ trades based on insider information produced a $72 million profit – a million time larger. Garner died. The Wall Street guys were able to hire elite criminal defense lawyers. They will walk. Wall Street’s culture is so corrupt that it will treat the now officially “innocent” defendants like heroes and even victims of a rapacious prosecutor. “Broken windows” is a discredited theory when it comes to offenses like that of Garner, but it is vitally and urgently needed as a corrective to Wall Street’s corrupt culture.

But worse will soon come. The Second Circuit’s decision is a “how to” manual on how elites Wall Streeters can become wealthy through insider trading with impunity from the criminal laws. The Second Circuit opinion shows that using a “cutout” is the key to achieve the “sure thing” of enormous wealth through insider trading without financial or legal risk. The Second Circuit lays out the game plan. The little folks in the organization develop the contacts with insiders in publicly traded firms. The analysts function initially like any good intelligence agent recruiting an asset. These assets have insider information of their employers, the publicly traded corporations. The analyst develops a rapport with the employee or exploits an existing tie. The analyst shows the employee a very good time – a taste of how good his life can be if he plays ball. But the analyst doesn’t make any explicit promises or deals. (In the case decided by the Second Circuit others cutouts earlier in the insider trading chain made the corrupt payments to the employees.) The Wall Street senior officers who grow wealthy by trading the insider information will make sure that the analysts are well cared for – discretely and at a later date.

The analyst then has to do one thing and avoid doing a second. Both are simple. The analyst needs to signal to his superior that the information is reliable. The government complaint against SAC show one the innumerable means of sending that signal. The government’s appellate brief contains the text of an email in which an analyst explicitly conveyed the reliable track record of the leakers of the inside information to the senior traders so that they could be sure they had a “sure thing” by investing on the basis of the inside information.

The analyst needs not to explicitly tell the senior officer conducting the trade that the insider information was the product of a deal in which the employee who leaks the insider information was explicitly promised a quid pro quo to the leaker. Again, the government complaint against SAC and the government appellate brief in the case reversed by the Second Circuit show in detail how simple it is to design systems of not making these matters explicit. That is why the Second Circuit ruling imperils prosecutions in every case in which the insider trading scheme was done with even modest cleverness.

The Second Circuit did not treat the elite traders’ use of a series of junior cutouts as what it really is – a cynical abuse of power sure to corrupt the firm, Wall Street professionals the financial industry, and financial markets. Ending the rule of law by making sophisticated insider trading schemes the perfect crime corrupts the industry by generating a “Gresham’s” dynamic in which “bad ethics drive good ethics out of the markets and professions.” The capacity for corruption makes the Second Circuit’s creation of a perfect crime all the more perverse. The sophisticated insider trading schemes using cutouts that the Second Circuit opinion immunizes from prosecution represent a far more dangerous and sophisticated conspiracy that should be subject to far more severe sanctions than simpler forms of insider trading.

The elites’ “don’t ask; don’t tell” insider trading scheme was designed solely to make already exceptionally wealthy elites even richer through corrupt “sure things.” The “don’t ask; don’t tell” scheme worked by coercing junior members of the firm (through perverse compensation and promotion or firing pressures) to corrupt employees of publicly traded corporations. The Second Circuit opinion treats the “don’t ask; don’t tell” tactic, the large power differentials between the participants of the scheme, and the elite traders’ use of multiple cutouts as if these factors were exculpatory. The more sophisticated and destructive the insider trading scheme, the more the Second Circuit opinion shields the elite traders made wealthy by the scheme from prosecution. The Second Circuit adopts, celebrates, and shields from accountability Wall Street’s corrupt culture by making sophisticated insider trading the perfect crime.

[The defendant senior traders] Newman and Chiasson were several steps removed from the corporate insiders and there was no evidence that either was aware of the source of the inside information. With respect to the Dell tipping chain, the evidence established that Rob Ray of Dell’s investor relations department tipped information regarding Dell’s consolidated earnings numbers to Sandy Goyal, an analyst at Neuberger Berman. Goyal in turn gave the information to Diamondback analyst Jesse Tortora. Tortora in turn relayed the information to his manager Newman as well as to other analysts including Level Global analyst Spyridon “Sam” Adondakis. Adondakis then passed along the Dell information to Chiasson, making Newman and Chiasson three and four levels removed from the inside tipper, respectively.

The Second Circuit’s reasoning has the perverse effect that the more corrupt individuals engaged in the insider trading scheme the more likely the scheme is to be declared lawful as long as the traders use their corrupt colleagues as cutouts. Note that the Second Circuit reasoning does not simply make it harder to prosecute sophisticated insider trading schemes – it holds that the actions of the elite traders who know that they are achieving the “sure thing” of immense insider trading profits on the basis of deliberate leaks of that information are not unlawful and cannot be prosecuted. The Second Circuit has created the perfect crime and publicized how to shape the scheme to insure wealth and impunity through creating widespread chains designed to corrupt the markets, employees of the publicly traded corporations, and the Wall Street firms.

The tone of the opinion is particularly galling. The Second Circuit is not even mildly distressed by the result. It expresses disdain for the idea that Wall Street elites should not be able to enrich themselves with complete impunity from the laws through corrupt arrangements such as those proven at the trial. The opinion consciously deliberately creates a straw man argument designed to hide the fact that insider trading schemes of this make it impossible for honest competitors to prevail through skill and hard work.

Although the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets.

Wall Street’s pet Court of Appeals sneers at the concept that there might be reasons to wish that the law did not (under its holding) create a perfect crime that is inherently corrupting. The three judges on the panel were appointed by Presidents Reagan and Bush II. The opinion does not contain even a perfunctory statement of regret that it creates a path to the perfect crime and the further corruption of Wall Street at the expense of honest traders and investors.

There was a real conspiracy to corrupt employees at publicly traded firms and to profit from the resultant insider information that was proven at the trial. The conspiracy produced the desired result, until the government brought it to a halt by prosecuting. The Second Circuit took the exceptional step of not reversing the conviction based on an erroneous jury instruction and allowing the prosecutors to retry the case and present again at the new trial the powerful evidence of conscious disregard by the elite traders made wealthy through trading on insider information. The government’s appellate brief demonstrates that the government presented what I would consider as a white-collar criminologist detailed and compelling evidence that the elite traders knew that they were trading on insider information that was improperly leaked for corrupt purposes. The Second Circuit forbade any retrial. Worse, the Second Circuit appears to be declaring that even a modestly sophisticated use of cutouts by elite traders using insider information creates the perfect crime. They will be made wealthy by the “sure thing” of insider trading and no future prosecutor will be permitted to even prosecute such a perfect crime.

Whatever one thinks of the Second Circuit’s legal reasoning, anyone who cares about the integrity of financial markets should be appalled by the result of their decision that announces a template of how to make insider trading a perfect crime for elites. Republicans and Democrats both purport to care about the integrity of Wall Street firms and the markets and proclaim that they are dedicated to the protection of investors from such forms of cheating. We are about to run a real world test of whether they believe what they say and are willing to take on the powerful Wall Street elites that crafted the corrupt culture of Wall Street. I call on the members of both parties to co-sponsor on an urgent basis a bill to clarify that Congress does intend to make the type of insider trading schemes that were the subject of the Second Circuit’s decision criminal violations of the securities laws.

I also call on members of both parties to double the number of FBI agents and federal prosecutors dedicated to elite white-collar crime investigations and prosecutions. Yes, I know it over 13 years late, but we can all see the costs – over $20 trillion in GDP and 10 million jobs – of ending the rule of law when it comes to bankers. The Second Circuit decision will make Wall Street even more corrupt – and that is saying a great deal. Only through prosecuting the corrupt can we block the “Gresham’s” dynamic and make it possible for honest bankers to take control of Wall Street.

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  1. Clive

    Here in the trenches at the front line of TBTF shenanigans, us grunts get a good proxy for what keeps the c-level execs await at night (okay, make that mildly concerned about who they might need to capture next in order to keep the gravy flowing nicely) — “mandatory” training.

    This mostly takes the form of tedious beyond endurance Mickey Mouse (Mickey Mouse is a step-up in sophistication by comparison, at least in additional to the colour and the movement there’s usually some discernable plot and an oblique morality play) computer-based training with a “test” which you have to score X% to pass.

    The proxy comes through what areas are included in the mandatory tests. Competition (anti competitive collusion in the industry), money laundering, dealing with sanctioned entities, customer confidentiality, procurement fraud / bribery and not following procedures to verify customers are all in the list.

    Completely absent — for several years now, probably as much as five — insider trading. It obviously isn’t an issue, as far as compliance checking is concerned. As there’s been little (none as far as I am aware) in the way of prosecutions — let alone fines or c-level execs being held to account — in the TBTFs for insider trading, well, duh, it’s not on their radar.

    Being a big softee for a moment, one could argue that the regulators have got their hands full with other industry problems and have bigger fish to fry. Hardly though Broken Windows policing is it ?

  2. pebird

    Can’t we assume that when it comes to Wall Street (if not most of us) that in any free exchange of information, the individuals are doing so for personal benefit?

    I thought that was the foundation of conservative political philosophy.

  3. Eric

    The problem with calling on member of both parties to do anything — well, one of the problems — is how many of them probably benefit from insider trading, especially since the STOCK Act was gutted.

    1. jrs

      More than probably I’d say. It’s pretty much been proven, their stock returns aren’t explainable otherwise.

    1. participant-observer-observed

      . . . followed by . . . let’s see . . . a return to mafia-era justice? triads?

  4. Generalfeldmarschall von Hindenburg

    I’ve had conversations with many libertarian/conservative types who are angry there is even a concept of insider trading. It’s just the Holy Ghost…errr…Invisible Hand at work.

    1. McMike

      Face it, Libertarians really really want to believe in unicorns.

      So, every time an alleged unicorn is revealed to be yet another horse’s a** with a paper towel tube glued to its forehead, the libertaritards launch into yet another rendition of No True Scotsman..

      Tomorrow; you’re always a day away.

    2. James Levy

      The ethical center of the civilization is hollow. It may have always been honored in the breech, but even 40 years ago there were things that were for the most part just not done. Many people feared doing something “bad” or “wrong” or “illegal.” The vestigial notion of sin was still in the air wafting about. Jesus wasn’t your buddy just crazy to “save” you–he was an omniscient scorekeeper with a clear list of dos and don’ts, and a nice warm place for you if the don’ts added up.

      We see the same depressing garbage in the torture “debate”–an incapacity to demarcate unacceptable behavior because we know it is just plain wrong. All we are left with are technicalities. We live in a society that yells “moral clarity!!!” one minute and “legality is for suckers” the next. We have lawyered ourselves into an ethical cesspool. We obsess over other people’s behavior (do they have sex with same-sex partners? do they have sex out of wedlock? do they smoke pot? do they believe in my iteration of God?) but set no universal standards for proper behavior we are prepared to live by.

      We are fast becoming a completely irresponsible, feckless, adolescent culture of shrill nincompoops yelling about this one’s racism and that one’s Sodomy and having no clue about how to do right and avoid wrong on a daily basis. Everything is measured subjectively and/or instrumentally. Nothing is judged on the simple criteria, if someone did this to you or a loved one, would you find it acceptable? Almost every moral thinker from Christ to Rorty must be spinning in his or her grave.

      1. OpenThePodBayDoorsHAL

        Thank you. I’ve raved from the beginning that this is a crisis of values, a basic lack of commitment to the difference between right and wrong. I don’t mean obscure interpretations of complex laws with ambiguous social benefits, I mean the stuff at the very core. OK to kill innocent people? No. OK to steal? No. The law must apply equally to everyone? Yes. OK for a government to lie to and spy on its own people? No. We started getting most of that right with the Magna Carta, then America made the amazing assertion that “man has certain inalienable rights” entirely above those of the state. We reconfirmed to some degree around the time of Nixon, Frank Church, Vietnam War, etc. Through our own inattention, and inaction, and sloth, and fear, we gave away those inalienable rights. That we are not all telling our bosses we have something more important to do today, grabbing a placard, and reclaiming them and letting our anger be known in the streets says everything about us, not them:

        1. Cromwell's severed head

          “We reconfirmed to some degree around the time of Nixon”
          Yes and no. Nixon was forced to resign but I would argue, the first step on the slippery slope to our present location was Ford’s, before the fact ,pardon of Nixon.
          His pardon speech is a masterpiece of logical fallacies, duplicity and double speak:
          “After years of bitter controversy and divisive national debate, I have been advised, and I am compelled to conclude that many months and perhaps more years will have to pass before Richard Nixon could obtain a fair trial by jury in any jurisdiction of the United States under governing decisions of the Supreme Court.

          I deeply believe in equal justice for all Americans, whatever their station or former station. The law, whether human or divine, is no respecter of persons; but the law is a respecter of reality.”

          Shorter version; we are a nation of laws except when we are not. Justice is important only when it is convenient. Expedience uber alles.
          Other than that, I agree with what you are saying.

      2. Crazy Horse

        Now that God is dead and the Law for sale (and the deal already closed), what is to prevent homo delusionous from acting out his every fantasy? He who dies with the most toys and ejaculations wins. And for those who believe in Hope, there is always cryogenics.

        Well, the planet still operates under it’s own laws— a system of laws with their own enforcement mechanism far more powerful than human fantasies about God or paper laws designed to keep power and property in the hands of the formulators. As humanity hustles about seemingly moving according to individual choice, they rarely bother to notice that they are actually moving together as a herd and there is a cliff ahead. And even if they did notice, there are no off ramps on the destiny industrial civilization has created for itself. The world that industrial civilization will bequeath the future may have a place for homo adaptus, or it may simply escalate down the climate feedback loop until it no longer can sustain carbon-based life forms.

  5. McMike

    Contrast the easing of agency in insider trading with just about every other law for the rest of us.

    Hell, just giving to a humanitarian relief organization that operates in the middle east can get your assets frozen. Picking up the wrong suitcase at the airport can get you a dime for drug crimes. You can go to jail for what happens at a party in your house when you are out of town. Being on the street during a police crackdown gets you maced and arrested. Passing counterfeit cash is a crime, even if you didn’t know.

    There is, in fact, not a single crime I can think of where not knowing that it was criminal relieves you of guilt.

  6. Ulysses

    “Yes, I know it over 13 years late, but we can all see the costs – over $20 trillion in GDP and 10 million jobs – of ending the rule of law when it comes to bankers. The Second Circuit decision will make Wall Street even more corrupt – and that is saying a great deal. Only through prosecuting the corrupt can we block the “Gresham’s” dynamic and make it possible for honest bankers to take control of Wall Street. ”

    This is a very moving and impassioned cri de coeur from a valiant warrior for justice in the world of finance. Sadly these “honest bankers” who stand poised in the wings waiting to “take control of Wall Street” just don’t exist. There are many thousands of honest bankers in the U.S. of course, but any of them who find their way to Wall Street soon discover the bleak truth– that if they attempt to blow the whistle on the shenanigans that happen there, every day, they will, at best, lose their position in the world of finance forever. The same is true for the City of London.

    We had a moment, in 2008/2009 where courageous politicians and regulators might have blocked this Gresham’s dynamic on Wall Street. That ship has been torpedoed and lies wrecked far below the East River, never to sail again. This kleptocratic private/public partnership, with equally criminal players in NYC and D.C., cannot now be reformed with a few more honest judges, regulators, or even bankers. The banksters’ power must be broken completely. We’ll know that we’ve gotten there when the best and brightest no longer want to work at a boring old financial firm. Why? Because working as a high school physics teacher will be as rewarding in material terms, and far more satisfying in an intellectual sense.

  7. Jim Haygood

    The court’s opinion stressed that for the defendants to be guilty, the higher-ups in the information chain had to be liable too. However, none of them were charged with anything, as none were shown to have derived any benefit.

    Bill Black is arguing for a legal model similar to stolen property. If you buy a painting at a public auction, and later it’s found to have been looted from its rightful owner 75 years ago, it can be taken away from you, despite your complete lack of knowledge that it was stolen.

    A stricter standard of civil liability (e.g. disgorgement of profits) might be reasonable. But criminal liability (54 and 78 month sentences) is quite extreme for defendants who were three and four steps removed, respectively, from the sources, none of whom faced any legal liability.

    If an unknown commenter on NC claims that Apple’s going to earn $2.82 in the fourth quarter, and later it turns out that his cousin’s sister-in-law in Apple’s accounting department was the source of that info, should every NC reader who owns Apple stock go to jail for insider trading? [This is not a recommendation to buy any security!]

    1. Yves Smith Post author

      American Litigation disagrees with your charitable reading:

      Second Circuit to Insider Traders: Trade Away!

      Are you looking to make extra money trading on inside information, but worried about the risks? The U.S. Court of Appeals for the Second Circuit has good news for you. The court on Wednesday released a blueprint in U.S. v. Newman that shows how someone can safely trade on inside information without violating the law.

      First, of course, you’ll need to find someone with confidential inside information. If you work at a hedge fund or have a network of contacts in the business world, then you surely know people with loose lips. Even better, find someone a few steps down the rumor chain, who isn’t the original source of the information.

      Second, if you’re getting the information directly from the source, don’t offer money or anything else of value. Just rely on your charm and, perhaps, your source’s desire to please. If you’re getting the confidential information indirectly from someone down the chain—let’s say you’re a hedge fund titan grilling one of your analysts—don’t ask too many questions about where the information came from.

      Once you understand these ground rules, you can pump your sources for confidential information and trade away. No joke.

      1. Jim Haygood

        The appeals court opinion repeatedly referenced the notorious case of Ray Dirks, a whistleblower who not only warned his clients about fraud at Equity Funding after receiving an insider tip, but also warned the SEC, which did nothing. After Equity Funding blew up in 1973 and Dirks got censured, the Supreme Court ultimately acquitted Dirks on the grounds that he didn’t personally profit from the information.

        Likely the motivations of Newman and Chiasson were less altruistic than those of Dirks. But the appeals court was bound by the Supreme Court’s logic in Dirks, which hinged on the absence of personal benefit for the tipper.

        Congress could have revisited the insider trading statute, after the SEC’s stinging defeat in Dirks. But it didn’t, and here we are.

          1. Jim Haygood

            Post #1: ‘the higher-ups in the information chain had to be liable too’

            Post #2: ‘the Supreme Court’s logic in Dirks … hinged on the absence of personal benefit for the tipper.’

            From a 1983 NYT article on Ray Dirks:

            In a highly unusual footnote, Rex Lee, the Solicitor General of the Justice Department, took Mr. Dirks’s side.

            Of paramount importance to a law enforcement agency, the footnote said, is the unfortunate message that the S.E.C. position would send to other whistle blowers: By punishing the person who had uncovered the fraud, others who might be willing to report scandal would be deterred.



            Dirks is alive, well and living in Manhattan. If I were Newman and Chiasson, I’d send him a Christmas card.

            1. Yves Smith Post author

              Being liable and deriving personal benefit are not even remotely the same thing in virtually every other area of law. The insiders giving out the information are violating a duty of loyalty and care to the corporation.

  8. NOTaREALmerican

    Why do people insist on creating laws, like “insider trading”, which can only exist with a “pure” judiciary? If one assumes that EVERYBODY is going to be a self-serving asshole wouldn’t the laws be different?

    I donno… it seems “Progressives” will never learn that government can’t protect them from the smart-n-savvy assholes. Not because “government is bad” but because the people that MUST run anything as large as a government* will be self-serving assholes.

    *Note: The this doesn’t apply JUST to government. Any organization larger than (oh, say) 3 people will be run by the smartest-n-savviest asshole. Deal with the reality of human behavior and THEN write the laws. The “Progressive” fantasy of nice people actually existing is really getting old (and is ruining the country too).

    1. Yves Smith Post author

      Uh, no. I suggest you read up on the idea of checks and balances. And contrary to your claims, we did have a financial regulatory system that comported itself well for over 40 years, from the Great Depression reforms through the late 1970s-early 1980s.

      And none of the firms I worked for fit your model. So your law is untrue as well. And I can name plenty of organizations now that are bigger than 3 people and don’t work the way you suggest either. They may have their own dysfunctions.

      I’ve also worked in M&A, lest you forget, which is in theory a prime spot for insider trading to take place. Let me clue you in: only the occasional stupid junior person engaged in it (although the people in risk arb were trying hard to wheedle precisely that sort of info out of them, witness, for instance, Ivan Boesky). So your “everybody does it” premise is false too.

      Your remark actually reveals a lack of much experience, despite your pretense at sophistication. Government and business was once corrupt only at the margin. The fact that conduct was in the past was better across the board is proof that it does not have to be this way.

  9. Lil'D

    Insider trading is typically someone “unfairly” getting early nonpublic price discovery. It’s not fraudulent – it’s exposing truth but profiting on the monopoly rent from knowing the truth early.

    There are plenty of actual frauds and predatory behavior that are much worse. Still, might as well prosecute scum when we can

    1. Yves Smith Post author

      One of the big points of the 1933 and 1934 securities laws was to stop insider trading. That was one of the big reasons for a disclosure regime where investors supposedly had access to important information about a company on the same footing. You need that for markets to work well. I agree that having the stock market work well is not the highest priority on the planet, but this ruling helps entrench a mentality of “cheating is fine if you follow certain steps so no one can bust you.”

  10. MartyH

    Was going to say something clever. Bill, Yves, and others have done a better job. All that’s left to say is that between the insiders, the TBTF financiers, the silent but active Central Banks, and the front-running high-speed trading robots, why would anyone consider it a “fair” and/or transparent market?

  11. steelhead23

    Even if Justice in the USA is not only blind, but misguided, at least it is fairly consistent in its wrongheadedness. If I recall correctly, the central point in the vaunted Citizens United case was that unless there was a clear ‘quid pro quo’, there was no reason to assume that campaign contributions would influence the actions taken by the recipient politician, suggesting or course, that the political class is made up of the most ethical members of the tribe. No quid pro quo, no crime. This court in this case reached an identical conclusion – no remuneration of the leaker – no crime. Looking at how the U.S. justice system (sic) has adjudicated this crime and the crime of selling untaxed cigarettes a few miles away leads me to the conclusion that white guys on Wall Street that break laws so they can house their mistresses in finer digs are golden, while black guys who break laws so they can feed their families are reprobates, worthy of summary execution. Makes me want to vomit.

    1. Clifford Johnson

      If there’s no absolute finality issue, I would advise her to try and have the felony voided–depends on the specifics of what she pleaded guilty to. If it wasn’t a crime she pleaded guilty to (i.e. if it lacked the scienter deemed essential in Newman), then her conviction would seem a nullity.

  12. susan the other

    Eliminating prosecution because intent (more or less) is almost impossible to prove, leaves a gaping hole in fairness and equality. It lets somebody get away with a clear advantage to front run everyone else who probably invested for the long run. The best solution would be to make public every iota of information on an hourly basis which has anything to do with the health of a public corporation. Every tiny piece of info. And to delay all trades for at least two hours.

  13. Jay M

    Word man, disruptive.
    Fleecing the slaves, run that DJ average up!
    Once the insiders meet each other, what will they think up next? Har har

  14. D

    Why is anyone still invested in the stock market. I don’t go to casinos or play rigged games. Everyone should pull out and let them have their own little circle jerk.

  15. Banger

    Haha. It’s been going on anyway in a convoluted way–now the people on the floor can ease up and be more direct. I don’t see the harm, really. Just let the guys and gals hang out and let ‘er rip. What we should have is a Wall Street sales tax, at minimum to balance things a little bit. Let them play around with stuff just have the citizens get a piece of the action.

  16. Knute Rife

    “Broken Windows” is a complete fraud. The only reason it “worked” for Giuliani was that he had the good fortune to rule NYC while its economy was improving. The rising economic tide dropped the crime rate, the implementation of Broken Windows was merely coincidental, and crediting it with the results is a classic case of false correlation/false causation. As a prosecutor in an area with a rising crime rate, I implemented Broken Windows in an effort to stem the tide. Unfortunately, my little corner of the world was not enjoying economic growth but rather decline. Broken Windows did nothing to curb the crime rate. When I looked around, I saw that areas in similar economic straits as my jurisdiction saw the same lack of results; only areas with economic growth saw the “results” Giuliani was proclaiming. The Broken Windows lie has been kept alive, though, because, while the program accomplishes nothing in actual crime prevention, it is very useful for expanding law enforcement authority and budgets.

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