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Evaluating the Government's cert petition in US v. Newman

DealBook reports that:

What constitutes insider trading has always been open to interpretation. Now, the Supreme Court is being asked to decide a knotty question: How much of a benefit does the source of confidential information have to receive in order to convict those who trade on it?

This week, the Justice Department filed a petition with the Supreme Court asking for review of the decision in United States v. Newman, which overturned the insider trading convictions of two hedge fund managers. The move comes after the United States Court of Appeals for the Second Circuit ruled that the government had not proved the tipper received a benefit, rejecting a request to revisit its ruling. ...

The Newman case involved insider trading based on information passed along by employees at Dell and Nvidia about earnings announcements that were not yet public. The two defendants, Todd Newman and Anthony Chiasson, got secondhand information from analysts at their hedge funds and traded on it. They never dealt directly with the employees who tipped off others, nor did they speak to those who initially received the illegal tips.

The United States Court of Appeals for the Second Circuit in Manhattan reversed the convictions last December. Its rationale was that the jurors were not told they had to find that the two defendants knew the tippers received a benefit in exchange for revealing the confidential information. The Justice Department did not challenge that part of the ruling in the Supreme Court, so at a minimum, Mr. Newman and Mr. Chiasson will have their convictions overturned.

The appeals court did not stop there, however. It also ruled that the government could not retry the defendants because the evidence was so deficient about the benefit provided to the tipper that no reasonable jury could find them guilty. It was this issue that has the Justice Department so upset, because in a brief description of what constitutes a sufficient benefit, the appeals court raised the bar for proving a violation of the securities laws in other cases.

The issue is not the sufficiency of the evidence, however, but rather "whether the court of appeals erroneously departed from this Court’s deci- sion in Dirks by holding that liability under a gifting theory requires 'proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.'"

I've written a lot about Newman over the years (here's a list of prior posts) so I won't rehash the issues and facts generally. Instead, I'll comment on the specifics of the government's cert petition.

The government argues that:

In the guise of interpreting this Court’s opinion, the court of appeals crafted a new, stricter personal-benefit test, stating that “[t]o the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades ‘resemble trading by the insider himself followed by a gift of the profits to the recipient,’ * * * we hold that such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” App., infra, 26a.

That new “exchange” formulation erases a form of personal benefit that this Court has specifically identified. Under Dirks, an inference of a personal benefit to the insider arises in two situations: when the insider expects something in return for the disclosure of the confidential information, or when the insider freely gives a gift of information to a trading friend or relative without any expectation of receiving money or valuables as a result. 

The problem elided by the government is that Dirks does require proof of a relationship between the tipper and tippee that rises to the level of a "relative or friend." Implicit in that requirement is a proof close personal relationship. Hence, as Adam Pritchard has demonstrated at length, "Newman’s knowledge standard is the correct reading of Dirks, and that its requirement of a 'meaningfully close personal relationship' is consistent with, if not compelled by, the rule laid down in Dirks." In particular, as Pritchard explains:

The ... counter‐argument to the government’s position – that only a minimal relationship is required – is that the personal benefit element requires the government to prove that the tipping insider disclosed the information for the purpose of receiving a personal benefit, direct or indirect. Would the existence of a casual friendship or acquaintance warrant the inference that the insider breached a duty of confidentiality for the purpose of bestowing a gift?  ...

Giving away corporate information to strangers might make you feel like a bigshot, but the standard is self‐dealing: the gift needs to be an indirect personal benefit, which suggests a close relationship, not a casual one.  

Second,the government mischaracterizes Dirks's personal benefit test. It argues that:

... an insider need not be specially attached to his friends and relations in order to decide for his own personal reasons to confer on them a gift of inside information (which, of course, requires no monetary outlay). 

But this ignores what Dirks actually said:

The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.

Dirks v. S.E.C., 463 U.S. 646, 664 (1983). I don't know about you, but I don't go around giving money to people to whom I am "not ... specially attached." In any case, notice how the government statement that "no monetary outlay" is required amounts to a basic misrepresentation, because Dirks requires that the tip amount to the functional equivalent of a monetary outlay.

Third, a critical point obfuscated by the government is that Justice Powell's majority opinion in Dirks was driven in large part by the need to protect securities analysts and, more specifically, analysts who interview corporate employees in hopes of gaining useful information:

Imposing a duty to disclose or abstain solely because a person knowingly receives material nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes is necessary to the preservation of a healthy market. It is commonplace for analysts to “ferret out and analyze information,” 21 S.E.C., at 1406, and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that the analysts obtain normally may be the basis for judgments as to the market worth of a corporation's securities. The analyst's judgment in this respect is made available in market letters or otherwise to clients of the firm. It is the nature of this type of information, and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporation's stockholders or the public generally.

Dirks v. S.E.C., 463 U.S. 646, 658-59 (1983). This is essentially what the defendants in Newman did, except at a distance and indirectly.

In addition, as Pritchard details, the government's argument in this case is tainted by the fact that the government has consistently tried to undermine the Dirks case:

The SEC was not happy with the constraints imposed on it by Dirks, and the agency worked hard to loosen those fetters. The agency initially sought to expand the definition of reputational benefit in ways that cannot be squared with Dirks. ... [T]he SEC also persuaded lower courts to adopt broad interpretations of Dirks’ personal benefit requirement. 

 Newman thus simply returned the law to where it stood before the SEC started trying to gut Dirks.

The government also relies on its tired argument that insider trading "strips investors of confidence that the markets are fair and open." As I have demonstrated elsewhere, "insider trading does not seriously threaten the confidence of investors in the securities markets." Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189, 1243 (1995).

Bottom line? Once again the government is trying to undermine the framework created by Justice Powell, with the chutzpah to do so in the Supreme Court itself.

Prior posts on US v. Newman and the personal benefit requirement in insider trading tipping cases

I'm working up a post on the government's cert petition in US v. Newman. In the meanwhile here are some earlier posts:

The personal benefit element of insider trading tipping liability post ...   Dec 15, 2014 ... Michael Perino has a Dealbook post about the state of insider trading law after US v. Newman. It's an lengthy and thoughtful argument, but ... www.professorbainbridge.com/.../the-personal-benefit-element-of-insider- trading-tipping-liability-post-newman.html

US v Newman: A big win for coherence and fairness in insider ...   Dec 11, 2014 ... The appeal is being pursued by Todd Newman and Anthony Chiasson, ... Personal benefit to the tipper is broadly defined: it includes not only ... www.professorbainbridge.com/.../us-v-newman-a-big-win-for-coherence-and -fairness-in-insider-trading-law.html

The SEC misspeaks about the effect of US v Newman on insider ...   Mar 5, 2015 ... The panel's opinion in Newman is both a correct application of the personal benefit test adopted by the Supreme Court in Dirks v. SEC and an ... www.professorbainbridge.com/.../the-sec-misspeaks-about-the-effect-of-us-v- newman-on-insider-trading-cases.html

 

Tipping chain liability: The Newman and Chiasson Appeal ...   Apr 23, 2014 ... The appeal is being pursued by Todd Newman and Anthony Chiasson, ... Personal benefit to the tipper is broadly defined: it includes not only ... www.professorbainbridge.com/.../tipping-chain-liability-the-newman-and- chiasson.html

Alison Frankel on our brief in the US v. Newman insider trading case ...   Feb 27, 2015 ... ... in the Newman and Chiasson case was exactly right on what constitutes a personal benefit to a corporate insider. (As it happens, the same... www.professorbainbridge.com/.../alison-frankel-on-our-brief-in-the-us-v- newman-insider-trading-case.html

Peter Henning on Insider Trading Post-Newman ...   Feb 2, 2015 ... Although the Newman decision appears to create a “buddy exception” to ... there is some evidence of a benefit that could be considered valuable. www.professorbainbridge.com/.../peter-henning-on-insider-trading-post- newman.html

Government dramatically wrong about Newman ...   Jan 21, 2015 ... Newman -- got it exactly right, as I explain in this post. ... The government shouldn 't have to also show any personal benefit was traded for it, the ... www.professorbainbridge.com/.../government-dramatically-wrong-about- newman.html

Frankel on Pritchard on Newman - ProfessorBainbridge.com   Jul 17, 2015 ... ... 2nd Circuit's interpretation of what constitutes a personal benefit for tipsters “is consistent with, if not compelled by, the rule laid down in Dirks. www.professorbainbridge.com/.../frankel-on-pritchard-on-newman.html

Memo to Congress: Leave Dirks/Newman alone ...   Jan 14, 2015 ... When defining a breach, the court explained that "the test is whether the insider personally will benefit," adding, "Absent some personal gain, ... www.professorbainbridge.com/.../memo-to-congress-leave-dirksnewman- alone.html

A couple of tweets about law schools, gunslingers, and social justice warriors

Law schools should be about training gunslingers. We shouldn't privilege one set of clients/causes over another. https://t.co/pCqcxoFMII

— Stephen Bainbridge (@ProfBainbridge) July 29, 2015

Which I followed up with:

Law schools should not produce social justice warriors. We should produce gunslingers who decide for themselves for whom to sling their gun

— Stephen Bainbridge (@ProfBainbridge) July 29, 2015

You're buying a company: How do you know what you're getting?

The information asymmetry between buyer and seller is a core transaction cost in corporate acquisitions. the M&A Lawyer has a good summary of the provisions of an acquisition agreement that help credibly reduce that asymmetry.

The errors of liberation theology

First Things has a succinct review of the basic errors of liberation theology.

Has the "Responsible Corporate Officer" doctrine run amok?

The WLF is asking the Eighth Circuit to rein the doctrine in:

On July 27, 2015, WLF asked the Eighth Circuit to overturn a district court decision that would impose a term of imprisonment on two executives of Quality Egg LLC under the “responsible corporate officer” (RCO) doctrine—a rare instance of strict supervisory liability in the criminal law. In a brief filed in the case, WLF argued that although the Supreme Court has sanctioned the imposition of strict criminal liability in the absence of mens rea in the narrow category of public welfare offenses, it has done so only with the understanding that penalties imposed in such cases will be relatively small and the conviction will not gravely damage defendant’s reputation. The government’s position in this appeal, WLF contended, asks the appeals court to expand such strict supervisory liability far beyond the constitutional bounds the Supreme Court first articulated when adopting the RCO doctrine over seventy years ago.

Here's a link to WLF's brief.

UCLA SJD alum Martin Petrin has the leading article on the RCO doctrine:

The recent oil spill disaster in the Gulf of Mexico and ensuing questions of accountability have brought a controversial legal tool to the forefront, the “responsible corporate officer doctrine.” This doctrine allows courts to hold individuals that exercise control over business policies or activities personally liable for failing to prevent statutory offenses by subordinates, even if they themselves were not aware of any wrongdoing. 

For corporate officials, the RCO doctrine is dangerous because of its ability to sidestep the usual requirements that apply to holding corporate agents responsible. Moreover, from their viewpoint, the doctrine is troubling in that it extends statutory duties of legal entities to their “responsible corporate officers” as an additional class of defendants. Examined from a broader perspective, the RCO doctrine may also result in additional costs, contribute to overdeterrence, and undermine the notion of limited liability.

This Article explains how the RCO doctrine runs contrary to established tort, criminal, and corporate law principles and why it represents an unwarranted augmentation of corporate agents’ duties. It then proceeds to explain that current justifications of the doctrine are not convincing and explores the doctrine’s negative effects. Finally, the Article advances the idea of a “cautious approach” to applying the RCO doctrine, arguing that legislatures and courts should reduce the RCO doctrine to rare and clearly delineated instances of statutory liability for intentional or knowing misconduct.

Petrin, Martin, Circumscribing the ‘Prosecutor’s Ticket to Tag the Elite’ – A Critique of the Responsible Corporate Officer Doctrine (2012). Temple Law Review, Vol. 84, No. 2, p. 283, Winter 2012. Available at SSRN: http://ssrn.com/abstract=1808344

Reason argues Dodd-Frank conflict minerals rule has made bloodshed in the Congo worse

Reason:

According to a working paper from Dominic P. Parker of the University of Wisconsin and Bryan Vadheim of the London School of Economics, there's strong evidence to suggest that "conflict mineral" regulations in Section 1502 of Dodd-Frank directly led to an increase in looting in affected regions of the Congo. ...

n economics terms, Parker says, conflict mineral regulations converted many of the DRC's militia groups from "stationary" bandits, which extract taxes from people but otherwise do little harm, into what are known as "roving" bandits.

This, it turns out, is much worse for the people on the ground.

"The roving bandit doesn’t have a long-run stake in the economic productivity of a place," Parker says, "so he takes what he can get now with little regard for how his [ransacking and stealing] will affect future productivity."

Meanwhile, stationary bandits have every incentive not to hurt too many people.

Kindly go read the whole thing.

Update: Hans Bader also has a helpful summary analysis of the conflict minerals question.

Dodd Frank Invades Canada

My colleagues Steven Bank and George S. Georgiev teach executive compensation and corporate governance at the University of California, Los Angeles School of Law and are affiliated with UCLA’s Lowell Milken Institute for Business Law and Policy. They've got an op-ed in The Globe and Mail on how the SEC's new executive compensation rules will affect not just USA but also Canadian corporations:

The primary U.S. market regulator, the Securities and Exchange Commission, served up ... far-reaching rules on bonuses and other incentive-based compensation for all firms listed on U.S. stock exchanges, which include about 300 of Canada’s best-known multinational companies as well as more than 600 other international companies. This was a curious choice since the United States has traditionally allowed non-U.S. companies to follow their home-country rules on executive compensation and corporate governance instead of the SEC’s rules.

Even worse than the geographic overreach, however, is the fact the SEC’s new rules are likely to prove expensive, counterproductive and easy to manipulate. ...

Unlike U.S. companies, Canadian and other international companies have an even easier way out. They can simply choose to delist from U.S. exchanges and rely solely on their home-market listing. In fact, many non-U.S. companies did just that when they were faced with complex new corporate governance rules under the Sarbanes-Oxley Act in the wake of the Enron and WorldCom scandals of the early 2000s. Studies show that a U.S. listing confers advantages on non-U.S. companies, but the burden from the new rules may well outweigh these advantages, especially at a time when international markets are becoming increasingly competitive.

Of course, this is just one more example of the general phenomenon of which I wrote in Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010). Available at SSRN: http://ssrn.com/abstract=1696303:

During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.

Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.

This essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.

Apropos my earlier post re Sean Griffith

The trial lawyers whose oxen Sean is seeking to gore fought back by asking for the court's permission to depose Sean on his standing and the basis of his legal opinions. This sort of harassment is common when you've got rich lawyers going up against an underdog opponent (it's the discovery equivalent of a SLAPP suit). They try to make it too expensive for the underdog to vindicate his rights. (In my humble, First Amendment-protected opinion, of course.)

VC Glasscock shot down their request, refusing to order the deposition. Good man.

Sean Griffith is doing yeoman service to all shareholders, so the trial bar is out for his hide

Alison Frankel (behind Westlaw firewall):

Last week, I told you about Sean Griffith, a law professor from Fordham who is quite literally putting his money where his mouth is when it comes to M&A class action settlements that result only in additional deal proxy disclosures(and fees for plaintiffs lawyers). Since the beginning of the year, Griffith has invested in shares in 30 newly acquired companies - the very corporations that are likely to be targeted in shareholder M&A class actions. Griffith, who coauthored a 2015 paper for the Texas Law Review casting doubt on the benefits to shareholders from disclosure-only settlements, told me he acquired the stock portfolio with the express purpose of establishing standing to object to class action deals he considers inadequate.

Go get 'em, tiger, I'd say, as would any other right thinking person. ... But wait, the trial bar strikes back:

"Make no mistake," the brief [filed by Gucci-clad trial lawyers in the first suit in which Griffith filed an objection] said. "The objector's brief is not a disinterested amicus submission from a neutral academic. It is a slanted, partisan piece of advocacy that relies on half-truths, exaggerations and misleading omissions." Griffith's "scheme" of acquiring shares in recently acquired companies is "an attack on core Delaware policies" against buying shares in order to sue, plaintiffs said. And the professor's filing is part of "a promotional campaign ... to force a debate on his policy ideas (and, perhaps, to highlight his expert-witness credentials and fortify a supplemental income stream)."

Me thinks the sharks doth protest too much.

Personally, I'm rooting for Sean and I hope more people decide to start taking on the trial lawyers pezzonovante. They're been on Easy Street far too long.

Paid law student externships? Why not? So go tell the ABA.

From Robert Anderson:

The American Bar Association Section on Legal Education and Admissions to the Bar has published a series of proposed changes to the rules for law schools. One of them is a change to "Interpretation 305-2" (current 305-3), a change that would repeal the current ban on law schools giving academic credit for field placements (i.e., externships) for which law students are paid. The current Interpretation prohibits your law school from giving you credit for paid work experience, no matter how practical the experience gained or how closely related to your proposed area of practice. The proposed change would lift this prohibition to allow law schools to decide whether to offer such credit.

I don't think I need to remind you that law school is expensive and that most students graduate with debt, often substantial debt. One of the best things a law student can do during law school is to work at a law firm to gain practical experience and defray some of the costs of tuition and living expenses. I have found that students' paid work experience often provides them with deep and valuable understanding in areas of the law that I teach, and often when a student has a truly interesting insight in one of my classes, it came from that student's paid law firm work. The opportunity to combine paid work and law school credit would be an ideal "bridge" to practice that would give students valuable contacts and experience in the real world while decreasing the cost of law school.

Unfortunately, a small but organized minority of law professors don't want you to be able to be paid for work and receive academic credit at the same time, and they are the ones being heard by the ABA. The Clinical Legal Education Association (CLEA) and the Society of American Law Teachers (SALT), which are special interest groups that advocate for the interests of law school professors, are lobbying the ABA to try to stop it from allowing you to receive pay and credit for the same externship. CLEA is very experienced at this sort of lobbying, regularly pressuring the ABA to add requirements to accreditation that pile on more tuition cost for law school students. These groups are adding insult to injury by depriving law students of the opportunity to defray some of the cost they themselves have created by preventing students from taking paying jobs and simultaneously earning law school credit.

Go read the whole thing and then take Prof Anderson's advice:

I encourage all interested law students and recent graduates to make their voices heard (whether you agree with me or not) by submitting a comment to [email protected], even though the "deadline" for comment has passed.

Frankel on Pritchard on Newman

Alison Frankel reports:

Law professor Adam Pritchard of the University of Michigan has done Judge Rakoff one better. In a draft version of a paper to be published later this year in the SMU Law Review, Pritchard delved into the papers of Justice Lewis Powell, author of the Supreme Court’s Dirks opinion, to conclude that the 2nd Circuit’s interpretation of what constitutes a personal benefit for tipsters “is consistent with, if not compelled by, the rule laid down in Dirks.”

Kindly go read the whole thing and then follow the link to Pritchard's paper.

Delaware Chancery Court Nixes Two M&A Settlements in Two Days

Alison Frankel has the details.

Did the irrepressible Judge Rakoff just create a circuit split on personal benefit in tipping cases?

Alison Frankel thinks not.

Does the business judgment rule subsume DGCL section 141(e): Updated

I'm pondering the relationship between the business judgment rule and Section 141(e) of the Delaware General Corporation Law. As I understand it, the business judgment rule is a broader defense than is 141(e). In other words, it is possible for directors to be unable to rely on an expert opinion, thus losing the statutory defense, but still have made a sufficiently informed to get BJR protection. But is the converse true? Imagine a board that was grossly negligent in gather information, but did get expert advice from a properly chosen expert and the board made sufficient inquiry of that expert to satisfy the requirement that they rely in good faith. Would the board be protected by 141(e) even though the business judgment rule would not protect them? Logically, it would seem that the answer must be yes if 141(e) is to have independent role, but the case law I've found provides no clear answer.

Thoughts?

Bill Klein sent along these thoughts:

I find the question puzzling by virtue of its lack of concreteness. It seems to me the question must posit a situation in which the expert opinion covers an aspect of the matter to be decided that is significant but still narrower than the entire matter. For example, suppose that the question is whether, and at what price, to sell a subsidiary and that the major asset of the subsidiary is an office building. The board is protected in reasonably relying on the opinion of a properly chosen expert as to the value of the building but could be exposed to liability for ignoring other relevant factors (e.g. tax effects).  The useful function and effect of 141(e) is that the value of the building is not a basis for liability; it drops out of the case.

But doesn't that read "fully" out of the statute?

Joel Feuer sent along a link to this Sadden client memo, which posits:

Section 141(e) protects the conscientious director’s pocket book. And narrowly interpreting “fully protected” permits judicial monitoring of director decision-making regarding certain important corporate circumstances, where a higher standard of review than the less stringent traditional business judgment standard should apply because those circumstances place inherent pressures on director motivations and conduct. If accomplishing this requires burdening conscientious directors with the risk, and on occasion the reality, of “no fault fiduciary duty breach,” it’s a price worth paying, isn’t it?

I, for one, do not think so. In any event, it is a question worth debating. Directors have a genuine interest in their reputations — as do the companies they serve. And Delaware also has an important interest in not having directors who have acted conscientiously, in reliance on advice and information on which they are statutorily permitted to rely, be found to have committed the ultimate directorial bad act — a breach of fiduciary duty — based on the misconduct of experts on which the directors were entitled to rely. Delaware should encourage the service of conscientious directors. The best way to do so is by really “fully protecting” them — including from a finding of fiduciary duty breach when they act conscientiously in accordance with the requirements of §141(e), and from the reputational stain such a finding would represent.