In the summer of 1991, the United States Court of Appeals for the Second Circuit overturned the conviction, for stock manipulation, of a man named John Mulheren.
Mulheren was a stock trader who had been arrested three years earlier, at the behest of Rudolph Giuliani, then the U.S. attorney for the Southern District of New York. Although Mulheren’s actual indictment didn’t take place until a few months after Giuliani left office, the case was still considered part of his legacy. As U.S. attorney, Giuliani had gone hard at Wall Street, forcing a guilty plea from Michael Milken, the most important financier of his day, and getting Ivan Boesky, a well-known arbitrageur, to turn state’s evidence. According to The Los Angeles Times, by 1988, Giuliani had brought five times as many insider-trading cases as had ever been brought before in his district.
The Mulheren case spoke to another part of Giuliani’s legacy, however. There were examples of Giuliani forcing Wall Street executives to make well-publicized perp walks and then never bringing charges. Defense lawyers complained of heavy-handed tactics, and cases that were brought with scant evidence. Indeed, the evidence against Mulheren was so thin that the Second Circuit’s unanimous decision said that “no rational trier of fact could have found the elements of the crimes charged here beyond a reasonable doubt.” The New York Times described the ruling . and several other reversals that had preceded it . as a “stinging blow” to the U.S. attorney’s office.
On Wednesday, 23 years later, the very same appeals court made a very similar ruling in overturning the convictions, for insider trading, of two hedge fund executives, Anthony Chiasson and Todd Newman. This time the U.S. attorney for the Southern District was Preet Bharara, who, like Guiliani, has built his reputation by prosecuting Wall Street wrongdoing, primarily insider trading. He put Raj Rajaratnam, the hedge fund big shot, in prison for 11 years. He gained a conviction against Rajat Gupta, a former top executive at McKinsey, the august consulting firm. In all, Bharara has ensnared almost 90 people who have either been convicted of, or pleaded guilty to, insider trading.
But as the reversal on Wednesday suggests, Bharara, like Giuliani, has sometimes gotten out ahead of his skis, bringing indictments that were not necessarily warranted by the evidence. Judge Barrington Parker, who wrote the Second Circuit’s decision, was scathing in his appraisal of the evidence, saying that there was no proof that the two “tippees” (as they are called in the ruling) knew they were trading on insider information, or that the tippers, who worked at Dell and Nvidia, had received any personal benefit for their tips. The court reversed the case “with prejudice,” meaning that Bharara won’t be able to retry the two men.
Here is the dirty little legal secret about insider trading: It’s not always illegal. In fact, there is no law on the books banning the practice; rather, it comes under the general purview of securities fraud. Over the years, prosecutors and the Securities and Exchange Commission have worked to expand what constitutes insider trading . and there have been times when the courts have refused to go along. Indeed, in his ruling, Parker relied on Supreme Court decisions that an insider trade was against the law only if the tippees knew they were getting inside information . and that they also knew that the tipper got a personal benefit from his leak.
Yet in the cases of Chiasson and Newman, the original tippers were never prosecuted for insider trading. “That is what was so baffling,” said Peter J. Henning, a law professor at Wayne State University who writes the White Collar Watch column for Dealbook in The New York Times. “How do you not go after the tipper?” In effect, said Henning, you can’t have a corrupt tippee if you don’t have a corrupt tipper. What’s more, Chiasson and Newman received the information third- or fourth-hand, and they had no idea who the tippers were. So how could they know if the tippers had done something corrupt?
Does this mean that Chiasson and Newman were paragons of virtue? Not necessarily. They could very well have known they were trading on inside information. Even so, given the court’s definition of insider trading, they were free to trade on that information. That is what Bharara ignored in bringing those cases. (A third Wall Street trader, Michael Steinberg, who worked for Steven Cohen’s hedge fund, SAC Capital, is also likely to have his conviction reversed on the same grounds.)
At a Dealbook conference this week, Mary Jo White, the chairwoman of the S.E.C., fretted that the Second Circuit’s ruling was “overly narrow.” And, in his statement after the ruling, Bharara said that he feared it would “limit the ability to prosecute people who trade on leaked inside information.”
That’s true, of course, if you agree with their definition of insider trading. Unfortunately for them, the courts don’t.
