Friday, December 12, 2014

Insider Trading Conviction Overturned

Insider Trading Conviction Overturned

The Second Circuit Federal Court of Appeals reversed the insider trading convictions of two hedge fund managers, Todd Newman and Anthony Chiasso.[1]    The appellate court ruled that the judge had failed to properly instruct the jury on a key element of the crime.  While the court acknowledged that officials at Dell and Nvidia improperly released material inside information, and that the managers had traded on the information, the court ruled the prosecutors had failed to show that Messrs. Newman and Chiasso knew that the corporate insiders released the information in order to obtain a personal benefit.

The problem was that the improper information moved through intermediaries before the hedge fund managers acted upon it.  Apparently the insiders leaked the information to brokerage analysts, who in turn leaked it to research analysts who worked for Messrs. Newman and Chiasso.  In other words, the managers were far enough removed from the improper information that they did not have the necessary and specific knowledge required to violate the law.

This decision is great news for money managers because it gives them a foolproof method of trading on inside information.   As long as they can create a series of intermediaries to filter inside information, they can trade on the tidbit without fearing the legal consequences.    In fact, it seems to me that the court has validated Stephen A. Cohen’s investment model.  Mr. Cohen put huge pressure on his analysts and brokerage analysts to provide him with actionable information and paid them well for their efforts.  However, he avoided dealing directly with the ultimate source of the information.

Congress could clarify and tighten the inside trading rules, but that isn’t going to happen. Under the new campaign limits, hedge fund managers will be able to invest $776,000 in Congressional races, which will ensure that the insider trading rules do not reach them.  The only hedge fund managers that will remain within reach of prosecutors will have to be reckless /or stupid.  If a hedge fund manager talks directly to insiders and bestows a benefit on the leaker, he’s still got a problem.  However, there’s no reason to ever have that conversation when you can pay intermediaries to do the dirty work.


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