Just days before former hedge fund portfolio manager Mathew Martoma was charged with insider trading, a panel of insider trading experts was discussing the rise of cases, like Martoma’s, based on so-called expert networks.
That prescient discussion wrapped up a wide-ranging, day-long conference on Nov. 16 at Columbia University Law School, where practitioners, judges, professors and regulators discussed issues in insider trading that remain murky and often contentious 50 years after In The Matter of Cady, Roberts & Co., 40 S.E.C. 907 (1961), the landmark case that created modern insider trading law by holding that a person who obtains non-public information about a company must “disclose or abstain” from trading on it.
“While I would like to take credit for the foresight to know that the government was going to indict a very prominent individual a few days after my conference, I can’t claim that I had that foresight,” said Columbia Law School Professor John Coffee, who organized the conference. Coffee is a regular columnist for the Law Journal.
“The Past, Present and Future of Insider Trading: a 50th Anniversary Re-examination of Cady, Roberts and the Revolution It Began,” opened with a panel examining recent developments in the theory of insider trading, both in the U.S. and abroad.
Panelist Mark Pomerantz, a partner at Paul, Weiss, Rifkind, Wharton & Garrison, said he believed that the federal sentencing guidelines for insider trading are unduly harsh, beyond what is necessary for deterrence.
He also introduced a theme that would recur throughout the conference: the considerable disagreement about the theory behind insider trading.
He noted a “disconnection” between the legal theory judges often rely on, which holds insider trading to be primarily the misappropriation of insider information for personal profit, and the idea of ensuring a “level playing field” among investors, which enforcement agencies often use when talking to the public.
K&L Gates partner Stephen Crimmins said that because in civil litigation the Securities and Exchange Commission must prove its case only with a preponderance of the evidence, it is increasingly taking up “edgy” cases that push the envelope of insider trading, introducing “uncertainty” and “risk” for traders.
The effect, Crimmins said, has been a shift toward a model that requires all investors to be operating with a “parity of information,” regardless of how that information is obtained, which can leave investors “paralyzed.”
Edward F. Greene, a partner at Cleary Gottlieb Steen & Hamilton, said that, while practitioners might wish for a clear statute defining insider trading, no one expects Congress to pass one and few would trust Congress to “get it right” anyway.
The second panel examined the history of SEC enforcement.
Panelist Stanley Sporkin, a former federal judge in the District of Columbia, began by praising William Cary, the SEC’s chairman at the time of Cady, Roberts and several years thereafter, as a “modest man with a tremendous force” who launched the age of SEC insider trading enforcement. In the following decades, however, the SEC brought relatively few insider trading cases, stepping up its enforcement sharply only within the last few years.
“The problem that I see right now is that somehow the SEC got lethargic,” he said. As market players innovated and found new ways to profit, the SEC was playing “catch-up,” he added.
University of Rochester president Joel Seligman, an expert on securities law, added that the SEC, for much of that time, was working under administrations that did not make securities enforcement a high priority, giving it a “very narrow field in which to play.”
The recent wave of enforcement—57 insider trading cases in the last fiscal year alone—will raise “some very close questions about how far you can go” in suing for insider trading, Sporkin said.
‘An Unfair Advantage’
The third panel found the judge who sentenced hedge fund manager Raj Rajaratnam, the lawyer who prosecuted him and the lawyer who defended him discussing their experiences of that case.
Dechert partner Jonathan Streeter, formerly an Assistant U.S. Attorney in the Southern District of New York, said that, for all the theoretical complexity behind insider trading, he found it easy to explain his case against Rajaratnam to a jury.
“At the end of the day, you’re explaining to the jury that the defendant had an unfair advantage over ordinary investors,” he said.
John Dowd, a partner in Akin Gump Strauss Hauer & Feld who defended Rajaratnam, said that he finds the “elements of insider trading to be amorphous and to be slippery.”
He also lamented the importance of SEC rules in insider trading cases: “From my point of view, the policemen made the law.”
Former Southern District Judge Richard Holwell, now a partner at Holwell, Shuster & Goldberg, who presided over the trial, said he found tricky explaining to a jury the legal underpinnings of insider trading.
“I gave up pretty early on trying to write jury charges that are understandable,” he said.
The conversation then turned to the nuts and bolts of the Rajaratnam case, especially the prosecutors’ relatively new reliance on wiretaps. The wiretaps allowed Streeter to put together a chronology for the jury matching a series of recorded calls with trades Rajaratnam made soon after.
“When they finally got that chronology tightened up, it was like four or five more bricks on my back,” Dowd said.
Holwell said that wiretaps are enormously persuasive to juries.
“I think, in front of a jury, playing a wiretap of you calling your mother asking what’s for Sunday dinner sounds criminal,” he said.
Rajaratnam was ultimately sentenced to 11 years.
The related case of Rajat Gupta, a Goldman Sachs director who was charged with supplying tips to Rajaratnam, was the subject of a different panel. Southern District Judge Jed Rakoff, who presided over that case, was on the panel, along with Assistant U.S. Attorney Reed Brodsky and defense attorney Gary Naftalis, of Kramer Levin Naftalis & Frankel.
Early in that discussion, Coffee, who was moderating, noted that no defendant had ever beat insider trading charges in the Southern District.
“Are we kidding ourselves?” he asked. “Is it possible to win an insider trading case?”
Naftalis conceded that it would always be an uphill battle.
“There is a perception jurors have that there should be a level playing field of information, he said. Furthermore, he said, the media attention surrounding major insider trading cases creates a “toxic” atmosphere.
“I think it’s naive to think that jurors don’t respond to the high visibility nature of a case,” he said.
Brodsky countered that the government wins so often because it chooses cases it knows it has a good chance of winning.
Later in the panel, Coffee asked Rakoff about the disparity between Rajaratnam’s sentence of 11 years and Gupta’s sentence of two years.
Rakoff called the comparison between the two “preposterous,” noting that Rajaratnam had been convicted of far more instances of insider trading than Gupta.
Rakoff criticized the federal sentencing guidelines, which he said were unrealistically high and thus put “an immense amount of power in the hands of prosecutors” to influence the sentence by deciding how much to ask for. Both Rajaratnam and Gupta received sentences more lenient than the guidelines.
The day’s final panel was the first to include a representative of the SEC, Daniel Hawke, regional administrator for the SEC’s Philadelphia office. He was joined by Southern District Judge Denise Cote, Deutsche Bank general counsel Richard Walker, Crimmins and Sporkin.
The panel addressed a series of questions on the details of how investigations proceed—for example, when the SEC decides to approach the general counsel of a company after receiving a tip from a whistleblower, and when it orders a company to conduct its own investigation. Those measures are more common when the SEC’s resources are constrained, according to Hawke.
When asked how far the SEC could go in asking criminal prosecutors to hold off on prosecuting a case in order to encourage more cooperation, he said “not very far,” underscoring the separateness of the criminal and civil enforcement spheres.
Walker said that, as insider trading enforcement ramps up, corporate counsel must take whistleblowers seriously, whatever suspicions they might have about the person.
But much of the panel focused on the complexities of “expert network” cases, in which insider information is disseminated through research firms that ostensibly connect investors with industry experts. The complaint against Martoma alleges that Martoma obtained insider information about an experimental Alzheimer’s drug through such a firm, which the Wall Street Journal has identified as Gerson Lehrman Group.
Martoma made his first court appearance yesterday and was released on $5 million bail.
Because the flow of information in those cases is usually much less straightforward than an investor simply paying for tips, they will require more sophisticated investigations to uncover, the panelists agreed.
Coffee said after the panel that he believed the Martoma case was only the beginning.
“I don’t think these prosecutions are going to stop with Mr. Martoma,” he said, comparing the case to “pulling on a loose piece of yarn in a sweater.”
“I think we were holding this conference at exactly the right moment,” he said.
@|Brendan Pierson can be reached at firstname.lastname@example.org.