By Peter J. Henning
Insider trading cases are sometimes as simple as a well-timed phone call warning an investor to bail on a stock before impending bad news.
The indictment this month of Rep. Chris Collins, R-N.Y., his son Cameron Collins, and the father of Cameron Collins’ fiancee is a good reminder of that.
Collins was a director and a large shareholder of Innate Immunotherapeutics Limited, an Australian drug company. He is accused of alerting his son and Stephen Zarsky, the father of Cameron’s fiancee, to impending bad news from the company. While Collins did not sell any shares of Innate Immunotherapeutics after receiving the information, his son and Zarsky did, avoiding more than $700,000 in losses. All three have pleaded not guilty.
An insider trading violation does not require the source of the information to trade on it. The law requires only that the government show the information was given to others with the intention that they trade on it and that the tipper received a benefit, which can be something as simple as cash or a gift to family or friends.
But insider trading law has followed a rather tortuous path over the past few years. Figuring out what was required to prove tipping of inside information was a challenge to prosecutors.
The most recent opinion from the U.S. Court of Appeals for the Second Circuit in Manhattan, where the Collins case will be heard, made life a bit easier for federal prosecutors and the Securities and Exchange Commission to pursue insider trading charges.
In June, the appeals court issued a revised opinion in United States v. Martoma, a case involving a former investment manager at SAC Capital Advisors, Steven Cohen’s now-defunct hedge fund group. Mathew Martoma was convicted of using inside information about a failed drug trial to avoid losses and rack up gains of more than $250 million.
Martoma challenged his conviction on the grounds that he did not have a “meaningfully close personal relationship” with the source of the information, a doctor involved in the drug trial. That requirement came from a Second Circuit decision in 2014 that roiled insider trading law and what qualified as a benefit.
In that decision, United States v. Newman, the Second Circuit overturned the convictions of two hedge fund managers who received the information from other investors and never dealt directly with the insiders providing the disclosures. The court held that the benefit to the tipper must involve an exchange of something of pecuniary value – like money or property – and that it was not enough to show just “the mere fact of a friendship, particularly of a casual or social nature.”
The personal relationship requirement would have made proving a benefit in insider trading cases more difficult because it required showing more than a casual friendship between the source and the recipient of confidential information.
The Supreme Court declined to review the Newman decision, but in United States v. Salman, it rejected one aspect of the appeals court’s ruling. It stated the benefit need not involve something of pecuniary value. The Supreme Court, however, did not address the “meaningfully close personal relationship” requirement outlined by the Second Circuit. That left its status as an element to prove insider trading unclear and complicated figuring out what was left of the Newman decision.
The first time the Second Circuit reviewed Martoma’s case in August 2017, two appeals court judges ruled that the Supreme Court had effectively overturned the entirety of the Newman opinion, so the “meaningfully close personal relationship” requirement was gone. A vigorous dissent from the third judge in the case pointed out that the Salman decision never mentioned this requirement and argued that the majority had overreached in their decision.
Two months ago, the appeals court judges revised that opinion. They pulled back from claiming the Supreme Court had scuttled the Newman ruling in its entirety and held that the “meaningfully close personal relationship” requirement was merely one way of proving the benefit to a tipper. An intent to benefit the recipient of the information, known as the “tippee,” was enough to prove insider trading. The appeals court went so far as to say that giving information to a “perfect stranger” by saying “you can make a lot of money trading on this” would be enough to hold the tipper liable. That’s a far cry from any meaningful personal relationship.
The revised Martoma decision means the government needs to prove only that Collins intended to benefit his son, who in turn sought to help Zarsky, the fiancee’s father, by passing on the information.
The Collins indictment indicates the case will be circumstantial, built around the timing of a series of telephone calls the congressman made to his son while he was attending a picnic at the White House.
According to the indictment, Innate’s chief executive emailed Collins and other directors to inform them that a trial for the company’s only drug had failed, which was sure to drive the stock price down. Within a few minutes, Collins called his son. Cameron Collins then quickly visited Zarsky, and they put in orders to sell their shares the next morning. That kind of timely trading – they avoided losing hundreds of thousands of dollars after shares tumbled more than 90 percent – can be powerful evidence of insider trading.
To strengthen the case, prosecutors included false-statement charges against the three defendants, accusing them of lying to FBI agents who interviewed them about the trading. That charge is designed to discourage the defendants from taking the witness stand because it would require them to explain statements that likely were at least misleading, and perhaps total falsehoods, which could effectively destroy their credibility as witnesses.
The Martoma decision makes proving an intent to benefit the linchpin of the government’s case. A father helping his son avoid losing hundreds of thousands of dollars is a powerful motive to disclose confidential corporate information. That may be enough for a jury to infer that the telephone call from Collins is sufficient to show he passed along confidential information, even though there is no evidence of what the men actually said to each other.
These charges are typical of an ordinary insider trading case involving tipping, with the added advantage for prosecutors that there are close relations among the defendants, which makes proving the benefit element fairly easy.
Collins has dropped his re-election campaign, although in a statement he said he would “continue to fight the meritless charges brought against me and I look toward to having my good name cleared of any wrongdoing.”
After the Martoma decision, that will be no easy task.