U.S. prosecutors may bring charges for ignoring the source of illegal information used for trading, an appeals court ruled in its second decision in as many days widening the scope and penalties for insider cases.
The ruling came in an appeal by Whitman Capital LLC hedge fund founder Doug Whitman. The U.S. Court of Appeals in New York yesterday rejected his argument that the judge improperly instructed the jury on how to consider the issue of willful blindness at his insider trading trial.
The ruling supports “the government’s most powerful prosecution tool,” said Benjamin Fischer, a partner at Morvillo Abramowitz Grand Iason & Anello PC who has written about insider-trading cases.
“The endorsement of the conscious avoidance theory will certainly embolden the government to rely upon it in securities fraud cases going forward,” Fischer said yesterday in a phone interview.
Whitman was sentenced to two years in prison for trading on illicit tips about Polycom Inc., Google Inc. and Marvell Technology Group Ltd. He said he’d received the information from his neighbor, former Intel Corp. executive Roomy Khan. The U.S. said he made $935,000 on the trades based on her tips, and those of Karl Motey, a consultant Whitman hired.
Whitman called Khan “Ms. Google” and told another witness that Khan “had a mole” at the company who provided her with information, the appeals court said. Jurors could “easily conclude that Whitman knew that Khan courted trouble.”
“Here Whitman’s own words were far more damning and provided ample factual basis for the conclusion that he could avoid positive knowledge that Khan and Motey used illegal channels to get confidential information only by deliberately closing his eyes to facts well known to him,” the court said.
The U.S. Securities and Exchange Commission won a ruling on Feb. 18 that may allow it to collect illegal proceeds from money managers who engage in insider trading even when their firms got all the profit.
The appeals court upheld a lower-court finding in an SEC lawsuit that Joseph Contorinis, an ex-Jefferies Paragon Fund money manager convicted of insider trading in 2010, must turn over $7.2 million he made for the fund and $2.5 million in interest.
The Feb. 18 decision could affect future insider trading cases and offers the government “another avenue” to put money managers on the hook for profits, said Marc Agnifilo, a New York defense lawyer who wasn’t involved in the case.
Khan was at the center of the biggest stock-tipping probe in U.S. history. A witness at Whitman’s trial, she twice pleaded guilty to passing inside information to Galleon Group LLC co-founder Raj Rajaratnam, now serving an 11-year prison term.
U.S. District Judge Jed Rakoff instructed jurors at Whitman’s trial that if they found the defendant took deliberate actions to avoid confirming “a high probability of wrongdoing,” they could find him guilty.
Whitman, testifying in his own defense, told jurors he never intentionally traded on nonpublic information and denied knowing the information from Khan and Motey was nonpublic.
His lawyers argued that in the absence of Whitman’s actual knowledge about the nature and source of inside information he’d received, jurors shouldn’t have been allowed to find him guilty of insider trading.
The appellate court, in rejecting his challenge to his conviction, said yesterday the “failure to question the suspicious circumstances establishes the defendant’s purposeful contrivance to avoid guilty knowledge.”
Fischer wrote in an article after SAC Capital Advisors LP fund manager Michael Steinberg was convicted of insider trading in December that the concept of conscious avoidance gives prosecutors an advantage at a time when public opinion has been against white-collar defendants and Wall Street traders. It gives the government the ability to argue that a busy trader making thousands of decisions a day didn’t do enough to determine the source of the information he was receiving, Fischer said.
“Professionals need to be aware of the fact that this endorsement of the conscious avoidance doctrine means the government will prosecute cases on the theory that they turned a blind eye to the wrongful conduct,” Fischer said.
The criminal case is U.S. v. Whitman, 12-cr-00125, U.S. District Court, Southern District of New York (Manhattan); the appeals case is U.S. v. Whitman 13-491, U.S. Court of Appeals for the Second Circuit (Manhattan).
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