The Justice Department has had a perfect record in winning insider trading cases since it began its most recent campaign in 2009. Now, it will put that record to the test as the trial of Michael S. Steinberg, a former portfolio manager at SAC Capital Advisors, begins this week. The case will highlight the crucial issue in most white-collar crime prosecutions: What did the defendant know about the illegal nature of the transactions?
The government’s proof hinges largely on the testimony of a cooperating witness that Mr. Steinberg understood he received tainted information from a source who should not have been revealing it. In this case, the star witness will be Jon Horvath, a former SAC analyst who pleaded guilty in 2012 to insider trading charges.
Mr. Steinberg is accused of being a “tippee†in the parlance of insider trading, which means he received confidential information from someone who improperly disclosed it. Mr. Horvath admitted he got tips about negative earnings announcements from sources inside Dell and Nvidia, a graphics chip maker, that he forwarded to Mr. Steinberg.
At Mr. Steinberg’s direction, SAC then bet that the two companies’ stock would fall once the information became public.
Proving that a tippee violated the law requires the government to jump through more hoops than in cases in which the insider personally trades on the information. The leading case on this issue is Dirks v. SEC, in which the Supreme Court laid out a three-part test for liability.
Under the Court’s analysis, the government must prove (1) an insider breached a fiduciary duty by disclosing confidential information (2) in exchange for a benefit that (3) the tippee knows, or at least should know, was provided improperly. It is this third step that will be at issue because Mr. Steinberg denies knowing there was any impropriety in what Mr. Horvath told him about the impending announcements at Dell and Nvidia.
The Justice Department has won cases against tippees that relied primarily on the testimony of cooperating witnesses. In December 2012, two hedge fund managers, Anthony Chiasson and Todd Newman, were convicted of trading in Dell and Nvidia after receiving the same confidential information that Mr. Horvath passed along.
An interesting twist in Mr. Steinberg’s case is that others at SAC, including the firm’s founder and owner, Steven A. Cohen, had communications with Mr. Horvath and sold Dell shares but were not charged. The defense wants to raise questions about whether Mr. Steinberg should have known the information was passed along improperly if someone else who received it was not accused of insider trading.
The government filed a motion to block the defense from offering SAC trading records for Gabriel Plotkin, another SAC portfolio manager, whose fund sold a block of its Dell shares after he received an email from Mr. Horvath indicating that the company’s earnings announcement would be negative. Mr. Plotkin has not been accused of any wrongdoing and is not expected to testify. Prosecutors argue that Mr. Plotkin’s trading is irrelevant to what Mr. Steinberg knew about the source of information provided by Mr. Horvath.
In the email to Mr. Plotkin, which was also sent to Mr. Steinberg, Mr. Horvath said that he had a “2nd hand read from someone at the company†about issues with Dell’s revenue. Mr. Plotkin replied that he had gotten similar negative views before “so we will have to see.†He then directed the sale of 300,000 shares, but continued to maintain a substantial investment in the company.
The email is equivocal about whether that Mr. Horvath was passing along information obtained improperly from a corporate insider, which is necessary to show Mr. Steinberg’s knowledge. An earlier email to Mr. Steinberg asked him to “keep the DELL stuff especially on the down low†after Mr. Horvath received the confidential information and the two men spoke by telephone. The emails and telephone call are potentially incriminating because they can show that Mr. Steinberg was aware the information was confidential, but they are not conclusive evidence that he knew Mr. Horvath obtained it improperly.
The issue is whether Mr. Plotkin’s receipt of the same information and his subsequent trading might undermine Mr. Horvath’s credibility on whether a recipient should have known the information was disclosed in a breach of a fiduciary duty. Mr. Steinberg’s attorney argued in a filing that the trading records can show to a jury “the lengths†to which Mr. Horvath “was prepared to go (i.e., to lie) in order to persuade the government that the ‘2nd hand read’ email was so obviously referring to illegal inside information that it caused Mr. Plotkin to reverse his long position.†In other words, if Mr. Plotkin has not been charged for insider trading after receiving the Dell information, what makes Mr. Steinberg different?
How much about his source Mr. Horvath was willing to share with Mr. Steinberg will be crucial to proving knowledge. The emails can help to back up Mr. Horvath’s claim that he had information he should not have received. But sharing the same information with another portfolio manager who questioned its strength could be a basis for the defense to raise a reasonable doubt with the jury about what Mr. Steinberg should have known about it.
Any case that turns on the credibility of a witness who made a deal with the government entails some risk that the jury will find that the person was only saying what the prosecution wanted to hear. In insider trading cases, that is especially true when equivocal email messages indicate that something is afoot, but do not clearly establish the tippee’s knowledge about the impropriety of the information.
The potential for jury bias because of publicity surrounding SAC’s recent plea agreement to settle criminal charges related to the same trading has been raised again by the defense, which fears that Mr. Steinberg will be tainted by the firm’s admission. Judge Richard J. Sullivan of the Federal District Court in Lower Manhattan rejected a request to delay the trial for three months to allow the news about SAC to dissipate. He did agree to individually question potential jurors exposed to publicity regarding insider trading cases to ensure there is no bias against the defendant.
The Justice Department’s string of victories will be tested in Mr. Steinberg’s case because there is no way to know how Mr. Horvath will come across to the jury. That makes the issue of potential bias so important. The defense will make much of the decision to cooperate, trying to portray Mr. Horvath as a liar out to save his own skin by pointing the finger at Mr. Steinberg.
