Appeals Court Raises Doubts About Government’s Insider Trading Case

Preet Bharara’s perfect record, 80 insider trading convictions without a single defeat, is on thin ice.

The federal appeals court in Manhattan on Tuesday picked apart the government’s case against two former hedge fund traders, Todd Newman and Anthony Chiasson, questioning whether the judge who presided over the trial erred in his instructions to jurors. Over an hourlong hearing, a three-judge panel signaled it might overturn the convictions, which would represent the first crack in Mr. Bharara’s sweeping campaign as United States attorney to root out insider trading in the hedge fund industry.

Just seconds after the prosecutor arguing the appeal introduced herself, the judges grilled her about the case and implied that Mr. Bharara’s office steered insider trading trials to Judge Richard J. Sullivan, who oversaw Mr. Chiasson’s and Mr. Newman’s trial and a subsequent case against another trader. The questioning appeared to send a cautionary message to Judge Sullivan, who is known for often siding with the government, and took a swipe at prosecutors for cherry picking judges.

Judge Barrington Parker â€" interrupting the prosecutor, Antonia M. Apps â€" referred to Judge Sullivan as the government’s apparent “preferred venue” for insider trading cases. While Ms. Apps argued that consolidating the cases created “judicial efficiencies,” another member of the appellate panel noted the “sheer coincidence that the judge who bought into the government’s theory was the one” assigned to the recent trials.

The appeal by Mr. Chiasson and Mr. Newman, which could take months to decide, has captivated the white collar bar. An overflow crowd, including top prosecutors and defense lawyers, attended the hearing in Lower Manhattan.

A victory for Mr. Chiasson and Mr. Newman would offer a blueprint for traders to defend future cases and imperil at least one other milestone conviction: Michael Steinberg, of SAC Capital Advisors, the once-giant hedge fund that Mr. Bharara indicted last year. When Judge Sullivan presided over Mr. Steinberg’s trial late last year, he provided a similar jury instruction as the one for the trial involving Mr. Chiasson and Mr. Newman.

Unlike other judges in insider trading trials, Judge Sullivan did not require jurors to conclude that Mr. Newman and Mr. Chiasson knew how insiders at two technology companies were leaking information in exchange for some personal benefit. Judge Sullivan’s instructions, the defense lawyers contended, ran afoul of a 30-year-old United States Supreme Court ruling that helped define insider trading. At a minimum, the lawyers have argued in court papers, the flawed instruction warrants a new trial, if not having the convictions thrown out altogether.

“Judge Sullivan left a piece out of the equation,” Mark Pomerantz, a lawyer at Paul Weiss who represents Mr. Chiasson, told the panel. Mr. Pomerantz likened it to the government claiming there was an egg salad sandwich without proving that there were any eggs.

The argument appeared to strike a chord with the judges, whose nonstop questioning of Ms. Apps contrasted with their scant interruptions of Mr. Chiasson’s and Mr. Newman’s defense lawyers. When the hearing ended, lawyers filed out of the courtroom buzzing about the prospect of the panel overturning the convictions.

But the appeal before the panel, which also included Ralph Winter and Peter Hall, is hardly a slam dunk. It is unclear whether the Second Circuit Court of Appeals, a court known for siding with the government and has rejected every other insider trading appeal filed during Mr. Bharara’s tenure, will take the rare step of narrowing what constitutes insider trading. A panel’s questioning in oral arguments does not always foreshadow the ruling.

To sow some doubt about the appeal, Ms. Apps pointed in the oral arguments to other cases that support Judge Sullivan’s jury instruction. And even if the appellate court takes issue with the instruction, prosecutors say that the error was “harmless.” The “harmless error” claim, which often resonates with appellate courts, amounts to legal parlance for a minor mistake given the overwhelming weight of evidence presented at trial.

After a five-week trial in late 2012, a jury convicted Mr. Newman and Mr. Chiasson for participating in what prosecutors called a “circle of greed” that generated more than $60 million in illicit gains. Judge Sullivan sentenced Mr. Newman, 49, to four and a half years in prison, while Mr. Chiasson, 40, received a six-and-a-half-year sentence. The appellate court allowed both defendants to remain free on bail while awaiting the outcome of their appeal.

Mr. Chiasson and Mr. Newman were far removed from the leaks at the two companies, the computer maker Dell and the chip maker Nvidia. Prosecutors placed them at the end of a four- or five-person chain of information that started with insiders at Dell and Nvidia and wound its way through a network of traders. While the prosecutors conceded that neither Mr. Chiasson nor Mr. Newman had any direct dealings with the Dell and Nvidia employees who leaked earnings information about the two companies in 2008, they accused the men of knowing that the information was too confidential to be shared legitimately.

Mr. Chaisson and Mr. Newman counter that they had assumed the information stemmed from legitimate, yet select, disclosures from Dell and Nvidia. Big companies, they said, routinely leak information to major investors.

At Dell, the leaks came from Rob Ray, an employee in the computer maker’s investor relations department. Mr. Ray shared information with a former colleague, Sandeep Goyal, who in turn passed the tips on to two analysts who worked with Mr. Chiasson and Mr. Newman at their respective hedge funds. Mr. Goyal and the former analysts â€" Jesse Tortora, who worked with Mr. Newman at Diamondback Capital Management, and Spyridon Andondakis, who worked for Mr. Chaisson at Level Global Investors â€" socialized together in Manhattan and the Hamptons. They went on to plead guilty and testify against their former bosses.

Lawyers for Mr. Newman and Mr. Chiasson note that prosecutors never charged Mr. Ray, even though the prosecution of insider trading requires proof that someone like Mr. Ray wrongfully disclosed secret information in a breach of a duty to his employer. In other words, if the source did not break the law, the traders should not be held liable.

Stephen Fishbein a partner at Shearman & Sterling representing Mr. Newman, argued that Mr. Ray was not charged “because there is not sufficient evidence of a breach or a benefit.”

Their appeal also hinges on what the Supreme Court intended in a 1983 ruling, Dirks v. the Securities and Exchange Commission, that said a trader can only be guilty of insider trading if he knew or should have known the corporate insider leaking the information was breaching a duty to the company. When defining a breach, the court explained that “the test is whether the insider personally will benefit,” adding that “absent some personal gain, there has been no breach of duty.”

The gain can be as overt as cash â€" or, in the case of Mr. Ray, as subtle as career advice from Mr. Goyal. Either way, the court ruled, there had to be a quid pro quo when releasing the inside information.

At the hearing on Tuesday, defense lawyers argued that Judge Sullivan’s instructions tainted the verdict because he allowed the jurors to convict Mr. Chiasson and Mr. Newman without finding that the men knew of any quid pro quo. A proper instruction, the lawyers say, could have led to an acquittal since Mr. Newman and Mr. Chiasson were unaware that Mr. Ray received career advice from Mr. Goyal.

The argument gained traction in the defense bar. Before the hearing on Tuesday, the National Association of Criminal Defense Lawyers filed a supporting legal brief calling Mr. Chiasson and Mr. Newman “remote” participants who largely were unaware of the original source of the information or even the intent of the leaker. The association contends that if the conviction of Mr. Chiasson and Mr. Newman was upheld, it would have a chilling effect on Wall Street analysts and their ability to gather information about a company.

The judges seized on the vague nature of what constitutes a personal benefit â€" and the impact it might have on Wall Street. Judge Parker questioned the “amorphous theory” underpinning some of the government’s case, noting an air of uncertainty hangs over Wall Street about just what constitutes illegal trading.

To illustrate his point about career advice being an unlikely benefit, Judge Parker questioned whether Ms. Apps would consider a suggestion that she stand closer to the courtroom microphone a beneficial piece of advice.

“I’m not sure that’s good career advice,” Ms. Apps quipped in reply, prompting an uproar of laughter in the courtroom. And Judge Parker noted that the advice was hypothetical; she was doing well.

Despite the apparent skepticism of the panel, some legal experts said that the prosecution still has a good case. Alafair S. Burke, a professor of criminal law at Hofstra University School of Law and a noted writer of crime novels, said the ruling in Dirks v. S.E.C. only requires prosecutors to establish that a trader knew or had a reason to know a person might get a benefit for passing on insider information. She said the jury instruction preferred by the defense lawyers would put “too high a burden on the government.”

Underscoring the importance of the appeal, Mr. Bharara’s top lieutenants attended the hearing: Richard B. Zabel, Lorin Resiner and Joon Kim grabbed seats in an overflow room adjacent to the courtroom. Nearby was David Chaves, an F.B.I. agent who supervised some of the insider trading investigations.

With their freedom hanging in the balance, Mr. Newman and Mr. Chiasson both attended the hearing on Tuesday. Mr. Chiasson sat next to his wife.

Mr. Steinberg, the SAC trader who is scheduled to be sentenced by Judge Sullivan next month, did not attend. But his lawyer, Barry Berke, was seated inside the courtroom.

When Ms. Apps exited the courtroom, she flashed a smile. Despite the interrogation, two of the judges applauded her performance, saying she had done just “fine.”