Insider Traders Should Be Ready to Do Hard Time

The length of the sentences being meted out for insider trading have been on an upward trajectory lately, and recent decisions by federal appeals courts in Manhattan and Philadelphia will further that trend. The message some judges are trying to send is that being caught trading on confidential information can be very costly, far beyond the gains a defendant might realize.

Two recent cases illustrate that message. Zvi Goffer, who organized a ring of sources that used disposable cellphones for sharing tips, was sentenced to 10 years in jail. Matthew Kluger, a lawyer who funneled information from his law firms over a number of years, received 12 years. Both had challenged their sentences as unreasonably long compared with what others have received.

Mr. Goffer was convicted after trial of paying lawyers at Ropes & Gray for deal information that he then traded on and distributed to others. He was known by the nickname “Octopussy” because of the many connections he had to sources of inside information. Under the federal sentencing guidelines, his recommended sentence was 10 to 12 and a half years.

Mr. Kluger pleaded guilty to charges of passing information through a middleman to a trader, Garrett Bauer. Mr. Kluger is said to have gleaned the information from different law firms where he worked over a 17-year period. The three men were supposed to share the profits, but Mr. Bauer bought far more than he ever told the others, reaping total profits of over $47 million. Mr. Kluger’s recommended sentence was approximately 11 to 14 years.

The appeals courts rejected their challenges, making it clear that the wide judicial discretion in deciding the appropriate sentence is not constrained even if others received much lighter punishments for similar violations. The opinions emphasize the need for deterrence as a means to preserve the integrity of the financial markets by making it very costly to trade on inside information.

Sentences have grown longer in the last few years, in large part because of how the federal sentencing guidelines rely on the size the defendant’s gain or avoided loss as the primary determinant of the punishment. A profit of $1 million, for example, will result in a recommended sentence of at least four years in prison, while a $20 million gain can lead to a recommendation of more than 10 years.

Nor must the defendant personally receive the benefits of the illegal trading to risk a significant prison term. Mr. Kluger claimed that he had an agreement with his co-conspirators to limit trading to modest amounts to avoid detection, and that he was unaware of the outsize profits Mr. Bauer generated from the tips.

The United States Court of Appeals for the Third Circuit rejected the argument that Mr. Kluger should not be held accountable for unforeseen conduct by Mr. Bauer, stating that “we are sending a clear warning to individuals, such as Kluger, who, in an attempt to limit their responsibility and the extent of their potential sentencing exposure allege that they had agreements with their co-conspirators to cap the illicit gains.” In other words, a lack of honor among thieves is not a valid reason to reduce the punishment.

Some insider trading cases have resulted in sentences well below the punishment recommended by the sentencing guidelines. Judge Jed S. Rakoff of United States District Court in Manhattan, in particular, has been a strident critic of the use of gains and losses as the best measure of the appropriate sentence for economic crimes. He told an audience of white-collar defense lawyers that the federal guidelines should “be scrapped in their entirety.”

The aversion to the guidelines is one reason for the growing disparity in sentences in insider trading cases, even leaving aside light punishments for those who cooperate and receive little if any jail time. Judge Rakoff has routinely given sentences well below the guidelines recommendation. He sentenced Rajat K. Gupta to a two-year jail term rather than the recommended six and half years, while Winifred Jiau received a four-year sentence although the government had sought a 10-year prison term.

In his appeal, Mr. Kluger cited Judge Rakoff’s statement in the sentencing of Ms. Jiau: “There’s no way that I’m going to impose a guideline sentence in this case,” the judge said, “[because] the guidelines give a mirage of something that can be obtained with arithmetic certainty.”
The appeals court was not persuaded, however, explaining that there were good reasons Mr. Kluger’s case was qualitatively different from others, including that of Mr. Bauer, who received a nine-year prison term. The appeals court pointed out:

“It is really quite remarkable that Kluger could not even wait to graduate from law school before using his employment at a law firm to initiate his illegal activities, and it is equally remarkable that during most of his legal career he was involved in criminal activity, so that in an actual though perhaps not in a legal technical sense as the term is used in the sentencing guidelines, he truly was a career criminal.”

In Mr. Goffer’s case, the United States Court of Appeals for the Second Circuit rejected his argument that lighter sentences given in other insider trading cases made his punishment unreasonable. The appeals court explained that just because “some judges have chosen as a policy matter not to sentence white-collar criminals to the harshest permissible punishments, this does not entitle other white-collar criminals to lighter punishments than are reasonable under the Guidelines.”

Defendants have hoped that lighter punishments in other insider trading cases, coupled with accompanying criticisms of the sentencing guidelines themselves, would establish a ceiling on what is permissible. But these two appeals court decisions have largely squelched that position, making it clear that judges can be as tough - or lenient - as they see fit, so long as the particular sentence is justifiable under the circumstances.

One of the goals of Congress in adopting federal sentencing guidelines was to minimize the disparity in punishments for similar offenses, especially white-collar crimes. The Supreme Court’s decision in 2005 in United States v. Booker, in which the court determined that the guidelines were advisory rather than mandatory, has permitted judges more freedom to apply their own predilections, as Judge Rakoff and others have done in insider trading cases.

As a result, the potential sentence is much more difficult to determine in advance. The appeals court decisions involving Mr. Goffer and Mr. Kluger show that the assignment of a case to a particular judge, which is done at the beginning of a prosecution, can have a significant effect on the eventual punishment if the defendant is convicted.