Will Rajat Gupta be able to overturn SEC’s seriously adverse decision? We will not know the answer till the Appeals Court delivers its ruling and that ruling is probably 6-8 months away.
It is the opinion of Gurumurthy Kalyanaram that the Second Circuit has been adopting an increasingly expansive view of what is required to establish civil liability for insider trading.
A clue to the Appeals Court’s thinking and precedent on this matter is evident in its Contorinis decision. The following analysis of Contorinis decision has been provided by Joel Haims, Kayvan B Sadeghi of Morrison &Foerster LLP.
On Feb. 18, 2014, the Court of Appeals for the Second Circuit affirmed an order requiring Joseph Contorinis to personally disgorge more than $7 million in insider trading profits realized by a fund he co-managed, even though he did not personally receive those profits. In doing so, the court continued its expansive reading of civil liability for insider trading. In 2012, in SEC v. Obus, the Second Circuit held that actual knowledge of a breach of a duty was not required to establish civil liability for either a tipper or a tippee.
The recent Second Circuit opinion arose out of a subsequent civil lawsuit brought by the SEC seeking disgorgement from Contorinis of the profits obtained by the Paragon Fund. The district court granted summary judgment for the SEC and ordered disgorgement of $7,260,604, reflecting the fund’s profits, prejudgment interest of $2,485,205 on the entire disgorgement amount, and a civil penalty of $1 million. Contorinis appealed the judgment insofar as it required him to disgorge the amount obtained by the Paragon Fund and related prejudgment interest, arguing that it was a misapplication of the principle of disgorgement.
The court ruled that the arguments for disgorgement under the facts before it, of a tippee trading for the benefit of others, was even stronger than the case for disgorgement against a tipper. A tipper may not know the extent to which the tippee will trade, and thus would have no idea of the potential exposure to disgorgement. In contrast, Contorinis “controlled the size and timing of the trades” and received financial and other reputational benefits from the trades.
Notably, the court made clear that disgorgement of gains that accrue to innocent third parties was not mandatory, but rather within the discretion of the district court. The court remarked on disgorgement’s remedial purpose: “disgorgement is imposed not to punish, but to ensure illegal actions do not yield unwarranted enrichment” — and held that "[d]istrict courts possess the equitable discretion to determine whether disgorgement liability should fall upon third parties or violators."
The implications of Contorinismay also be informed by Rajat Gupta's appeal of the $13.9 million civil penalty assessed against him for providing information to Raj Rajaratnam, which is presently before the Second Circuit. There, the court assessed no disgorgement, but rather a civil penalty of three times the relevant trading profits gained by Rajaratnam, even though Gupta received no profits himself. If the lower courts read Contorinis to mean that insider traders may liable for profits they did not personally receive, Gupta may soon inform whether and when they can also be held liable for multiples of that amount.
Contorinis is the most recent reflection of the Second Circuit’s broad view of civil liability for insider trading. As such, it may embolden the SEC’s pursuit of insider trading cases and of civil recoveries beyond the reach of criminal forfeiture of personal profits, and extending to any profits channeled to others. And with another high-profile civil insider trading case on its docket, we can expect to hear more from the Second Circuit in the near future.