On Monday, a jury convicted Doug Whitman of insider trading, extending the government’s unbeaten streak in its recent sweeping crackdown on insider trading, which has resulted in more than 75 convictions and guilty pleas. In this recent round of insider trading cases, brought by the United States Attorney’s Office for the Southern District of New York beginning in 2009, juries have rejected practically every defense proffered by defendants. In the case against hedge fund billionaire Raj Rajaratnam, the jury rejected Rajaratnam’s “mosaic defense,” a theory that sought to justify Rajaratnam’s trades on the basis that the confidential information he received was publicly available in news and analyst reports. In the government’s insider trading case against Rajat Gupta, a former Goldman Sachs director convicted of revealing confidential information to Raj Rajaratnam, a jury rejected Gupta’s arguments that others at Goldman Sachs were responsible for conveying confidential information to Rajaratnam, and that Gupta did not receive any benefit by conveying non-public information to Rajaratnam. And, last Thursday, Doug Whitman became the first insider trading defendant in this recent round of cases to testify in his own defense. Some believed that Whitman’s testimony could be effective in providing jurors with an explanation regarding whether Whitman actually relied on non-public information in making his trades. But the jury rejected Whitman’s testimony—Whitman was convicted after less than a day of deliberations.
In the aftermath of these convictions, defendants and defense lawyers have been left to wonder whether they stand any chance to defeat an insider trading charge. One defense—endorsed last year by a federal appellate court—may well resonate with jurors in a way that other defenses have not. Last September, a federal appellate court held in United States v. Gansman—a case in which my firm appeared as counsel of record—that a rule promulgated by the Securities and Exchange Commission (SEC Rule 10b5-2) recognized an often unstated reality: that family members and close personal friends have legitimate expectations of confidentiality in their communications. The Court found that under SEC Rule 10b5-2, it is not illegal or improper to convey non-public information to a person with whom you maintain a “relationship of trust and confidence,” particularly where the parties have had a “history, pattern, and practice of exchanging confidences.” Put differently, SEC Rule 10b5-2 allows those accused of improperly conveying non-public information to argue that although they conveyed the non-public information, they did so pursuant to a “relationship of trust and confidence,” and therefore, had an expectation that the recipient of the information would not use it to trade securities. This defense reflects the real-world view that those with access to non-public information may, in the course of their communications with spouses, family members, and close friends, reveal confidential information, but not for the purpose of trading securities.
In the year since this defense has been recognized, not a single insider trading defendant has invoked it. The defense could have had potential appeal in the Rajat Gupta case, if there had been evidence to support its applicability. Although Gupta and Rajaratnam were once close friends, the evidence at trial showed that they had had a falling out at the time of Rajaratnam’s trades. If they had remained close friends during the period when Gupta conveyed the information to Rajaratnam, Gupta could have argued that although he conveyed confidential information to Rajaratnam, he did so pursuant to a relationship of trust and confidence and an expectation—forged by their years of friendship—that Rajaratnam would have maintained the confidentiality of that information. That defense could have presented jurors with a legal and factual basis to justify why Gupta conveyed non-public information to Rajaratnam in the first place, a fact that ultimately proved difficult for Gupta to contest given wiretap evidence and phone records strongly suggesting Gupta conveyed non-public information to Rajaratnam.
While a defense under SEC Rule 10b5-2 may be more applicable to defendants charged with wrongfully conveying the non-public information, rather than to those charged with trading on the basis of the information, given the government’s success rate beating back other proffered defenses, it is critical for defense lawyers keep this potential defense in mind when handling an insider trading case.