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Second Circuit Affirms Insider Trading Conviction

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Rejecting the defendant’s argument that the government failed to introduce sufficient evidence at trial of his criminal intent to engage in insider trading, the Second Circuit in United States v. Klein1 recently held that the jury was presented with extensive circumstantial evidence supporting its conclusion that the defendant’s comment to his financial adviser about King Pharmaceuticals’ (“King”) ongoing merger talks with Pfizer constituted material non-public information and that the defendant intended for his financial adviser to trade in King securities.  This case serves as an important reminder that even an offhanded remark can unleash a chain of events culminating in a regulatory enforcement action and/or criminal prosecution.

Factual Background

In 2016, a grand jury charged patent attorney Robert Schulman and his financial adviser, Tibor Klein, with securities fraud in violation of section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder and conspiracy to commit securities fraud in violation of 18 U.S.C. § 371.  Klein moved to sever his trial from Schulman’s, which the district court granted.  Schulman proceeded to trial on March 6, 2017.

The evidence adduced at trial established that Klein had been Schulman’s investment adviser since 2000 and that the two, along with Schulman’s wife, became friends.  In early August 2010, Schulman, who had been representing King in a patent lawsuit, had learned from one of his partners that King and Pfizer were engaged in merger discussions.  This partner had directed Schulman to keep this information confidential.

Less than 10 days later, on August 13, 2010, Klein had dinner with the Schulmans and spent the evening at their home.  During this evening, Schulman commented to Klein, “boy it would be nice to be king for a day.”  The Securities and Exchange Commission (“SEC”) deposed Schulman in 2012 and asked him about his conversation with Klein that evening.  In his SEC testimony, which was admitted at trial, Schulman conceded that he made this remark to Klein, but insisted he did not communicate that King and Pfizer were meeting about a potential merger.  Rather, Schulman characterized his statement to Klein as “a joke” and that he was “telling him, like acting like I am a big shot and I know this thing.”

Three days later, Klein told a friend he had inside information, expressly saying that “Pfizer’s buying King Pharmaceuticals.”  Both Klein and his friend began executing trades in King securities.  Klein bought almost $600,000 in King shares for his various clients, including about $27,000 in purchases for the Schulmans.  After Pfizer announced its acquisition of King in 2010, Klein sold the King shares he had purchased for himself and his clients for a substantial profit; the Schulmans made over $15,500, a return of over 50% in less than two months.  Klein’s friend also sold the stock and options he purchased for a profit of $110,000.  Following the SEC’s investigation into these transactions, Klein’s friend admitted liability and agreed to cooperate with the U.S. Attorney’s investigation into this matter by testifying for the government at Schulman’s trial.

Legal Discussion

Following his conviction, Schulman moved for a judgment of acquittal pursuant to Rule 29 of the Federal Rules of Criminal Procedure.  Schulman argued that “no reasonable jury could have inferred that he told Klein more than the ‘king for the day’ comment and that no reasonable jury could have found that he had intended for Klein to trade on it.”  2019 WL 149629, at *4.  The district court denied the motion and sentenced Schulman to three-year period of probation, 2,000 hours of community service, a $50,000 fine and forfeiture of the profits he made on the sale of his King securities.  See id.  Schulman appealed the judgment of conviction to the Second Circuit.

In affirming Schulman’s conviction, the Second Circuit began its analysis noting that “[i]n an insider trading case, the government must prove that the insider will personally benefit from the disclosure to the tippee.”  2019 WL 149629, *4, citing United States v. Martoma, 894 F.3d 64, 73 (2d Cir. 2017).  The Court further observed that the “[p]ersonal benefit requirement can be established in a number of ways, including by illustrating the nature of the relationship between the tipper and the tippee or the tipper’s receipt of something of value.”  Id., citing Martoma, 894 F.3d at 79.  

The tipper’s purpose is a critical component to the government’s burden of proof.  The government must establish that the tipper disclosed material non-public information “with the expectation that the tippee will trade on it.”  Martoma, 894 F.3d at 79; see also United States v. Gansman, 657 F.3d 85, 92 (2d Cir. 2011) (“In prosecuting a putative ‘tipper’ under the misappropriation theory of insider trading, the government must prove as an element of the offense that the tipper conveyed material non-public information to his ‘tippee’ with the understanding that it would be used for securities trading purposes.”).

Under this legal standard, the Second Circuit concluded that the government readily met their burden.  Specifically, the court held that the evidence supported the jury’s conclusion that the “king for the day” comment was a direct reference to King Pharmaceuticals, opining that common sense “would lead a rational juror to conclude that Schulman had to have communicated additional information to Klein for Klein” to convey to his close friend that he was in possession of “inside information” about King and Pfizer.  Klein, 2019 WL 149629, at *5.  The court also held it was rational for the jury to conclude that Schulman intended for Klein to trade in King securities in that Klein did so within two days following the receipt of information from Schulman about the King/Pfizer merger.  See id.  The court held this inference was proper despite the fact that there were no communications between Schulman and Klein in the months following Schulman’s disclosure of inside information.  See id.  

Key Takeaway

This case is yet another example of the government’s commitment to pursue insider trading cases vigorously – both civilly by the SEC and criminally by the Department of Justice (“DOJ”).  As the New Year begins, the outcome in Klein should serve as an important reminder to our clients, particularly our corporate and institutional clients, to review their insider trading policies and to ensure that both new and existing employees have received the proper training on such policies.  The disclosure of inside information – even an offhanded remark – that prompts trading activity can spawn the SEC and/or the DOJ to investigate, resulting in civil enforcement action, or even worse, criminal prosecution. 

If you have any questions about your insider trading policy or you have questions about the type of training that would be helpful to your organization on this topic, we are happy to assist.

United States v. Klein, No. 17-3355, 2019 WL 149629, (2d. Cir. Jan. 10, 2019).

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