US v. Richard Lee: Surprising Revelations, and Another Case Invalidated Due To Lack of a ‘Personal Benefit’ Element
On June 21, 2019 Judge Paul G. Gardephe vacated the guilty plea of Richard Lee, despite the plea occurring nearly six years earlier. The judge’s decision and analysis in this case reveal important information regarding when material, non-public information can be considered public information, and a re-affirmation that the ‘personal benefit’ element is separate and distinct from the breach of confidentiality fiduciary duty element.
A quick note before we begin. I can’t believe I have to say this but Richard Lee and Richard “Choo-Beng” Lee are NOT the same person! Sloppy reporting from journalists and other blog posts from practicing attorneys have confused the two. Both were traders for SAC, and both were convicted of insider trading during the financial crisis investigations but let me clear — they are two entirely different people with two different cases!
In July 2013, Richard Lee pled guilty to conspiracy to commit securities fraud and securities fraud in violation of 15 U.S.C. and 17 C.F.R. Lee worked as a portfolio manager at SAC Capital Advisors in New York from April 2009 through May 2011. In his plea, Lee confessed to trading while in possession of MNPI that he “knew, or had reason to believe, other persons had breached a fiduciary duty or duty of confidentiality,” on three separate occasions.
Lee admitted trading Yahoo’s stock on insider information in April 2009 when, “somebody i knew provided me with a copy of an earnings release for Yahoo Incorporated before that earnings release was made public.” He also traded Yahoo in July 2009 (discussed below) and 3Com in November 2010 using insider information.
Lee admitted that he knew “it was wrong for me to trade” on all three occasions.
In his recent motion, Lee attempted to use a three-pronged strategy to invalidate his 2013 guilty plea. (1) Lee claimed that newly discovered evidence how research firm Collins Stewart released the information regarding the potential Microsoft-Yahoo merger to its clients well before he spoke to their analyst privately shows that Lee did not commit insider trading since the information was already public and thus he was ‘actually innocent’. (2) If Lee had been aware of this evidence he would not have plead guilty. (3) In any event, the guilty plea is insufficient due to developments in insider trading law. Judge Gardephe’s response to Lee’s alternate pleadings are explored below.
I. The majority of Judge Gardephe’s decision is spent on the Yahoo insider trading event on July 10, 2009. Around 9:13 a.m. Lee learned through an intra-firm instant message at SAC that investment research firm Collins Stewart was advising its clients that a Microsoft-Yahoo merger would likely occur within approximately two weeks. This prompted Lee to begin buying up hundreds of thousands of shares of Yahoo. Around 11:39 a.m. Lee personally talked to Sandeep Aggarwal, the Collins Stewart analyst who had made the call and received insider information regarding a potential Microsoft-Yahoo merger. Aggarwal disclosed to Lee that his source was a ‘high-level’ close friend at Microsoft who gave him the information regarding the merger. After talking privately to Aggarwal, Lee increased SAC Capital’s Yahoo position further, and Lee admits he purchased 25,000 Yahoo shares for himself.
Judge Gardephe analyzes the fine line between public and non-public information to invalidate prong one of Lee’s guilty plea. Although Collins Stewart had disseminated the information regarding the proposed Microsoft-Yahoo merger to its numerous traders and clients in an email blast, Lee received significantly more detailed information than the Collins-Stewart clients via his one-on-one call with Aggarwal (the “Aggarwal call”) and thus was not factually innocent.
The most striking point is Judge Gardephe’s curious view regarding when insider information disclosed to the marketplace becomes public information, and is thus tradeable. In several previous cases, courts have looked at this issue (in a notably different manner).
In Contorinis, the court ruled that information is public if it is known by only a few securities analysts or professional investors, because their trading will set a share price incorporating such information.
In SEC v. Mayhew, the court ruled that information is public when it is disclosed to the general public without favoring any particular group, or a few people trading on that information has fully impounded the information into the share price.
Gardephe’s dicta analysis helps to flesh out the two step Mayhew test to determine whether information is public or non-public, and therefore whether subsequent trading is considered legal or insider trading.
Under Gardephe’s approach, if information is impermissibly acquired, then it must be (1) disclosed to the general public AND not favor any ‘special person or group’, OR (2) if it does favor a particular person or group, the trading has caused the information to be ‘fully impounded into the price of the particular stock’ (quoting Dirks).
The key words here are fully impounded. During the morning of the Collins Stewart blast to clients, the price of Yahoo stock was rising, suggesting other people were buying on the illicitly obtained Microsoft-Yahoo merger information, but the share price had not yet fully adjusted to this information since it kept on rising after Lee’s trades. In other words, illicit information is only considered fully impounded into the share price once the price stabilizes, and trading on non-public information before such stabilization could be considered insider trading.
In light of the fact that Lee had more specific illicit information than the Collins Stewart clients via the Aggarwal call, and the information was not fully impounded into the share price, the judge did not have to delve too deeply into this factual analysis and ruled that Lee possessed and traded on non-public information, and therefore cannot claim ‘actual innocence’. Basically, Lee fails both parts of the two step trading test determined by Mayhew.
II. The second part of Lee’s alternative pleading is that he would not have pled guilty if he had been aware of the fact that Collins Stewart had disseminated the proposed Yahoo-Microsoft merger information to all of their clients. What Lee means by this is he would not have admitted guilt to his other Yahoo earnings trades and 3Com trades, which are separate incidents from the Yahoo-Microsoft merger trades (the FBI had withheld the information during discovery), if he knew that the case against him on the Yahoo Merger trade was wasn’t as strong as he initially believed when he pled to it. Gardephe views this as an argument of regret, and regret is not enough to withdraw a guilty plea in his opinion.
III. The third part of Lee’s defense is that due to subsequent changes in judicial interpretation of insider trading laws, his guilty plea is factually insufficient since it does not address the required ‘personal benefit’ element.
In Newman, the court ruled that if there is absence of proof regarding whether the tippee knows of the personal benefit received by the insider in exchange for the information, then the government cannot meet its burden of proof that the tippee knew of a breach.
The Newman court summarized the elements of insider trading as follows: “to sustain an insider trading conviction against a tippee, the Government must prove each of the following elements beyond a reasonable doubt: that (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit.”
The Court noted that the Newman standard has been partially abrograted by Salman and clarified in Martoma citing Martoma’s very broad standard that “a jury can infer that a corporate insider receives a personal benefit… from deliberately disclosing confidential information without a corporate reason and with the expectation that the tippee will trade on it.”
Gardephe found no proof that Lee had knowledge of any personal benefit whatsoever for either the Yahoo or 3Com corporate insiders who originally divulged the illicit information. Indeed, there is no proof that Lee even knew who these insiders were, nor any proof who they first divulged the information to.
Therefore, due to lack of proof regarding personal benefit accruing to the corporate insiders, the judge ruled that Lee’s guilty plea was factually insufficient.
“There is no reason to believe that Lee — in using the phrase ‘breach of fiduciary duty’ during his 2013 allocution* — understood that phrase to include the liability components” in the later decisions, Gardephe wrote. “His guilty plea must be vacated.”
KEY POINT: From a compliance perspective, and as a former portfolio manager and attorney with 20+ years experience in markets, Judge Gardephe’s dicta in the case is fairly shocking. Had you told me on the desk that a sell-side blast to institutional clients could still be deemed, ‘restricted’ and illegal to trade upon 2 hours later with the speed and spread of information these days, I’d be surprised to put it mildly.
However, as the court notes, “This evidence does not demonstrate that the information Lee obtained prior to the Aggarwal Call was public at the time he received it. There is, for example, no evidence as to how many or which Collins Stewart clients received this information, or when they received it. Accordingly, there is no basis for this Court to find that the information Lee obtained had been widely disseminated. Moreover, any disclosure that was made by Collins Stewart was made to a “special group” — Collins Stewart’s clients.
UPDATE: At a conference last week, both sides postured as expected. The government voiced that it intended to bring Mr. Lee to trial and Lee’s attorneys articulated they’re ready to dig in for a fight. His lawyer, Greg Morvillo, said he never got crucial evidence in the case and may make another motion to set aside the criminal complaint Lee pleaded guilty to in 2013.
Judge Gardepehe deferred on setting a trial date because Morvillo said he has to see discovery (he says he never got it because it was only a criminal complaint and there was no indictment when he pleaded out). Meanwhile, the lawyer for Aggrawal (Lee’s alleged tipper) was in court monitoring, but did not reveal his client’s intentions.
Lee’s only successful outcome here is getting the case dropped. Since he didn’t pay a large financial penalty or do any prison time, a felony plea would leave him in the same position he’s in now. Then again, does he have enough financial wherewithal to hire Morvillo for a full trial and really want to risk prison time if he loses? So it’s an interesting game theory case study at this point.
KEY TAKEAWAY: While these types of situations will hopefully be limited to the known disclosure of illicit information, it does open up a rather sizable can of worms for the broader trading landscape.
What if the news appears to be incorporated, i.e. the share price stabilizes and/or trades down for a period of time but then resumes its climb after a brief plateau?
Does a resumption in the advance turn seemingly legal trading thought to be fully impounded illegal again? As you can see, it can be a very difficult, fact specific standard.
Previously, a blast from a sell side analyst was usually deemed fully impounded or public information in short order. Every portfolio manager and academic is quite familiar with the Efficient Market Hypothesis (while at the same time, being appropriately skeptical of its validity as it would mean active portfolio management can’t possibly work). Market participants have seen for years first-hand that markets incorporate information quite quickly (especially in today’s age of high frequency and algo trading).
Prior to Gardephe’s decision, I think most lawyers, PMs and compliance officers would’ve scoffed at the notion that 2 hours (or even 20 minutes) after a sell-side blast to institutional clients, that the stock price would not have ‘impounded’ the new information.
Fortunately Gardephe didn’t have to tackle these questions in earnest as it was clear that the Collins Stewart analyst provided Lee in their one-on-one call with significant additional illicit details above and beyond his client-wide blast, including that his source was a “senior level person at Microsoft” who is “like a brother to him” and that their relationship was clearly much more than a professional one.
The court notes, “Aggarwal thus provides Lee with specific information regarding his well-placed Microsoft source, as well as details regarding the high-level talks then taking place between the two companies. Accordingly, even assuming arguendo that the information Lee received before the Aggarwal Call was public, after the Aggarwal Call Lee possessed material non-public information, and he nonetheless ordered another 25,000 Yahoo shares for SAC Capital’s account and 25,000 Yahoo shares for his personal account.”
After the Gardephe decision, trading restrictions for inadvertent or intentional disclosures may have to be notably longer and wider than previously thought to allow the potentially illicit information to be fully incorporated into the share price.
*Allocutions can be tricky. In my case, Gautham Shankar, a former Goldman analyst and prop trader pled guilty to receiving illicit information in 3com that, “he now knows was acquired in breach of a fiduciary duty.” Judge Sullivan performed a kick-save on that allocution by appropriately noting that insider trading law is not determinant on what a defendant knows at the allocution (after the FBI has played tapes and showed why, when and where the information comes from), but at the time the defendant made the trade. Judge Sullivan asked Shankar whether he indeed knew at the time, and Shankar rephrased his plea to Sullivan’s satisfaction. He also went ahead and allocuted to insider trading in Avaya at the behest of the prosecutor and the FBI lead case agent. Embarrassingly, it was discovered later that the tipper didn’t have any illicit knowledge of Avaya, and it was just purely circumstantial good fortune that Shankar bought Avaya before it received a takeover offer (or bad fortune, if you consider that it heightened his ‘person of interest’ target profile).