The Second Circuit Court of Appeals has broadened the Securities and Exchange Commission’s power to seek civil disgorgement of profits from insider trading violations even where an individual did not personally profit from the illegal trades.
In its panel opinion in SEC v. Contorinis, decided on February 18, the Second Circuit upheld a trial court order requiring that Joseph Contorinis, the former managing director of the Jeffries Paragon Fund, disgorge more than US$7 million in unlawful profits obtained by the fund as a result of Contorinis’s trading on material nonpublic information. This is despite the fact that he did not trade with his own personal assets and his personal compensation from the trades amounted to only US$427,875.
In a two-to-one vote, the Second Circuit panel rejected Contorinis’s argument that disgorgement is limited to personal, as opposed to institutional, profit on insider trading activity. The panel analogized the relationship between a fund manager and the fund to that of a tipper and a tippee, holding that “the district courts possess discretion to allocate disgorgement liability for insider trading to those responsible for the illegal acts, including to those with investment power over third-party accounts used to make illegal investments as well as to tippers.”
It is important to note, however, that the Contorinis panel “[did] not conclude that district courts must impose disgorgement liability for insider trading upon wrongdoers when the gains accrue to innocent third parties, but rather that the district courts may elect to do so in appropriate circumstances.” Even after Contorinis, disgorgement remains fundamentally an equitable remedy entrusted to the broad discretion of the district courts.
The Contorinis panel also recognized in a footnote that, “[c]ircuits which have considered related issues are mixed regarding the extent to which a party can be ordered to disgorge total gain from an unlawful act, when the party has not personally received the full benefit of the wrongdoing.” As an example, the panel pointed to SEC v. Blatt, 583 F.2d 1325 (5th Cir. 1978), which “vacated a district court’s order that individual, knowing participants in an illegal securities scheme [must] disgorge amounts beyond their personal gain.”
In addition, Contorinis appears ripe for en banc review by the full Second Circuit. In a strong dissent, Judge Denny Chin explained that the panel’s decision is inconsistent with the Second Circuit’s recent decision in the parallel criminal case, United States v. Contorinis, 692 F.3d 136, 145–48 (2nd Cir. 2012), which held that criminal forfeiture of ill-gotten gains is limited to a defendant’s individual gain. Notably, Judge Chin was also a member of the Second Circuit panel in the criminal case.
For now, however, Contorinis gives the SEC a powerful tool to impose considerably greater financial liability against fund managers and others who trade on behalf of third parties, including the investment entities that they own or that employ them, using insider information. It is also an open question whether the SEC will seek to apply this disgorgement holding in other securities fraud contexts.