In United States v. Rajaratnam, No. 11-4416-CR, 2013 U.S. App. LEXIS 12885 (2d Cir. June 24, 2013), the United States Court of Appeals for the Second Circuit upheld the conviction of Raj Rajaratnam ("Rajaratnam") for insider trading, holding that a jury instruction that the non-public information obtained by Rajaratnam "was a factor, however small" in his decision to purchase stock was proper as a matter of controlling Second Circuit law. The unanimous three-judge panel rejected Rajaratnam's argument that more of a "causal connection" between the inside information he possessed and the trades he executed was required. After discussing the separate issue of wiretapping evidence, the court analyzed and applied previous decisions to conclude that the district court's instruction was proper -- and, in fact, was more generous to Rajaratnam than the law required. This decision reaffirms that criminal liability for insider trading may lie simply for trading while in possession of material inside information, even if trade was not motivated by that inside information.
Rajaratnam founded and managed hedge funds known collectively as the Galleon Group. In 2009, Rajaratnam was indicted on five counts of conspiracy to commit securities fraud and nine counts of securities fraud for trading on inside information. At the end of a seven-week trial, the district court instructed the jury that it could convict if the “material non-public information given to the defendant was a factor, however small, in the defendant’s decision to purchase or sell stock” (emphasis added). After twelve days of deliberation, the jury returned a guilty verdict on all counts.
Rajaratnam appealed to the Second Circuit, arguing, in part, that the jury instruction allowed for conviction without the necessary finding of a causal connection between the inside information possessed and the trades executed. The Second Circuit rejected this argument.
The Court began by analyzing United States v. Teicher, 987 F.2d 112, 120-21 (2d Cir. 1993). In Teicher, the district court instructed the jury that "[i]t is sufficient if the government proves that the defendant purchased or sold securities while knowingly in possession of the material nonpublic information." Upon review, the Second Circuit enumerated the factors that weigh in favor of a "knowing possession" (as opposed to a "causal connection") standard. First, Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, require only that a deceptive practice be conducted in connection with the purchase or sale of a security. Second, a "knowing possession" standard is consistent with the truism that someone with a duty to hold material nonpublic information in confidence must either disclose or abstain from trading. Third, a "knowing possession" standard has the attribute of simplicity. The Second Circuit in Teicher explained that a "knowing possession" standard satisfies the "in connection with" requirement of the relevant statutes. Although that particular language in Teicher was dicta, in United States v. Royer, 549 F.3d 886 (2d Cir. 2008), the Second Circuit elevated the Teicher "knowing possession" standard to an applicable, precedential holding.
Rajaratnam argued that the United States Supreme Court's decision in CSX Transportation, Inc. v. McBride, 131 S. Ct. 2630 (2011), casts doubt on the law of the Second Circuit. In CSX Transportation, the Supreme Court addressed the causation element in the Federal Employers' Liability Act ("FELA"), holding that "a railroad worker need only demonstrate that the railroad's negligence 'played a part -- no matter how small -- in bringing about the injury.'" That the injury can "result in whole or in part from [the defendant's] negligence," the Supreme Court held, is reflective of the fact that FELA's causation requirement is "as broad as could be framed." The Supreme Court then went on to contrast the breadth of FELA's causation requirement with "traditional notions of proximate causation under the RICO, antitrust, and securities fraud statutes." Rajaratnam argued that this contrast in CSX Transportation necessarily lent itself to a causation requirement in securities cases more exacting than the Second Circuit's "knowing possession" standard. The Second Circuit rejected this argument, noting that the Supreme Court's reference to securities fraud statutes in CSX Transportation was accompanied by a citation to a civil securities fraud case (Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005)), not to a criminal securities fraud prosecution, making the distinction inapplicable.
The holding in Rajaratnam reaffirms the Second Circuit’s continuing application of the “knowing possession” standard in criminal insider trading cases, a standard less favorable to defendants than the “causal connection” standard Rajaratnam argued for and used in civil cases. It is worthwhile to note that the jury instruction given in the case was actually generous to the defendant when compared to what the statutes and existing Second Circuit standard require.