Misguided Prosecutions and Washington “Gaffes”

There’s a well-known saying in Washington that the definition of a “gaffe” is when a politician inadvertently tells the truth. Assistant Attorney General Leslie R. Caldwell is not a politician, but she had her own “Washington gaffe” moment earlier this month while speaking on a panel sponsored by the Federalist Society (YouTube video available here).

Caldwell, who serves (for a few more weeks, at least) as the head of the Criminal Division at the U.S. Department of Justice, appeared on the panel with four white collar defense attorneys on December 8 at the Washington Press Club. The topic was overcriminalization – not as in too many criminal statutes being on the books, but overcriminalization in the form of federal prosecutors bringing cases that never should have been pursued as criminal matters.

The defense attorneys on the panel had represented corporate and individual defendants in recent major cases involving FedEx, a medical device company called Vascular Solutions, and pharmaceutical company Warner Chilcott. Those cases ended either in acquittals or, in the case of Fed Ex, with the government dismissing the case mid-trial. Each defense attorney told a version of the same basic story: the prosecution was an outrageous miscarriage of justice, criminal charges never should have been filed or even considered, and no one within the relevant prosecutor’s office had been willing to give the defense a fair hearing about why the case should not be indicted.

When AAG Caldwell took the podium as the final speaker, she appeared to throw her colleagues in the U.S. Attorneys’ Offices under the proverbial bus. She went out of her way to distinguish the Criminal Division at Main Justice in DC from the ninety-four U.S. Attorney’s Offices around the country. She said that while the attorneys in the Criminal Division operate with professionalism and integrity, she has seen “wide variation around the country” in the U.S. Attorney’s Offices in terms of their level of experience and quality of supervision.

Although not commenting on the specific cases discussed by the other panelists, AAG Caldwell agreed that sometimes cases get filed that should not have been filed; “I’m not going to dispute that.” She discussed a couple of additional examples where U.S. Attorney’s Offices had proposed misguided prosecutions. In one instance, prosecutors wanted to indict two partners at a law firm for obstruction of justice for seeking additional time to respond to a grand jury subpoena; in another, prosecutors proposed to charge all the adult residents of a small town in a RICO conspiracy. Because RICO cases and indictments of attorneys — unlike most cases — require review by Main Justice, those cases were able to be quashed by the Criminal Division.

Finally, Caldwell encouraged defense lawyers who believe prosecutors are pursuing inappropriate cases to seek review by Main Justice if they cannot get their concerns addressed. She said the Criminal Division recognizes that “not all U.S. Attorney’s Offices are created equal,” and that defense attorneys should not hesitate to go over the U.S. Attorney’s head and appeal to Washington in appropriate cases.

Caldwell’s suggestion that prosecutors in the U.S. Attorney’s Offices around the country do not always measure up to those in her own Criminal Division apparently did not sit well with her Justice Department colleagues. Two days later she issued a letter of apology to all DOJ attorneys. She wrote that while speaking at the panel she had defended the Department “in a way that inappropriately suggested that the care taken by U.S. Attorney’s Offices and others in making prosecutorial decisions was less than that taken by attorneys in the Criminal Division.” She said she deeply regretted the remarks, which she called “a mistake.”

doj seal

Caldwell’s Comments: Mistake or D.C. Gaffe?

For AAG Caldwell to make her points in that particular forum and format may indeed have been a mistake – but was she wrong?

Before considering that, a couple of observations about the panel discussion. First, the Federalist Society’s agenda was pretty transparent, and the ratio of four defense attorneys to one prosecutor was not exactly an attempt to be “fair and balanced.” The defense attorneys were naturally presenting the details of their cases from their own perspective. They did prevail, so no doubt their claims have some merit. But there are always two sides to such stories, and I think it would be surprising if the facts were indeed so black and white. The panel would have been more interesting if prosecutors in some of those cases could have been persuaded to participate and explain why they believed the case was justified.

Second, as one of the panelists pointed out, there are between eighty and ninety thousand criminal defendants prosecuted each year by the Department of Justice and all but a relative handful end up with either a guilty plea or a conviction at trial. So while talking about a few high-profile cases where the defense prevailed is interesting and worthwhile, it would be wrong to conclude that those cases represent anything close to the norm. As they say in journalism, no one writes stories about all the planes that don’t crash. Examples where the prosecution’s case falls apart are interesting and newsworthy in part because they are so unusual.

But back to AAG Caldwell’s comments. It really shouldn’t be controversial to admit that occasionally cases get filed that should not be filed. Law is a human enterprise and thus inherently flawed. There are thousands of prosecutors working for the Department of Justice across the country on tens of thousands of case each year. People sometimes are going to screw up.

It also should be relatively uncontroversial to observe that the U.S. Attorney’s offices vary in terms of their levels of experience and quality. Those offices operate with a great deal of autonomy, and are staffed by individuals with varying backgrounds and experiences from different parts of the country with different legal communities and traditions. Obviously some offices are going to be better run and more experienced than others.

With relatively few exceptions, AUSAs are free to investigate and indict their cases with no oversight from D.C. I don’t know whether the average line attorney in the Criminal Division in Washington is smarter than the average AUSA around the country, but I do know the attorney in Washington is going to have his or her cases supervised and reviewed by veteran prosecutors who have seen many similar cases and issues in the past. That level of seasoned review and quality control is not always available within every U.S. Attorney’s Office, where they may not see nearly as many large or complex cases.

It’s not fair to suggest that Main Justice itself is immune from making mistakes or bringing bad cases, but I think it’s perfectly fair to suggest that such cases are more likely to originate in the U.S. Attorney’s offices.

So although I’m sure she wishes she had phrased them differently, I think AAG Caldwell’s comments were basically correct. And they highlight an issue I think DOJ needs to take seriously: a need for renewed focus and training nationwide on the sound exercise of prosecutorial discretion.

Emphasizing the “Discretion” in Prosecutorial Discretion

There have been a number of high-profile examples recently of cases that appear to have involved bad charging decisions. If the government loses, as in the cases discussed during the Federalist Society panel, that is generally the end of it — other than providing great war stories for defense counsel. But when the defendant in such a case is convicted, the government is faced with defending its charging decisions on appeal. As I wrote in this recent post, that has led the U.S. Supreme Court recently to question whether prosecutors can be trusted to exercise their discretion appropriately.

For example, in Bond v. United States a woman who was angry at her husband’s lover sprinkled a caustic chemical on her doorknob and mailbox, which caused a minor skin irritation easily treated with cold water. Federal prosecutors responded by charging Bond with a felony aimed at punishing the use of chemical weapons. In Yates v. United States, a commercial fisherman received a civil citation for catching several dozen undersized red grouper and was ordered to take the fish back to port to be seized by authorities. When instead he threw the fish overboard, he was indicted for obstruction of justice under a statute that carries a maximum twenty-year penalty. Both these cases made it to the Supreme Court, and in both cases the Court expressed incredulity that prosecutors had chosen to bring the charges.

Cases where inappropriate charges are filed do not cast the Department of Justice in a favorable light. For the individual defendants, of course, they can result in tremendous injustice, which is contrary to DOJ’s fundamental mission. And if courts lose faith in the judgment and charging decisions of prosecutors, they will try to find ways to rein the government in – even if, as in Yates, that means adopting an interpretation of a statute that seems contrary to its plain language and common sense. This can make it more difficult for all prosecutors to do their jobs.

Members of the Federalist Society panel also talked about prosecutor myopia, where prosecutors could only see the facts a certain way and remained convinced, up to the end, that their cause was righteous. I think this is a real phenomenon; those who are trained in criminal prosecution may tend to see criminal remedies as the best option. As the saying goes, when your only tool is a hammer, every problem looks like a nail. But particularly when it comes to white collar crime and regulatory offenses, it’s critical for prosecutors to recognize there are many possible alternative remedies and that criminal prosecution may not be the best solution.

Cases like Yates, Bond, and those discussed at the Federalist Society panel, along with AAG Caldwell’s observations about the varying levels of experience within the U.S. Attorney’s Offices, suggest that DOJ could benefit from a renewed emphasis on the proper exercise of prosecutorial discretion. Washington may not be able to review all proposed indictments, but Main Justice could ensure that all prosecutors around the country are thoroughly trained in the “discretion” aspect of their jobs.

Prosecutors need to know the criminal law, of course, but they also need to have hammered into them, from day one, that deciding when not to apply criminal law is a huge part of their jobs. All prosecutors know this on some level, but there’s a difference between knowing it and having it ingrained and repeatedly stressed as a part of your professional identity and institutional culture. If there is too much emphasis on indictment numbers and “stats,” prosecutors may lose sight of the fact that often they are doing their jobs by declining to file charges, even after a lengthy investigation.

It’s not unheard of for prosecutors and investigators who have worked on a case for months or years to “fall in love” with their case or their witnesses and lose some ability to evaluate it objectively. That’s where some level of review by experienced and uninvolved prosecutors could be particularly useful.

I think it would be interesting if DOJ established some more formal mechanism whereby defense attorneys like those who appeared at the Federalist Society panel could obtain Main Justice review of proposed major indictments they feel are misguided. Currently defense attorneys can try to seek such a review, but there is no official process and no guarantee that anyone will listen. It would be easy for such a system to be abused, of course, and so setting up guidelines might be tricky. But if there were some official avenue for review of major cases, perhaps some mishaps such as those discussed by the panel could be avoided.

If inappropriate cases get filed it isn’t good for anyone: certainly not for those charged, not for the Department of Justice that ends up with a black eye, and not for the justice system as a whole. The culture within any institution is set at the top, and the Department of Justice needs a culture that emphasizes the importance of the sound exercise of prosecutorial discretion. If DOJ recognizes, as AAG Caldwell observed, that not all U.S. Attorney’s Offices are created equal and some lack appropriate expertise and experience, it would be wise to take some nationwide steps to remedy that situation and provide some safeguards.

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The Supreme Court, Salman, and Insider Trading: Why Stock Tips Make Bad Stocking Stuffers

Almost exactly two years ago, this blog posed the following question in a post about insider trading:

Suppose your brother-in-law has too much eggnog at Christmas dinner and starts blabbing about confidential inside information concerning the company where he works. If you trade the company’s stock based on that information, do you risk finding a subpoena from the SEC in your stocking?

Last week, in Salman v. United States, the Supreme Court provided some answers to this holiday conundrum. The bottom line: insider stock tips still make lousy holiday gifts.

Image of the bull on Wall St., home of insider trading

The Standards for Tippee Liability: Dirks v. SEC

Salman involves a subspecies of insider trading called “tippee” liability. Insider trading is defined as buying or selling securities based on material, non-public information, in violation of a duty of trust and confidence. Corporate insiders and others who acquire company secrets may not use that information to enrich themselves in violation of a duty owed to the source of the information.

But the ban on insider trading would be easily evaded if a corporate insider, forbidden to trade herself, could simply tip off an outside friend or family member and encourage them to trade instead. Accordingly, in some circumstances such tippees may themselves be charged with insider trading.

The Supreme Court first addressed tippee liability in Dirks v. SEC in 1983. Dirks held that a tippee who does not owe a direct duty to shareholders may nevertheless be liable for insider trading, but only if: 1) the tipper was violating a duty by providing the information; and 2) the tippee knew or should have known about that violation.

Whether the tipper was violating a duty, the Court said, turns on the purpose of the tip: “[T]he test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach [by the tippee].”

The Court recognized that potential benefits to tippers are not limited to monetary gains and may include reputational benefits or other intangibles. In particular, a benefit could be inferred when an insider “makes a gift of confidential information to a trading relative or friend.”

An important aspect of the Dirks test, therefore, is determining whether the tipper received a personal benefit sufficient to find a breach of duty. The Court took the Salman case to shed some light on how courts should approach this question.

Teeing up Salman: The Second Circuit’s Newman Decision

To fully appreciate Salman one must first consider the U.S. Court of Appeals for the Second Circuit’s 2014 decision in United States v. Newman, the subject of my post two years ago. Corporate insiders in Newman had disclosed confidential information to several securities analysts who passed the information along to others, including the defendants.

After they were convicted for trading on that information, the defendants appealed and argued the government had failed to satisfy both prongs of the Dirks test: they claimed there was insufficient evidence the insiders had received a personal benefit in exchange for the tips and thus violated their duty, and even if they did, there was no evidence the defendants knew about that violation.

The Second Circuit agreed that the government’s evidence of personal benefit to the tippers was inadequate. The government had argued that one tipper received occasional career advice from an analyst to whom he leaked information, while the other tipper and another analyst were social friends who attended the same church.

The Court agreed that “personal benefit” could include intangible benefits, but this did not mean the government could simply establish that the tipper and tippee were friends. If that were sufficient this requirement would practically disappear, because at least a casual friendship between tipper and tippee probably exists in almost all such cases.

Accordingly, the court held, proof of a personal benefit requires evidence of a “meaningfully close relationship [between tipper and tippee] that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”   The evidence in Newman did not meet that standard, and so the court reversed the convictions.

The Supreme Court turned down the government’s request to review Newman, but then just three months later it granted certiorari in Salman, a Ninth Circuit case that also raised the “personal benefit” issue. (I wrote about Salman at the time, in a post you can find here.)

Image of street sign for Wall Street, the home of insider trading

Salman: What Qualifies as a Benefit to the Tipper?

Salman represents the Supreme Court’s first foray into tippee liability since Dirks. Maher Kara, a Citigroup investment banker, repeatedly passed confidential information about upcoming mergers and acquisitions to his brother Michael, knowing that Michael would use it to trade. Michael, in turn, shared the information with Bassam Salman, a close friend whose sister was married to Maher. Salman made more than $1.5 million by trading on these tips before the scheme was discovered. He was convicted of insider trading and sentenced to 36 months in prison.

On appeal to the U.S. Court of Appeals for the Ninth Circuit, Salman urged that court to apply Newman to overturn his conviction. Salman argued that Maher, the tipper, was simply helping his brother out and did not receive anything of a “pecuniary or similarly valuable nature” in exchange. Under the Newman test, he claimed, that meant no violation of a duty by Maher and thus no tippee liability for Salman.

The Ninth Circuit rejected Salman’s arguments, finding that his case involved a straightforward application of Dirks and disagreeing with the analysis in Newman. That created a circuit split that likely led the Supreme Court to take Salman’s case. But when it came to convincing the high court to adopt Newman, Salman was swimming upstream.

In a unanimous opinion by Justice Alito, the Court agreed with the Ninth Circuit and held that Dirks “easily resolves the narrow issue presented here.” Dirks, the Court observed, held that a personal benefit may be inferred when an insider “makes a gift of confidential information to a trading relative or friend.” Maher passed information to his brother knowing he would trade on it, which falls squarely within this language. Game, set, match.

The Court noted that if Maher had traded on the information himself and given the proceeds to his brother, there is no question that would be insider trading. By passing the information to his brother knowing he would trade himself, Maher achieved exactly the same goal. “In such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.” Because he obtained this personal benefit, sharing the information was a violation of Maher’s duty of trust and confidence to his clients – a duty that Salman inherited and then violated when he traded on the information with full knowledge of its improper origins.

The Supreme Court expressly rejected the more stringent benefit test adopted by Newman: “To the extent that the Second Circuit [in Newman] held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends . . .we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.”

The Court also rejected Salman’s claim that the benefit test was unconstitutionally vague. Although it agreed that determining whether a benefit occurred might be difficult in some cases, the Court said it did not need to confront that issue because “Salman’s conduct is in the heartland of Dirks’s rule concerning gifts.”

Image of Christmas Stockings - stock tips make bad holiday gifts

Issues Remaining after Salman: Moving Beyond Friends and Family

The most significant aspect of Salman is its rejection of Newman. Because the Second Circuit includes New York and Wall Street, Newman had caused quite a stir and was seen as a significant blow to the government. Prosecutors were forced to drop a number of insider trading cases in the wake of the decision. Salman thus should give a boost to both criminal and civil insider trading investigations.

The court of appeals in Newman had also considered what the government must prove concerning the tippee’s knowledge – the second part of the Dirks test. The government argued it had to prove the tippee knew the information was given in violation of the tipper’s duty but did not need to prove the tippee knew the tipper had received a benefit. The Second Circuit, however, held that the government must prove that the tippee knew both.

The knowledge issue was not before the Supreme Court in Salman, as the Court noted in a footnote. But the briefs, oral argument, and opinion all indicate the government now agrees it must prove the tippee knew both that the tipper violated a duty and that he received a benefit. Salman therefore provides some clarity on the knowledge prong of the Dirks test as well, and that portion of Newman appears to remain good law. And that means cases like Newman involving “remote tippees” – those several steps removed from the source of the information and thus less aware of the details of the tipper’s activities – may continue to be challenging for the government.

Some commentators have suggested Salman leaves unanswered how close a friendship must be before the tipper can be said to benefit from disclosure. Must there be a close, personal friendship, or would the standard apply to an occasional golfing buddy or even a casual Facebook friend? And who qualifies as a “relative”? In-laws? Second cousins twice removed?

I think future cases are unlikely to hinge on such questions. Basing criminal liability on determining, for example, whether a friendship was sufficiently “meaningfully close,” as the Second Circuit suggested in Newman, would likely be vague and unworkable.

The Court in Dirks listed a gift of information to a friend or relative merely as an example of an improper disclosure, not as the definition of one. It would be a mistake to believe that a court must now determine whether a tippee is truly a “friend” or “relative” and what exactly that means. The test should focus not on the nature of the relationship but on the purpose behind the tip.

Dirks held that whether disclosure is a breach of duty “depends in large part on the purpose of the disclosure,” and the Court in Salman reaffirmed this language. Much of the Salman oral argument also focused on the purpose of the gift, with the Justices (and the government) pointing out that Maher’s gift of inside information was done for a personal purpose and not a corporate one.

The government in Salman argued that the benefit requirement of Dirks is met any time an insider discloses information for a personal purpose rather than a corporate purpose. The Court did not need to go that far because Salman fell squarely within the language of Dirks about disclosure to a relative, and the Court simply took the narrowest path possible to decide the case at hand. But for future cases a test that hinges on the tipper’s purpose is the logical outgrowth of Dirks and Salman.

To borrow an analogy used during oral argument, suppose I see a sad person on the street and feel bad for them, so I give them inside information intending that they trade on it. If I traded on the information myself and give the stranger the money, that would be insider trading. That tip benefits me – it allows me to make the desired charitable gift without actually taking money out of my pocket. As the Court said in Dirks: “[t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”

A test based on the tipper’s purpose does not make criminal liability rest upon something as nebulous as the closeness of the relationship between tipper and tippee. Instead it focuses on intent, with which criminal law is accustomed to dealing. An insider who tips to a family member, occasional golfing buddy, or stranger on the street does not act for any proper corporate purpose. All such disclosures violate the insider’s duty to refrain from using corporate information for some personal end.

Tippee liability based on gifts of information is unlikely to be limited to close friends and family. Anyone who believes Salman leaves them free to act on improper tips from casual acquaintances will likely find that prosecutors and courts disagree. The Supreme Court’s reaffirmation of Dirks and rejection of Newman signify that it remains very comfortable with a robust theory of insider trading liability.

And as for that errant brother-in-law, tell him you’d rather have a nice sweater or something — and ask him to pass the eggnog.

Note: This post is adapted from a commentary I published in the George Washington Law Review’s “On the Docket.”  You can find that commentary here.

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