Can the SEC require an insider trader to disgorge more than he has personally “swallowed”? The United States Court of Appeals for the Second Circuit answered “yes,” thereby expanding the SEC’s disgorgement authority. Insider traders now have to worry about more than just the criminal and civil liability imposed for the profits they have personally realized: they can now be held responsible for what others have gained from their crimes.
In some insider trading cases, the Securities and Exchange Commission (“SEC”) and the Department of Justice (“DOJ”) pursue parallel civil and criminal charges for the same transaction. This is what happened with Joseph Contorinis. Four years ago, Contorinis, a portfolio manager at Jefferies & Company, Inc. (“Jeffries”) was convicted of insider trading based on trades involving the stock of the supermarket chain Albertson’s, Inc. (“Albertson’s”), using tips received from Nicos Stephanou, an investment banker at UBS Investment Bank (“UBS”). These illegal trades resulted in $7.2 million in profits to the Jeffries Paragon Fund (the “Paragon Fund”), managed by Contorinis. Contorinis, however, only received $427,000 in compensation as a result of the trades. The typical criminal penalty requires an insider trader to forfeit all gains realized from the violation. On appeal, the United States Court of Appeals for the Second Circuit upheld the conviction of Contorinis, but held that Contorinis was only required to forfeit the personal profits gained from the insider trading, not the $7.2 million in profits that went to the Paragon Fund. The Court’s rationale was simple: Contorinis could not be required to forfeit money that he hadn’t received.
Is such a result fair? The same Court didn’t seem to believe so, going on to even the playing field in the civil arena. Following the criminal charges brought by the DOJ, the SEC brought civil charges against Contorinis in the Federal District Court for the Southern District of New York, which ordered Contorinis to disgorge the $7.2 million that he was not required to forfeit in the prior criminal matter. The United States Court of Appeals for the Second Circuit affirmed. The majority opinion drew a parallel between cases where a hedge fund manager trades for another person’s account, and tippers, which provide information that others can benefit from. Established precedent in this area showed that the tipper could be ordered to disgorge profits realized by others, even if the tipper never personally traded on the inside information, and therefore never personally benefitted from it. It would therefore be inconsistent to allow the manager that trades for another’s account to avoid disgorgement, while holding the tipper who provided the information, responsible for disgorging the profits realized by others.
Empowered by this decision, the SEC is proceeding full steam ahead in other cases. Just last week, it filed trading charges against Frank Perkins Hixon Jr., a former investment banker at the Evercore Group, in a Federal District Court for the Western District of Texas. If the Texas court accepts the analysis of the Second Circuit, Hixon can be responsible for disgorging profits realized from his insider trader, even though such profits never flower directly to him. This broad scope of disgorgement gives the SEC a tool that is not available to the DOJ when combating insider trading. The SEC is sure to pursue many others cases capitalizing on this broad authority.
The case is, SEC v. Contorinis, United States Court of Appeals for the Second Circuit, No. 12-1723-cv.