GPSolo Magazine - September 2006

Business And Commercial Law
Insider Trading . . . or Not? Lessons Learned from an Acquittal

Insider-trading cases can be difficult to defend. They are largely built on circumstantial evidence and inferences, derived from a relatively simple scenario. Your client—who knows a corporate insider—has purchased stock just days before the announcement of favorable news about the insider’s company or has sold stock in the insider’s company before the announcement of bad news. The client has made a substantial amount of money or avoided a substantial loss. The prosecutors will argue that these facts do not demonstrate luck but are compelling evidence of guilt. If other friends and relatives of the same insider also traded, the circumstantial evidence becomes overwhelming.

The government may also immunize one of those other friends or relatives. Thus, the government will add to its circumstantial case direct testimony by someone claiming to have received the tip in a furtive conversation with the insider. From this, the prosecutor will ask the jury to conclude that all the other people who traded and knew the insider received the tip in the same way. The evidence demonstrates that the tipper and tippee knew each other, that they communicated, and that the client traded just before the announcement, thereby making a large sum of money. To compound matters, other co-conspirators traded in the same pattern as the client.

Experience from acquittals in insider-trading cases can serve as a model for constructing a winning defense. Defense counsel must do more than simply rebut the government’s evidence and impeach its witnesses. It must tell its own story in order to create reasonable doubt in the mind of the jury.

Counsel must first convince the jury that the government’s circumstantial evidence is not evidence at all, but mere ambiguous circumstances from which the government asks the jury to hypothesize as to what might have occurred. The jury must be continually reminded that it cannot convict based on speculation or guilt by association. Just because an insider and a friend spoke and the friend traded, it does not mean a violation of the law has occurred.

Second, defense counsel must present an alternative theory explaining all of the government’s facts. Every successful case must have an overarching theme. In an insider-trading case, the overarching theme is that there is a rational alternative explanation for the government’s circumstantial evidence. In other words, confront the weaknesses in your case and turn them to the client’s advantage.

The first weakness to be confronted is the question of why the client traded this particular stock out of tens of thousands of stocks traded on the markets. Normally, the best course is to concede that your client heard of the company from a friend or became interested in the company because of that friend’s connection with it. It is often this question that trips up clients in initial interviews with SEC staff. They believe that conceding familiarity or contact with the insider will make the SEC assume they received a tip, so clients often will deny that they ever spoke to the insider about the stock. But juries simply will not believe such blanket denials. An open admission of knowledge or contact is not a concession of guilt if coupled with the argument that hearing about a company and trading on inside information are two different things.

Once you have established how your client became interested in the corporation, the next hurdle will be to explain to the jury why your client traded the stock just before the newsworthy public announcement. Here, it is essential to have a rational explanation showing that the publicly available information made this stock pick a “buy” or “sell.”

What do the annual reports reveal? What do news stories and analyst reports show? Such evidence is crucial to a client’s defense. The Internet should be reviewed for chat room stories discussing the stock and predicting that it would go up or down.

You will then have to justify the size of the investment by showing that your client could afford the risk he or she undertook, and that your client had traded in a like manner in the past. If your client purchased on margin, you will have to explain this to the jury. One way to do this is to argue that it is actually cost effective to buy on margin, rather than sell stocks with a potential for appreciation held in your client’s portfolio.

The defense outlined above can be bolstered by an expert’s testimony. In the 1980s, the SEC conducted a study of insider trading and concluded that it is normal for friends and relatives of an insider to trade the stock of corporations with which such insiders were associated. The study found that such trading occurs for reasons other than trading on inside information, that is, friends and relatives of insiders have a natural tendency to trade in the stock of corporations where they know someone associated with management or the board of directors. It also found it was not unusual that such trading occurs immediately before a material corporate event.

The fact is that friends and relatives often observe an insider’s behavior and can sometimes conclude that a material event is about to occur at the insider’s corporation without the insider tipping them. This phenomenon is known as “leakage.” It is not illegal to trade based on such observations.

Thus, the key to a successful defense is an alternative theory as to why and when the client traded. Defense counsel must explain how the client learned about the information and why the client traded that stock when he or she did. Counsel must show the jury that the client did precisely what you would expect any investor to do in a capitalist society. The client analyzed the market and placed a bet. There is nothing illegal about that!

Perhaps the hardest piece of evidence will be the fact that in the same period of time, other individuals who were close to the insider also traded. The government will argue that it was no coincidence that several friends and relatives traded at precisely the same moment. If it finds that others were tipped by the insider, the jury can infer that the client was tipped, too. In order to blunt this argument, defense counsel must constantly remind the jury that each of the defendants has to be judged based on the evidence offered against him or her and that a jury cannot convict based on mere guilt by association.

In conclusion, ambiguous circumstances and trading may often be transformed by the prosecution into circumstantial evidence of insider trading. The job of defense counsel is to take those same circumstances and present the jury with an equally plausible and believable story consistent with innocence.


Frank C. Razzano is a partner at Dickstein Shapiro Morin & Oshinsky LLP in Washington, D.C. He can be reached at

For More Information about the Section of Business Law

- This article is an abridged and edited version of one that originally appeared on page 34 of Business Law Today, May/June 2006 (15.5)

- For more information or to obtain a copy of the periodical in which the full article appears, please call the ABA Service Center at 800/285-2221.

- Website:

- Periodicals: Business Law Today, bimonthly magazine; The Business Lawyer, quarterly law journal; eSource, monthly e-newsletter.

- Books and other recent publications: Corporate Director’s Guidebook, 4th ed.; Bankruptcy Deadline Checklist, 3d ed.; Financial Statement Analysis and Business Valuation for the Practical Lawyer, 2d ed.; Reorganizing Failing Businesses, rev. ed.; Guidebook for the Directors of Nonprofit Corporations, 2d ed.; Model Asset Purchase Agreement with Commentary; The Practitioner’s Guide to the Sarbanes-Oxley Act; The Portable Bankruptcy Code & Rules, 2006 ed.; The M&A Process: A Practical Guide for the Business Lawyer.


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