Disgorgement for Inside Trader Slaps Status Quo
MANHATTAN (CN) - An inside trader who raked in millions for his fund without using any personal assets is responsible for disgorging the ill-gotten gains, plus interest, the 2nd Circuit ruled.
"Because a tipper can be required to disgorge all gains obtained by his tippees through illegal insider trading even without direct economic benefit to the tipper, and because defendant gave the fund the benefit of his inside information just as does a tipper, we hold the district did not abuse its discretion by ordering the defendant to disgorge all profits," Judge Gerard Lynch wrote for the federal appeals court's divided three-judge panel.
The Securities and Exchange Commission brought its action against Joseph Contorinis after the former managing director at Jeffries & Co. was convicted of one count of conspiracy to commit securities fraud and seven counts of securities fraud.
Prosecutors had shown that Contorinis executed several illegal insider trades in 2005 involving Albertson's Inc. stock based on nonpublic information transmitted by an employee of UBS Investment Bank.
UBS employee Nicos Stephanou disclosed inside information to Contorinis before it became public as negotiations involving the bank's advising work of the financial acquisition of the grocery store chain progressed, according to the ruling.
Rather than trading in Albertson's stock with his own personal assets, Contorinis did so on behalf of the Jeffries Paragon Fund, which he co-managed.
The trades netted the fund $7.2 million in profits and avoided $5.3 million in losses.
As part of the criminal action, the court had sentenced Contorinis to six years in prison and ordered him to pay $12 million - the combined value of those realized profits and avoided losses - in criminal forfeiture penalties in October 2010.
Though the 2nd Circuit affirmed his conviction, it vacated the forfeiture order because it found that the calculation reflected the total benefit to the Paragon Fund, not the gains accruing to Contorinis himself.
The trial court found on remand that Contorinis should forfeit the personal profit of just $427,875 that he earned from the trades in the form of linked compensation.
U.S. District Judge Richard Sullivan then resolved the SEC's action in 2012 by ordering Contorinis to disgorge the $7.2 million in unlawful profits, plus $2.4 million in prejudgment interest.
Contorinis argued on appeal that he never controlled the profits that the Paragon Fund gained, and that ordering him to repay the entire amount misunderstands the principles of disgorgement, which he says is to return him to the "status quo."
"On the one hand, Contorinis argues that because he illegally traded not for his own account with his own funds, but rather on behalf of an investment fund that he managed and whose assets belonged to third-party investors, he did not personally enjoy the proceeds of the resulting gain (beyond the increase in his compensation linked to the performance of the Paragon Fund)," Lynch wrote.
"On the other hand, although Contorinis did not pocket the profits from his trades, it was he who utilized the inside information, executed the trades, and secured the resulting profit for the benefit of his clients."
The 2nd Circuit thus focused on whether an insider trader can be forced to turn over both the profit he enjoyed and the profits that he channeled to his cronies, and it affirmed Tuesday.
"It would make little sense to allow the insider to escape disgorgement when he gives away not the proceeds of a trade predicated on his insider knowledge, but rather the knowledge itself to others who he knows will spin the information into gold by trading on it themselves," Lynch wrote.
"But if that is so, and our precedents confirm that it is, it must follow that the insider who, rather than passing the tip along to another, directly trades for that other's account must equally disgorge the benefits he obtains for his favored beneficiary."
Intent is irrelevant, according to the ruling.
"Whether the defendant's motive is direct economic profit, self-aggrandizement, psychic satisfaction from benefitting a loved one, or future profits by enhanced one's reputation as a successful fund manager, the insider trader who trades for another's account has engaged in a fraud, secured a benefit thereby, and directed the profits of the fraud where h has chosen them to go," Lynch wrote.
He added, "The tipper is liable for the tippees gains, whatever they may be."
The ruling emphasizes the distinction between criminal forfeiture and disgorgement as means to "deprive wrongdoers of their illicit gain."
But, "the two remedies reflect different characteristics and purposes - disgorgement is an equitable remedy that prevents unjust enrichment, and criminal forfeiture a statutory legal penalty imposed as punishment," Lynch wrote.
Judge Denny Judge Chin wrote in dissent that the order is inconsistent with the resolution of Contorinis' criminal appeal and with the principle that disgorgement is remedial rather than punitive in nature.
"The District Court ordered [Contorinis] to disgorge funds he never had and to pay back profits he never received," Chen wrote. "Instead of returning Contorinis to his status quo prior to his wrongdoing, the district court's disgorgement order penalized him by requiring him to pay an amount equal to the $7.2 million in profits earned by the fund and an additional $2.5 million in prejudgment interest."