Penalty Can Exceed Insider's Own Profits, Circuit Says

, New York Law Journal

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$100 dollar bills

An insider trader can be required to disgorge the profits he channeled to others above and beyond the profits he earned for himself, the U.S. Court of Appeals for the Second Circuit ruled Tuesday.

A divided Second Circuit said Joseph Contorinis, a convicted investment fund manager, was rightly ordered to repay the full amount he made by acquiring confidential information about the Albertson's supermarket chain.

Accepting the argument of the Securities and Exchange Commission, a two-judge majority said it didn't matter whether the motive is "direct economic profit, self-aggrandizement, psychic satisfaction from benefiting a loved one, or future profits by enhancing one's reputation as a successful fund manager," disgorgement is appropriate for an insider trader who has "engaged in fraud, secured a benefit thereby, and directed the profits of the fraud where he has chosen them to go" when trading for another's account.

Judges Gerard Lynch (See Profile) and Susan Carney (See Profile) upheld a lower court's order that Contorinis, the former Managing Director at Jeffries & Co., must pay back $7,260,604 in illegal insider trading profits.

Judge Denny Chin (See Profile) dissented in Securities and Exchange Commission v. Contorinis, 12-1723-cv.

Contorinis was convicted by a jury in 2010 before Judge Richard Sullivan (See Profile) of conspiracy and seven counts of securities fraud.

Evidence at the trial showed that Contorinis made several trades beginning in 2006 on information about a potential acquisition of Albertson's that he received from Nicos Stephanou, an employee of UBS Investment Bank.

The trades, made on behalf of customers in the Jeffries Paragon Fund, netted profits of more than $7.2 million for the fund and avoided losses of $5.3 million.

Sullivan sentenced Contorinis to serve six years in prison.

In the parallel civil proceeding brought by the SEC, Contorinis conceded his criminal verdict had a preclusive effect requiring a finding of civil liability. Sullivan ordered him to disgorge the $7.2 million.

Writing for the majority Tuesday, Lynch said,"Because disgorgement's underlying purpose is to make lawbreaking unprofitable for the law-breaker, it satisfies its design when the lawbreaker returns the fruits of misdeeds, regardless of any other ends it may or may not accomplish."

Contorinis had argued before the circuit that disgorgement of the $7.2 million was not appropriate because he didn't have personal control of the profits earned by the Paragon Fund, he didn't trade for his own account with his own funds and he didn't earn any money from the trades beyond the increase in his compensation linked to the fund's performance.

"Contorinis argues, in effect, that one can only 'disgorge' what one has personally 'swallowed,'" Lynch wrote. "The SEC argues that a fraudster should be compelled to return not only those profits from the fraud that he has reserved for his own use, but also those that he has bestowed on others."

The decision said the circuit's case law indicated that an insider trader can be ordered to disgorge "not only the unlawful gains that accrue to the wrongdoer directly, but also the benefit that accrues to third parties whose gains can be attributed to the wrongdoer's conduct."

"We have long applied that principle in the tipper-tippee context," Lynch wrote in the decision. "It would make little sense to allow the insider to escape disgorgement when he gives away not the proceeds of a trade predicated on insider knowledge, but rather the knowledge itself to others who he knows will spin the information into gold by trading on it themselves."

So, he concluded, "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 benefit he obtains for his favored beneficiary."

If anything, compared to a tipper-tipper situation, "the case for disgorgement is stronger here," Lynch wrote, because Contorinis "had "greater control over the Paragon Fund's illegal profits than a tipper does over a tippee."

And the court's conclusion made sense, he said, because "it prevents insider traders from evading liability by operating through or on behalf of third parties."

In his dissent, Chin said disgorgement is supposed to "have the effect of returning a defendant to his status quo prior to the wrongdoing."

"Here, the district court ordered Contorinis to pay an amount substantially above what he acquired through his wrongdoing," Chin said. "The district court ordered him to disgorge funds he never had to pay back profits he never received."

Contorinis was represented by Roberto Finzi, Theodore Wells, Mark Pomerantz and Farrah Berse of Paul, Weiss, Rifkind, Wharton & Garrison.

Allan Capute, Anne Small, Michael Conly and Jacob Stillman represented the Securities and Exchange Commission.

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