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The Second Circuit Grants A New Trial: Why Market Movements Should Come With Cliff Notes

Causation is tricky.

So often we infer what caused what from the order things happen in – the government fails to reach an agreement on the debt ceiling, and the stock market drops. We conclude that one causes the other.

What do we do when there are multiple causes of a movement in stock price? If Greece defaults at the same time new job numbers are released, can we say which causes the movement of a stock price?

If you’re just chatting about the markets, it probably doesn’t matter. You don’t need to answer the question of what caused the market action – it can be overdetermined.

If, however, you’re the United States government, and you are trying to show that a series of actions mattered to investors, you are going to want to show that they affected the stock price. But what to do about all the other things that affected the stock price?

This question was taken up by the Second Circuit in United States v. Ferguson.

There, executives at General Reinsurance and an executive at AIG were convicted of numerous charges – conspiracy, mail fraud, securities fraud, and making false statements to the Securities and Exchange Commission.

The basis of the charges was a reinsurance transaction between the two companies. Such a transaction is, apparently, normally done to mitigate risk. Here, there was, the government alleged, no risk to mitigate – the transaction was intended solely to create an accounting illusion about AIG’s reserves so that its stock price would not suffer.

To prove fraud, the government has to prove that a false statement is material – that it matters to someone in some decision they have to make. In this case, the government wanted to prove that it mattered to investors; that the reinsurance transaction affected the stock price.

The problem, though, is that lots of things affect stock price. At the same time at issue in the case, AIG was being accused of “bid-rigging, improper self-dealing, earnings manipulations, and more.” Each of these allegations also affected AIG’s stock price.

So, for the folks on trial to challenge whether the reinsurance contract affected the stock price, they would have had to argue that it wasn’t the allegedly fraudulent reinsurance contract, rather it was the allegedly unlawful bid-rigging.

It’s kind of like arguing that you couldn’t have killed Tom because you were busy robbing Mary across town. It doesn’t sit well with a jury.

The defendants offered to just agree that the reinsurance contract affected the stock price, so it wouldn’t have to be submitted to the jury. The government, though, wouldn’t agree.

This likely seems odd. The government thinks something happened. Why can’t the defendant just agree, then that would be one less thing that the jury needs to worry about? The answer is that the Supreme Court has held that a defendant can’t prevent the government from putting on the salacious bit of its case just by stipulating to it. The case is called Old Chief. It’s how we know jury nullification works both at least one ways.

So the government wouldn’t stipulate that the stock price dropped. Instead, they introduced a chart showing that the stock price dropped. But everyone agreed that the chart was inaccurate, because it reflected a drop in the price that was caused by other allegations of misconduct other than those in the trial.

The Second Circuit held that this was soup. The government doesn’t have to stipulate to an element of the offense, but they can’t use that as a mechanism to introduce misleading evidence. Moreover, the government really played the falling stock price up to the jury, arguing that:

[B]ehind every share of [AIG] stock is a living and breathing person who plunked down his or her hard-earned money and bought a share of stock, maybe [to] put it in their retirement[] accounts, maybe to put it in their kids’ college funds, or maybe to make a little extra money for the family.

As a result, the Second Circuit vacated the conviction and ordered a new trial.

As an aside, it’s nice to see that Seth Waxman came into the case on the side of the lead defendant. I’m sure I’ll bump into him at a National Association of Criminal Defense Lawyers meeting soon.

FYI, I’m late to the party. Everyone and their mother has written about this. See:


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