For years the U.S. Department of Justice and Securities and Exchange Commission have been on a crusade to prosecute “insider trading,” even though it’s far from clear that activity should be criminal to begin with. Lately, those efforts have been led by Preet Bharara, U.S. Attorney for the Southern District of New York, who has obtained more than 80 convictions and plea deals, ruining countless careers and fortunes along the way.

On Wednesday, things changed. A three-judge panel of the New York-based Second Circuit U.S. Court of Appeals—the most influential lower court on questions of financial regulation—unanimously threw out Bharara’s high-profile conviction of hedge funders Todd Newman and Anthony Chiasson, directing that charges against them be dropped. It’s a “huge blow” to Bharara’s campaign, notes the New York Post, while Bloomberg Media calls it a “harsh rebuke” that “is likely to have far-reaching effects.” Alison Frankel of Reuters describes the ruling as “emphatic” and its conclusion “momentous.” The opinion is here.

Yale law professor Jonathan Macey, writing in the WSJ:

[The SEC and Bharara] prefer that the law exalt vague conceptions of “fairness” above the more concrete goals of having robust, liquid and efficient securities markets.

The new opinion is a game-changer. It signals to prosecutors that they cannot bring flawed cases and then hide behind the excuse that the law is vague. The Court of Appeals admonished that “the Supreme Court was quite clear” in previous cases about what is required to establish illegal insider trading.

Specifically, the Supreme Court and the lower federal courts have been explicit in saying that trading on an informational advantage is not necessarily illegal. To be illegal, the courts have said, trading by insiders must involve breaching a duty of trust and confidence. Courts have been clear, as the Supreme Court noted in Chiarella v. U.S. (1980) and again in U.S. v. O’Hagan (1997), that there is no “general duty between all participants in market transactions to forgo actions based on material, nonpublic information” because it is possible to acquire such information legitimately.

Tellingly, the Court of Appeals pointed out “the doctrinal novelty” of the government’s “recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders.”

And note this, from Alison Frankel’s Reuters column:

The opinion not only sets clearer definitions for future insider trading prosecutions but also undermines the foundation of at least a half-dozen guilty pleas the Manhattan U.S. attorney’s office has already obtained [emphasis added—W.O.]. According to the 2nd Circuit, the government hasn’t proved the illegality of the insider disclosures underlying those pleas.

Yesterday, at a Cato book lunch for Brian Aitken, who was imprisoned by the State of New Jersey for carrying unloaded guns and ammunition in the trunk of his car, I observed that students of the plea bargaining system consider it absolutely standard that under the pressure of prosecution a large share of persons who believe themselves innocent of charges, and would have been cleared had they persisted to a final resolution in court, will nonetheless accept a plea deal for fear of the consequences of remaining defiant. That’s one reason congressional oversight of this area is urgently needed: our plea-bargain-driven system of criminal prosecution doesn’t really police itself well, even when the courts do the right thing.

For another example of financial prosecutions run amok, see my post a while back on Justice Department enforcement actions under the Foreign Corrupt Practices Act.