Just before the 2008 financial crisis, a Wall Street insider tipped off the Securities and Exchange Commission (SEC) to insider trading at a large, successful, but largely little known hedge fund, the Galleon Group.

The founder, Raj Rajaratnam, had a vast network of contacts that he would pay in exchange for confidential information about a company that would affect its stock price when the information became public.

Ultimately, he was found guilty of insider trading and was sentenced to an 11-year prison term and fined $150 million.  More importantly, though, the case started a large sweep of insider trading on Wall Street that resulted in 89 convictions across a variety of firms and number of large players.

In my view, the investigations and prosecutions were great news.  Fair markets that are free of insider trading and other kinds of market manipulation are central to the integrity of our capital markets system.

To operate efficiently and benefit everyone, markets need to be transparent and fair so that participants can be confident about their dealings, or they won’t participate.

The trouble with insider trading cases is that they are tough to prove because it’s hard to collect enough evidence that clearly shows someone traded on material, nonpublic information or whether they just had a hunch that played out well.

That’s what made the nearly perfect conviction record of Manhattan’s US Attorney Preet Bharara so impressive.  He used aggressive strategies like expansive wiretaps and search warrants that you might find in drug cases that aren’t normally applied to insider trading cases.

A few weeks ago, however, the US Court of Appeals in Manhattan reversed two of Bharara’s convictions.   The court found that the traders in question were too far removed from the people who initially provided the illicit information.

In this case, the appeals court wrote that the two traders ‘were several steps removed from the corporate insiders and there was no evidence that either was aware of the source of the inside information.’

The court went on to say that the two traders hadn’t compensated the insiders or the people who had initially leaked the confidential information or those who passed it along.

Essentially, the court said that now, to prosecute insider trading, the government has to prove that the trader (or investor) knew that the information was confidential and that the person who provided the tip was somehow compensated for providing the information.

A number of the people who plead guilty in the case are now expected to get their cases or pleas dismissed.  One of the most prized convictions was of Michael Sternberg, formerly of SAC Capital, who may have his entire conviction overturned because the tip that he traded on may now be considered too far removed to be illegal.

I don’t have an opinion about any of the specific cases in question, but I think that anything that makes it more difficult to prosecute insider trading is unfortunate because insider trading undermines confidence in the entire system.