On April 3, 2015, the U.S. Court of Appeals for the Second Circuit denied the government’s petition for en bancrehearing of the court’s decision in U.S. v. Newman, No. 13-1837, a case that the government has described as “one of the most significant developments in insider trading law in a generation.” The panel’s December 2014 decision clarified the standards for proving tippee liability and the personal-benefit element of securities fraud. The Second Circuit’s Newman decision is expected to make future insider-trading prosecutions more difficult.
In January, U.S. Attorney for the Southern District of New York Preet Bharara asked the Second Circuit to revisit the panel’s decision vacating convictions of Todd Newman and Anthony Chiasson, two hedge-fund managers. At a jury trial on charges of securities fraud and conspiracy to commit securities fraud, the government alleged that the defendants were involved in an insider-trading scheme with corporate insiders from two public companies and a group of financial analysts. The government presented evidence suggesting that Newman and Chiasson traded on material nonpublic information that they received from the analyst group, who in turn had received the information from the corporate insiders. Thus, while Newman and Chiasson executed the trades at issue, they were at least one step removed from the sources of the information.
On appeal, the Second Circuit overturned the convictions. The court acknowledged a “somewhat Delphic” body of law regarding tippee liability and explained its holding that: (i) tippee liability derives from the tipper’s breach of fiduciary duty; (ii) proof of the tipper’s breach requires proof that he or she received a personal benefit in exchange for the disclosure; and (iii) the tippee is only liable if he or she knows of the breach.
The Second Circuit also clarified the legal standard for proving personal benefit, although it nonetheless left the question somewhat open. It rejected the government’s position that a personal benefit can be inferred from proof of a casual or social personal relationship alone. Instead, the court held that a personal benefit can only be inferred from “proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” What exactly that means as applied to specific facts will be determined in future litigation.
In its petition for rehearing, the government specifically challenged the court’s view of personal benefit. The government argued that the court’s definition of personal benefit “added an unprecedented limitation that effectively upended” the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983).
In the wake of Newman, several individuals convicted of insider trading have filed motions for post-trial review, claiming that their convictions should be overturned due to faulty jury instructions regarding the personal-benefit standard. Many such motions are pending and possibly benefit from the fact that the panel decision still stands. The Second Circuit decision could also prompt the Securities Exchange Commission (SEC) to refocus some of its attention on civil-enforcement actions, in which the standards of intent are lower, as U.S. District Judge Jed Rakoff noted in an insider-trading decision issued just days after the denial of en bancreview in Newman. See Order on Motion to Dismiss [Dkt. 42] at 2, SEC v. Payton et al.,14-cv-04644, (S.D.N.Y. April 6, 2015) (“[W]hile a person is guilty of criminal insider trading only if that person committed the offense ‘willfully,’ i.e., knowingly and purposely, a person may be civilly liable if that person committed the offense recklessly, that is, in heedless disregard of the probable consequences.”).
In light of Newman, how the Department of Justice, the SEC, and defendants adjust their insider-trading litigation strategies, both inside and outside the Second Circuit, will remain closely watched in 2015.