On December 10, 2014, the Second Circuit reversed two insider trading convictions on the grounds that prosecutors failed to establish defendants’ knowledge that the tipster received a benefit for disclosing inside information. Moreover, the circuit held, the benefit received must be more than mere friendship.
Defendants Todd Newman and Anthony Chiasson were convicted of securities fraud after a six-week trial. Prosecutors alleged that the two men had traded securities based on inside information illicitly obtained from analysts who received the information from employees of publicly traded tech companies. The district court declined to instruct the jury that the government was required to prove defendants’ knowledge that the insiders had disclosed the information for a personal benefit.
On appeal, the unanimous circuit court panel found that “in order to sustain a conviction for insider trading, the government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.” Relying heavily on the Supreme Court’s decision in Dirks v. S.E.C., 463 U.S. 646 (1983), the opinion by Judge Barrington Parker noted that the “test for determining whether the corporate insider has breached his fiduciary duty ‘is whether the insider personally will benefit, directly or indirectly, from his disclosure,” and that “a tippee may be found liable ‘only when the insider has breached his fiduciary duty . . . and the tippee knows or should know that there has been a breach.’” In short, “the exchange of confidential information for personal benefit is not separate from an insider’s fiduciary breach; it is the fiduciary breach that triggers liability for securities fruit under Rule 10b-5.” The government therefore cannot establish that the tippee has knowledge of the breach without showing that the tippee “knows of the personal benefit received by the insider in exchange for the disclosure.”
Addressing policy arguments, the opinion emphasized that, “[a]lthough the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets.” It also noted the “doctrinal novelty of [the government’s] recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders.”
Additionally, the evidence against the defendants was insufficient in two respects. First, the government failed to establish that the insiders received a personal benefit—merely demonstrating that they received “friendship, particularly of a casual or social nature” is insufficient. Second, there was no evidence that the defendants knew that they were “trading on information obtained from insiders, or that those insiders received any benefit in exchange for such disclosures, or even that Newman and Chiasson consciously avoided learning of these facts.”
The decision calls into question the validity of several recent convictions in the Southern District of New York. Following the opinion, U.S. Attorney Preet Bharara stated that the opinion “appears in our view to narrow what has constituted illegal insider trading,” and that it “interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information.”