On December 10, 2014, the United States Court of Appeals for the Second Circuit vacated the insider trading convictions of two hedge fund portfolio managers, Todd Newman and Anthony Chiasson. United States v. Newman, No. 13-1837-cv (L) (2d Cir. Dec. 10, 2014), The decision substantially raises the government’s burden in insider trading cases, and represents a major setback for U,S. Attorney Preet Bharara, whose office has won several high-profile trials and convicted more than 80 individuals for insider trading since 2006. In the instant case, the government produced evidence that a group of financial analysts exchanged information that had been passed along from company insiders, which they then passed on to their portfolio managers to trade on, including Newman and Chiasson. Newman and Chiasson were as many as four levels removed from the corporate insiders, and no evidence was introduced that either defendant was aware who provided the inside information or whether that person had received any benefit for the tip. Noting that the issue was one of first impression, the court held that in order to meet its burden the government must prove beyond a reasonable doubt that the tippees knew that the insider disclosed confidential information to the analysts in exchange for a personal benefit. The court agreed with Newman and Chiasson, that the district court’s jury instructions failed to inform the jury of this requirement. The court summarized the elements that must be demonstrated to establish insider trading by a tippee as follows:
- the corporate insider was entrusted with a fiduciary duty;
- the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit;
- the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and
- the tippee still used that information to trade in a security or tip another individual for personal benefit.
The court also agreed with the defendants that the evidence was insufficient to demonstrate that a personal benefit was conveyed to either of the insiders who disclosed inside information. The government’s evidence of personal benefit consisted of career advice, resume input and socializing. The court noted that if these were “personal benefits” then “practically anything would qualify.” The Court held that in order to infer a personal benefit to the tipper, the government must demonstrate “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.” As a result of this decision, it will be considerably more difficult for the government to bring criminal and civil insider trading actions in the Second Circuit against tippees, particularly those down the chain from the initial tip from the corporate insider. The SEC, however, may continue to test the limits of Section 10(b) and Rule 10b-5 through civil actions instituted outside the Second Circuit and administrative actions brought before the SEC’s administrative law judges. Notwithstanding the significance of the decision, the DOJ and SEC can be expected to continue to actively enforce the securities laws prohibiting insider trading. As a consequence, companies should take steps to protect their shareholders and reputations by putting in place adequate compliance policies and employee training programs to prevent their employees from engaging in insider trading. By Widge Devaney and Joseph Rindone (Baker & McKenzie New York)