In the Courts

Second Circuit: 'Tipping' Liability for Insider Trading Requires Knowledge of Tipper's Benefit

On Dec. 10, 2014, the Second Circuit Court of Appeals vacated an insider-trading conviction because the government failed to prove that the defendants knew the ultimate source of their inside information had benefited from sharing the information. United States v. Newman, et al., 2014 U.S. App. LEXIS 23190 (2d Cir. Dec. 10, 2014). In an opinion highly critical of recent insider-trading prosecutions, the Second Circuit emphasized past Supreme Court doctrine illustrating that “not every instance of financial unfairness constitutes fraudulent activity under [insider-trading laws].” Newman at *20 (quoting Chiarella v. United States, 445 U.S. 222, 232 (1980)).

In 2008, Todd Newman and Anthony Chiasson worked as portfolio managers in investment firms. See Newman at *3. Through a network of friends, colleagues, and some other persons they had never met, Newman and Chiasson learned financial information about two companies, Dell and NVIDIA, before the information became public. See id. at *5. The various non-public facts, which originally came from corporate insiders, all passed to Newman and Chiasson through at least three other people. Id. at *6. In their capacity as portfolio managers, Newman and Chiasson made stock trades in Dell and NVIDIA based on the information they learned. See id. at *5. These trades earned Newman's firm $4 million and Chiasson's firm $68 million in profits. See id. at *6.

The government charged both Newman and Chiasson with securities fraud and conspiracy to commit securities fraud under ' 10(b) of the Securities Exchange Act of 1934, SEC Rules 10b-5 and 10b5-2, and associated conspiracy and penalty statutes. See id. at *5. The government's insider-trading prosecution focused on establishing that Newman and Chiasson were liable as “tippees” ' persons who are not insiders or “misappropriators” of confidential information, but who instead receive confidential information from others (the “tippers”) and then illegally trade on it. See id. at *6-7, *13.

At the close of evidence during their trial, Newman and Chiasson moved for an acquittal. They argued that the government had presented no evidence that the tippers received a personal benefit for sharing inside information, and presentation of such evidence, in Newman and Chiasson's view, was required under Dirks v. S.E.C., 463 U.S. 646 (1983). They also maintained that Dirks required the government to present evidence that Newman and Chiasson were aware that the insiders had received such a benefit. The district court used jury instructions that did not require evidence that the defendants knew of any benefit to the tippers. The court later denied the defendants' motion for acquittal. The jury convicted both defendants on all counts.

On appeal to the Second Circuit, Newman and Chiasson repeated their argument that the government needed to show that the tippers benefitted and that the defendants knew about the tippers' benefit. The Second Circuit agreed, vacated all of the defendants' convictions, and remanded the case to the district court for dismissal of the indictment with prejudice.

In its opinion, the court emphasized that insider-trading convictions require tippees to know the tipper breached a fiduciary duty, not simply a duty of confidentiality. Relying on several Supreme Court opinions, the Second Circuit held that the government must prove, beyond a reasonable doubt, that the “insider was entrusted with a fiduciary duty,” that the “insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit,” that “the tippee 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.” Id. at *24.

Additionally, the Second Circuit criticized the government's contrary view that tippees need only to know that a tipper breached the duty of confidentiality ' that the tipper shared material, non-public information ' for liability to attach. The court noted, in particular, 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.” The Second Circuit noted that the Supreme Court's decisions in both Chiarella and Dirks plainly rejected the view that informational asymmetries are illegal whenever they create unfair advantages in the marketplace.

The government further argued that the error in jury instructions was harmless ' the record contained enough evidence to find that the defendants could have inferred the tippers' benefits from the circumstances. However, the court rejected this claim, noting that “absolutely no testimony or any other evidence” supported the government's contention.

In the Courts and Business Crimes Hotline were written by Edward Doumolin , an associate at Mayer Brown LLP in Washington, DC.

Second Circuit: 'Tipping' Liability for Insider Trading Requires Knowledge of Tipper's Benefit

On Dec. 10, 2014, the Second Circuit Court of Appeals vacated an insider-trading conviction because the government failed to prove that the defendants knew the ultimate source of their inside information had benefited from sharing the information. United States v. Newman, et al., 2014 U.S. App. LEXIS 23190 (2d Cir. Dec. 10, 2014). In an opinion highly critical of recent insider-trading prosecutions, the Second Circuit emphasized past Supreme Court doctrine illustrating that “not every instance of financial unfairness constitutes fraudulent activity under [insider-trading laws].” Newman at *20 (quoting Chiarella v. United States , 445 U.S. 222, 232 (1980)).

In 2008, Todd Newman and Anthony Chiasson worked as portfolio managers in investment firms. See Newman at *3. Through a network of friends, colleagues, and some other persons they had never met, Newman and Chiasson learned financial information about two companies, Dell and NVIDIA, before the information became public. See id. at *5. The various non-public facts, which originally came from corporate insiders, all passed to Newman and Chiasson through at least three other people. Id. at *6. In their capacity as portfolio managers, Newman and Chiasson made stock trades in Dell and NVIDIA based on the information they learned. See id. at *5. These trades earned Newman's firm $4 million and Chiasson's firm $68 million in profits. See id. at *6.

The government charged both Newman and Chiasson with securities fraud and conspiracy to commit securities fraud under ' 10(b) of the Securities Exchange Act of 1934, SEC Rules 10b-5 and 10b5-2, and associated conspiracy and penalty statutes. See id. at *5. The government's insider-trading prosecution focused on establishing that Newman and Chiasson were liable as “tippees” ' persons who are not insiders or “misappropriators” of confidential information, but who instead receive confidential information from others (the “tippers”) and then illegally trade on it. See id. at *6-7, *13.

At the close of evidence during their trial, Newman and Chiasson moved for an acquittal. They argued that the government had presented no evidence that the tippers received a personal benefit for sharing inside information, and presentation of such evidence, in Newman and Chiasson's view, was required under Dirks v. S.E.C. , 463 U.S. 646 (1983). They also maintained that Dirks required the government to present evidence that Newman and Chiasson were aware that the insiders had received such a benefit. The district court used jury instructions that did not require evidence that the defendants knew of any benefit to the tippers. The court later denied the defendants' motion for acquittal. The jury convicted both defendants on all counts.

On appeal to the Second Circuit, Newman and Chiasson repeated their argument that the government needed to show that the tippers benefitted and that the defendants knew about the tippers' benefit. The Second Circuit agreed, vacated all of the defendants' convictions, and remanded the case to the district court for dismissal of the indictment with prejudice.

In its opinion, the court emphasized that insider-trading convictions require tippees to know the tipper breached a fiduciary duty, not simply a duty of confidentiality. Relying on several Supreme Court opinions, the Second Circuit held that the government must prove, beyond a reasonable doubt, that the “insider was entrusted with a fiduciary duty,” that the “insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit,” that “the tippee 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.” Id. at *24.

Additionally, the Second Circuit criticized the government's contrary view that tippees need only to know that a tipper breached the duty of confidentiality ' that the tipper shared material, non-public information ' for liability to attach. The court noted, in particular, 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.” The Second Circuit noted that the Supreme Court's decisions in both Chiarella and Dirks plainly rejected the view that informational asymmetries are illegal whenever they create unfair advantages in the marketplace.

The government further argued that the error in jury instructions was harmless ' the record contained enough evidence to find that the defendants could have inferred the tippers' benefits from the circumstances. However, the court rejected this claim, noting that “absolutely no testimony or any other evidence” supported the government's contention.

In the Courts and Business Crimes Hotline were written by Edward Doumolin , an associate at Mayer Brown LLP in Washington, DC.