United States: US Second Circuit Heightens the Standard of Proof Required To Sustain Tipper/Tippee Insider Trading Convictions

On December 10, 2014, in United States v. Newman, et al., the US Court of Appeals for the Second Circuit clarified the elements required to establish insider trading in tipper/tippee cases by holding that "in order to sustain a conviction for insider trading, the government must prove beyond a reasonable doubt that the tippee knew that the insider disclosed confidential information and that he did so in exchange for a personal benefit."1 The Court also rejected the long held government position that the personal benefit to the tipper could be inferred from mere friendship between the tipper and tippee. Instead, the court held that this inference is impermissible absent "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."2 The Newman decision will likely make it significantly more difficult for the government to win insider trading convictions based a tipper-tippee theory of liability.

Modern insider trading law is rooted in the Securities Exchange Act of 1934. Section 10(b) and 10b-5 of the '34 Act make it "unlawful for any person, directly or indirectly . . . [t]o use or employ, in connection with the purchase or sale of any security registered on a national securities exchange . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate."3 Under this framework, the classic theory of insider trading prohibits corporate insiders, such as directors and officers, from trading in a corporation's securities on the basis of "material, non-public information" about the corporation.4 Insider trading law expanded to include the misappropriation theory of liability, which makes it illegal for certain corporate "outsiders" who have no independent fiduciary duty to a corporation, but have access to material nonpublic information, to trade in that corporation's securities.5

Liability for insider trading is not limited to persons trading for their own benefit. A person may also be subject to liability when an insider or misappropriator in possession of material, non-public information (the "tipper") discloses the information to an outsider (the "tippee") who then trades on the basis of the nonpublic information. However, under these circumstances a tipper is liable for insider trading only if he receives a benefit for disclosing the information. For instance, in Dirks v. SEC, 463 U.S. 646 (1983), the insider divulged the confidential information to a tippee in order to expose corporate fraud. The Supreme Court found that because Dirks did not personally benefit from disclosing the nonpublic information to the tippee, he was not guilty of insider trading. Moreover, the Court held that in order for liability to extend to a tippee, "the test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach [by a tippee]."6

In Newman, the Second Circuit clarified the proof required for insider trading in a tipper/tippee case by holding that "in order to sustain a conviction for insider trading, the government must prove beyond a reasonable doubt that the tippee knew that the insider disclosed confidential information and that he did so in exchange for a personal benefit."7 The Second Circuit overturned the convictions of the defendants finding that the government did not present sufficient evidence that the defendants willfully engaged in substantive insider trading or conspiracy to commit insider trading in violation of the federal securities laws.

This case involved the former Level Global Investors LP manager, Anthony Chiasson, and former Diamondback Capital Management LLC manager, Todd Newman, who, following a six-week jury trial, were found guilty of conspiracy to commit insider trading and insider trading in violation of federal securities laws.8

The government alleged that Chiasson and Newman illegally traded stock in Dell, Inc., and NVIDIA Corp. based on tips that originated with technology insiders at each of these companies. The sources of the nonpublic information in this case were several steps removed from both Chiasson and Newman. In the NVIDIA tipping chain, for instance, the evidence indicated that an employee of NVIDIA's finance unit tipped information to a person he knew from church, who was also a former executive at two major corporations. The government claimed that this former executive then passed the information to an analyst at Whittier Trust. The Whittier Trust analyst allegedly circulated this information to several of his analyst friends, who then gave the information to Chiasson and Newman. As such, both Chiasson and Newman were four levels removed from the inside tipper. The Second Circuit noted in its decision that there was no evidence that either of the defendants were aware of the source of the inside information. Nevertheless, Chiasson and Newman were convicted at trial and the district court sentenced them to 6 1/2 and 4 1/2 years imprisonment respectively.

On appeal, the government argued that criminal liability could be imposed by only proving a tippee's knowledge of the breach of the duty of confidentiality without knowledge of any personal benefit.The defendants argued that the Supreme Court's holding in Dirks dictated that trading on material, non-public inside information is illegal only if the insider engaged in self-dealing by disclosing the inside information for a personal benefit. The Second Circuit agreed with defendants, holding that in order to sustain a conviction for insider trading liability, the government must prove each of the following elements beyond a reasonable doubt:

  • the corporate insider was entrusted with a fiduciary duty;
  • the corporate insider breached this fiduciary duty by
  • disclosing confidential
  • information to a tippee
  • in exchange for a personal benefit;
  • the tippee knew of the tipper's breach, in that he knew the information was confidential and divulged for a personal benefit; and
  • the tippee still used the information to trade in a security or tip another individual for personal benefit.

Newton's heightened standard mandates that in order to sustain an insider trading conviction on the tipper/tippee theory of liability, the government must establish beyond a reasonable doubt that a tippee knew of the personal benefit received by the insider in exchange for the disclosure. In other words, a tippee must have actual knowledge, not only of the tipper's breach of the duty of confidentiality, but also of the personal benefit received by the tipper in exchange for disclosure. The Second Circuit flatly rejected the government's contention that the "personal benefit" requirement could be met by showing that a tippee gave career advice, passed along a person's resume, attended the same social gatherings, or attended the same educational institutions as the tipper. The court noted that if these types of associations and small favors constituted "personal benefits" that requirement would essentially be rendered a nullity. Moreover, the court clarified that a personal benefit cannot be inferred from a personal relationship between the tipper and tippee, "in the absence of 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."9

The Second Circuit's decision has important implications for the future of insider trading law. The Second Circuit has now adopted a stricter standard for proving tipper/tippee liability. In overturning the convictions of individuals three or four levels removed from the insider tipper, the court essentially narrowed the group of people that can be effectively prosecuted for insider trading on the tipper/tippee theory of liability. In the wake of this decision, the government will have a much more difficult time prosecuting remote tippees and will be required to obtain more evidence to secure these convictions. This landmark decision signifies a welcome clarification in insider trading law.

Learn more about our Securities Litigation & Enforcement and White Collar Defense & Compliance practices.

1 United States v. Newman, Nos. 13-1387-cr, 13-1917-cr, slip op. at 3 (2d Cir. Dec. 10, 2014).

2 Id. at 22.

3 15 U.S.C. § 78j(b).

4 See generally Chiarella v. United States, 445 U.S. 222 (1980).

5 See generally United States v. O'Hagan, 521 U.S. 642 (1997).

6 Dirks v. SEC, 463 U.S. 646, 662 (1983).

7 United States v. Newman, Nos. 13-1387-cr, 13-1917-cr, slip op. at 3 (2d Cir. Dec. 10, 2014).

8 See 18 U.S.C. § 371, sections 10(b) and 32 of the Securities Exchange Act of 1934, and SEC Rules 10b‐5 and 10b5‐2.

9 Newman, slip op. at 22.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2014. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions