In Newman, the government presented evidence at trial that financial analysts obtained confidential earnings information from company insiders, then passed it along to defendants, tippee portfolio managers, who traded on the information. None of the evidence indicated the defendants knew the source of the information. At trial, the defendants argued the evidence that the insiders had tipped in exchange for a personal benefit was insufficient, and that, even if a benefit had been provided, they were unaware of it. The trial court instructed the jury that to find them guilty the defendants needed only to “have known that [the confidential information] was originally disclosed by the insider in violation of a duty of confidentiality.” Both defendants were convicted and appealed the verdict.
The Second Circuit reversed, holding the jury instructions were erroneous; there was insufficient evidence of any personal benefit to the insiders, and no evidence the tippees knew about any such benefit. The court rejected the government’s argument the tippees could be found guilty even without knowing the tipper had received a personal benefit. Following the U.S. Supreme Court case of Dirks v. SEC, 463 U.S. 646, 662 (1983), which held that a corporate insider breaches his fiduciary duty only when he personally will benefit from his confidential disclosure, the Second Circuit here held, “[f]or purposes of insider trading liability, the insider’s disclosure of confidential information, standing alone, is not a breach. Thus, without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knows of a breach.”
The court order, declining reconsideration, reaffirms the heavier evidentiary burden imposed on insider trading prosecutions in the Second Circuit and has broader applications as well. In the wake of Newman, several convicted defendants have petitioned for reversal of their own insider trading convictions and other dismissals. Following last week’s order, applications may well increase, and the number of insider trading prosecutions are expected to drop, especially where the subjects of U.S. Department of Justice investigations are downstream tippees (as in Newman). The ruling also may be instructive in the enforcement of the STOCK Act, under which members of Congress and employees of Congress are subject to insider trading proscriptions. No doubt the U.S. Securities and Exchange Commission will continue to turn to administrative proceedings, rather than federal district court, as its preferred forum for insider trading and other securities fraud cases. Absent a petition to the Supreme Court for review, the Justice Department may seek to prevail on Congress to enact a statute that would set forth the express elements of criminal insider trading.
Finally, the order preserves an important check on prosecutorial power. At least in the Second Circuit — and likely in other jurisdictions — the government will be required to prove criminal knowledge as an element of insider trading. Tippees will not be prosecuted for merely trading on inside information when they are unaware of a personal benefit to the insider; rather, the government must prove beyond a reasonable doubt they were aware of an insider’s breach of a fiduciary duty and personal benefit.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and our colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:
Lisa M. Noller
Partner and Chair, Government Enforcement, Compliance & White Collar Practice
Chicago, Illinois
312.832.4363
lnoller@foley.com
Beth I.Z. Boland
Partner and Chair, Securities Enforcement & Litigation Practice
Boston, Massachusetts
617.226.3179
bboland@foley.com
Jonathan N. Halpern
PartnerGovernment Enforcement, Compliance & White Collar Practice
New York, New York
212.338.3650
jhalpern@foley.com
Ehren M. Fournier
Associate
Business Litigation & Dispute Resolution Practice
Chicago, Illinois
312.832.4371
efournier@foley.com
