On February 29, 2016, in Securities and Exchange Commission v. Payton et al, a jury found two stockbrokers liable for trading on confidential tips about an acquisition being made by IBM despite the ruling made by the Second Circuit Court of Appeals in United States v. Newman[1] in December 2014.

In United States v. Newman, decided in December 2014 by the Second Circuit, the court vacated the criminal convictions of two portfolio managers, Anthony Chiasson and Todd Newman.  Basically, in Newman, the criminal convictions for insider trading were reversed due in part to the facts that the tippers were several levels removed from the sources of the tips and that the tippers did not receive a personal benefit in exchange for the disclosure.  The Second Circuit clarified that mere friendship is not sufficient and to sustain a tippee liability; the SEC must show that the source of information received “personal benefit.” The court outlined the elements of tippee liability:  “to sustain an insider trading conviction against a tippee, the [SEC] must prove each of the following elements beyond a reasonable doubt:  that (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit,” leading many to believe that establishing liability  would be much harder for the SEC in future civil cases.

Securities and Exchange Commission v. Payton et al[2] calls into question the assumption that the Newman ruling will make pursuing insider trading cases more difficult for the SEC.  In thePayton case, while the defendants’ guilty pleas were vacated, Judge Rakoff declined to dismiss civil insider trading charges against the defendants and the case went to trial.  The SEC presented evidence that stockbrokers Daryl Payton and Benjamin Durant improperly purchased shares of a statistical software company before the company was to be acquired by IBM.  Payton and Durant were tipped about the prospective acquisition by IBM by Thomas Conradt.  Conradt, in turn, had received the tip from Trent Martin, who learned of the IBM acquisition from Michael Dallas, who was an associate at a law firm who had been assigned to work on the acquisition.  Martin roomed with Conradt, and the SEC alleged that Martin and Conradt had a close, mutually-dependent financial relationship and a history of personal favors.  For example, Conradt took the lead in organizing and paying shared expenses for the apartment, negotiated a rent reduction, renegotiated a cable bill, hired a cleaning service and arranged for apartment repairs, and assisted Martin after Martin was arrested and charged with criminal assault following a street altercation.  Martin thanked Conradt for his prior assistance with the criminal legal matter and told Conradt that he was happy that Conradt profited from the tip.  The SEC claimed that the benefits that Conradt provided Martin were sufficient to prove a “personal benefit.”  Given the tenuous connection and the multiple layers of tippees, many thought the outcome would mirror Newman in that the SEC would not be able to establish liability.

In his April 6, 2015 decision declining to dismiss the civil charges, Judge Rakoff found that the SEC could prove the elements of insider trading for a remote tippee. He stated that the Complaint alleged that “the defendants (a) knew that Martin was the source of the tip to Conradt. . . (b) knew that Conradt and Martin were friends and roommates. . . and (c) knew. . . of Martin’s assault arrest. . . [therefore, there was] reasonable inference that the defendants knew that Martin’s relationship with Conradt involved reciprocal benefits.”  He differentiated the Payton case from theNewman case by stating that in Newman, “the defendants ‘knew next to nothing’ about the tippers, were unaware of the circumstances of how the information was obtained, and ‘did not know what the relationship between the [tipper] and the first-level tippee was’” whereas the SEC had alleged that “the defendants [in Payton] knew the basic circumstances surrounding the tip.”  He also noted that the per the allegations, it could be viewed that “defendants recklessly avoided discovering additional details,” and that the court “may draw an adverse inference from their conscious avoidance of details about the source of the inside information and nature of the initial disclosure.”

The jury found liability based on the facts presented after trial.

The Payton decision and verdict is arguably inconsistent with the Newman decision.  This is certainly not the last word on the issue, however.  Notably, the Supreme Court has granted certiorari for United States v. Salman[3] on January 19, 2016. Salman, decided by the Ninth Circuit, involved a tippee who had a familial relationship with the tipper, and the tippee in Salmanargued that Newman should apply such that “evidence of a friendship or familial relationship between tipper and tippee, standing alone, is insufficient to demonstrate that the tipper received a benefit.”  The Ninth Circuit, also in an opinion written by Judge Rakoff,  disagreed stating that “we decline to follow [Newman.]”  It will be interesting to see whether the Supreme Court applies theNewman analysis in determining the threshold to satisfy the “personal benefit” element of an insider trading conviction or whether the Supreme Court will limit or refine the Newman holding.  We also would expect to see an appeal of the Payton verdicts.