On December 10, 2014, in United States v. Newman, Nos. 13-1837-cr; 13-1917-cr, the U.S. Court of Appeals for the Second Circuit issued a much anticipated decision concerning the law of insider trading as it applies to tippee liability. There, the Court was confronted with the following question: “whether the tippee’s knowledge of a tipper’s breach requires knowledge of the tipper’s personal benefit.” The Court answered this question in the affirmative, resolving a split among federal District Court judges in the Southern District of New York.
Defendants Newman and Chiasson, portfolio managers (and here, the tippees), were indicted, and ultimately convicted of insider trading, under a theory that they willfully participated in an unlawful scheme by trading in securities based on inside information they allegedly procured from a cohort of analysts. The evidence established that these analysts first obtained the inside information from various corporate insiders. At trial, however, there was no dispute that Newman and Chiasson were “several steps removed from the corporate insiders.” Following the presentation of evidence, Newman and Chiasson sought a judgment of acquittal as a matter of law because the Government had failed to prove that corporate insiders provided inside information in exchange for apersonal benefit as required by the U.S. Supreme Court in Dirks v. S.E.C., 463 U.S. 646 (1983). Newman and Chiasson also argued that an acquittal was warranted because -- even if the corporate insiders received a benefit -- there was no evidence that Newman and Chiasson had any knowledge of such benefit. The trial court reserved decision on the motion and proceeded to instruct the jury.
The trial court declined to instruct the jury that, to support a guilty verdict, it must find that Newman and Chiasson had knowledge of the personal benefit the corporate insiders received for the disclosure of the inside information. Rather, on the issue of knowledge, the Court merely instructed that all the Government had to prove was that Newman and Chiasson had to know that the information originally disclosed by the corporate insider was in violation of a duty of confidentiality.
The Second Circuit reversed Newman’s and Chiasson’s convictions concluding,inter alia, that the trial court’s instructions improperly stated the law regarding the required state of mind for tippee liability1. Contrary to the trial court’s instructions, the Second Circuit held that “a tippee’s knowledge of the insider’s breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit.” The Second Circuit’s determination was consistent with that of several other District Court judges in the Southern District, unmistakably resolving the split in views within the Southern District.
What are the implications of the Second Circuit’s decision? In the ever-evolving judicial interpretation of Section 10(b) of the Securities Exchange Act and Rule 10b-5, Newman today heightens the required state of mind of a tippee that the Government must prove beyond a reasonable doubt to successfully prosecute such tippee for insider trading. Significantly, the burden of proof is the same whether the tippee received inside information directly from a corporate insider in exchange for a benefit or the tippee’s source of information is three, four or even ten times removed from the corporate insider. In each instance, the Government must prove the tippee’s knowledge that the tipper received a personal benefit. Newman no doubt signals to the Government that, the farther removed the tippee is from the tipper alleged to have received a personal benefit, the more difficult it will be for the Government to sustain its burden of proof at trial.