The recent decision of the federal Second Circuit Court of Appeals in U.S. v. Newman et al. (December 10, 2014) is noteworthy for a few reasons. Among them is the Court’s analysis and discussion – and clarification – of what constitutes a “personal benefit” that must be received by a tipper for tipping insider-trading liability to be imposed on a tippee under SEC Rule 10b-5.
The Court acknowledged that “personal benefit” has been broadly construed by courts to “include not only pecuniary gain, but also… any reputational benefit that will translate into future earnings and the benefit one would obtain by simply making a gift of confidential information to a trading relative or friend.” But the Court stated that “the mere fact of a friendship, particularly of a casual or social nature,” is not enough from which to deduce that the tipper received a personal benefit. Instead, there must be “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. In other words, … this requires evidence of ‘a relationship between the [tipper] and the [tippee] that suggests a quid pro quo from the [tippee], or an intention to benefit the [tippee].’”
Accordingly, the Court concluded that, in light of the evidence in the particular case regarding two separate tipping relationships,
- the first tipper’s receipt of “career advice” or other professional encouragement that the tippee routinely gave to industry colleagues, which preceded the disclosure from the tipper and would have been provided without any such disclosure, did not involve an exchange or a quid pro quo arrangement and, therefore, did not constitute a personal benefit to the tipper; and
- the relationship between the second tipper and tippee as merely casual acquaintances, with no history of personal favors between them and no evidence that the tipper knew that the tippee was trading in securities based on the information disclosed by the tipper, did not involve an exchange or a quid pro quo arrangement and, therefore, did not constitute a personal benefit to the tipper.
The Court’s analysis of “personal benefit” in the situation involving a tipper and a tippee may also be relevant to whether an insider’s gift of his or her company’s securities exposes the insider to insider-trading liability. As described in a previous blog post, an argument that such a gift constitutes a “sale,” or an action “in connection with” a sale, of securities for the purpose of Rule 10b-5 is made by analogy to a tipper-tippee relationship. That is, such a gift would be more likely to be characterized as a sale, or in connection with a sale, of securities if the donor receives a “personal benefit” by making the gift. The Court’s emphasis on evidence of an exchange or a quid pro quo arrangement to find a personal benefit may suggest that such a gift should not be characterized as a sale, or in connection with a sale, of securities unless the donor controls or significantly influences, or is otherwise closely associated, with the donee or receives some significant reputational benefit from the gift.
OUR TAKE: As other commentators on the Court’s decision have pointed out, the Court’s analysis and decision may adversely affect the SEC’s efforts to criminally prosecute insider-trading. Nevertheless, the Court’s analysis and discussion of what constitutes a “personal benefit” provides some valuable clarity, and may apply beyond tipper-tippee situations.