The Supreme Court declined to hear the United States’ challenge to the Second Circuit Court of Appeals’ controversial decision on insider trading in U.S. v. Newmanyesterday, without comment. This is a significant blow to the United States, which has been reeling in the wake of the Newman decision by a panel of the Second Circuit last December. The Appeals Court vacated the convictions of hedge fund portfolio managers Todd Newman and Anthony Chiasson for conspiracy to commit securities fraud, in violation of 18 U.S.C. § 371, and securities fraud, in violation of 15 U.S.C. § 78j(b) and 15 U.S.C. § 78ff. It also remanded the case to the District Court for the Southern District of New York to dismiss the indictments, with prejudice, against Newman and Chiasson, who were considered “remote” or “downstream” tippees, i.e., several steps removed from the corporate insiders who disclosed the confidential information on which they traded.
Following more than 80 guilty pleas and trial convictions in insider trading cases prosecuted over the last several years by the office of Preet Bharara, the United States Attorney for the Southern District of New York, the Appeals Court opinion, which clarified the elements of the offense of insider trading, was met with incredulity by the government and emphatic praise by the defense bar. The Newman opinion made clear that not all improper disclosures of “inside” information rise to the level of securities fraud; i.e., a company insider breaches his fiduciary duty to the company by disclosing confidential information only if he does so in exchange for a personal benefit. Relying on the Supreme Court’s 1983 decision in Dirks v. Securities and Exchange Commission, the Appeals Court declared that even if a company insider (i.e., the “tipper”) discloses confidential, inside information about a company, in violation of his fiduciary duty or a duty of confidentiality, he cannot be held liable for engaging in insider trading “unless the tipper acts for personal benefit, that is to say, there is no breach unless the tipper ‘is in effect selling the information to its recipient for cash, reciprocal information, or other things of value for himself . . . Newman, 773 F.3d at 450 (quoting Dirks v. S.E.C., 463 U.S. 646, 664 (1983)).
Because tippee liability is derivative of tipper liability, the Newman Court reasoned, “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 knew of a breach.” Newman, 773 F.3d at 448. Thus, the government must identify a concrete and meaningful “personal benefit” to the tipper of which the tippee was aware; lip service to friendship between tipper and tippee will not suffice. While acknowledging that its prior opinions “broadly defined” personal benefit “to include not only pecuniary gain, but also, inter alia, any reputational benefit that will translate into future earnings and the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend,” the Second Circuit declared that the standard, “although permissive,” was not a “nullity.” Id. at 452.
By circumscribing the parameters of the offense, Newman threatened to rein in Bharara’s highly aggressive pursuit of alleged insider traders. The defense bar quickly capitalized on the Second Circuit’s decision by seeking the dismissal of insider trading charges against and reversal of insider trading convictions of numerous defendants (including convictions following guilty pleas). Notwithstanding Bharara’s vehement objection to the Newman decision and vow to see it overturned, in April 2015, the Second Circuit denied the government’s petition for panel rehearing, or, in the alternative, for rehearing en banc. United States v. Newman, 2015 U.S. App. LEXIS 5788 (2d Cir. Apr. 3, 2015). With the Supreme Court’s denial of the government’s petition for certiorari today, Bharara’s worst nightmare is a reality. The United States will now likely find itself playing defense in dozens of additional challenges to insider trading convictions that fail to satisfy the Dirks/Newman standard.