Yesterday, U.S. District Judge Andrew L. Carter, Jr. rejected the argument by the U.S. Attorney’s Office for the Southern District of New York to limit the Second Circuit’s decision in United States v. Newman to classical insider-trading cases. Judge Carter’s order, vacating four insider-trading guilty pleas in United States v. Conradt, represents another setback for U.S. Attorney Preet Bharara in the wake of the Second Circuit’s landmark decision in Newman—a case that we’ve written about here and here.

In Conradt, the government alleged that Trent Martin, a research analyst at a financial services firm, had received material, non-public information from an attorney working on a merger between two publicly traded technology companies. According to the government, Martin then passed information about the merger to his roommate Thomas Conradt, a stock broker at a securities trading firm, who shared the information with three co-workers—Daryl Payton, David Weishaus and Benjamin Durant. 

Martin, Conradt, Payton, and Weishaus ultimately pleaded guilty to insider trading; however, after Newman, the sufficiency of those pleas was called into doubt. In Newman, the Second Circuit reversed insider-trading convictions against two hedge fund portfolio managers, holding that, to sustain a conviction for insider trading, the government must prove that a tippee who trades on the basis of material non-public information knew the information was confidential and was divulged for personal benefit. Importantly, the court also appeared to narrow the scope of what constitutes a personal benefit, explaining that “the mere fact of friendship, particularly of a casual or social nature,” was insufficient to meet the standard under the insider-trading laws. The apparent narrowing of the scope of an actionable personal benefit raised questions about the sufficiency of the evidence underlying the plea agreements in the Conradt case.

On January 12, 2015, the U.S. Attorney’s Office for the Southern District of New York filed a brief supporting the sufficiency of the defendants’ guilty pleas. The government argued that Second Circuit’s holding in Newman was limited to cases brought under the “classical” theory of insider-trading liability—cases in which the tipper is a corporate insider, who owes fiduciary duties to the corporation and its shareholders. The government maintained that Newman did not apply to cases, like Conradt, brought under the “misappropriation” theory of insider trading, in which the tipper is a corporate outsider, who misappropriates confidential information in breach of a fiduciary duty owed to the source of the information. 

The government took the position that misappropriation cases do not require that the initial tipper have received a personal benefit, arguing that the misappropriation itself was sufficient to constitute a violation. In the government’s view, a misappropriator who gives away material, inside information in exchange for no personal benefit has still breached his duty to the source of the information, who presumably expected that the information would not be revealed or disclosed for any purpose. This deception of, or breach of duty to, the source would thus violate the law and create a potential for tippee liability as well.

Judge Carter rejected the government’s position and vacated the defendants’ guilty pleas, explaining that, “as indicated in Newman, the controlling rule of law in the Second Circuit is that ‘the elements of tipping liability are the same, regardless of whether the tipper’s duty arises under the ‘classical’ or ‘misappropriation’ theory.’” Judge Carter highlighted that “Newman’s unequivocal statement on [this] point is part of a meticulous and conscientious effort by the Second Circuit to clarify the state of insider-trading law in this Circuit.” In addition to feeling itself bound by the Second Circuit’s language, the court “note[d] that it agrees with Newman’s articulation of the requirements of tipping liability and its statement that such analysis applies equally in misappropriation cases.”

Accordingly, if the Conradt court’s view is adopted by other courts, the misappropriation theory as well as the classical theory will require the government to prove both that the tipper received a personal benefit as defined by Newman and that the tippee knew of that benefit.