On October 5, 2015, the Supreme Court declined to hear the federal government’s appeal in U.S. v. Newman, 773 F.3d 438 (2nd Cir. 2014), an insider trading case in which the US Court of Appeals for the Second Circuit reversed the convictions in the district court of Todd Newman and Anthony Chiasson for trading on confidential earnings information. The Second Circuit had held on appeal that, to convict on a charge of insider trading, the government must prove beyond a reasonable doubt that the recipient of insider information knew not only that the insider had disclosed confidential information, but also that the insider did so in exchange for personal benefit. The Supreme Court’s refusal to hear the case leaves in place the Second Circuit’s landmark ruling.

Newman

In Newman, an employee of Dell, Inc., Rob Ray, and an employee of Nvidia Corp., Chris Choi, provided confidential quarterly earnings reports to their friends. Eventually the friends passed on the information to others, and eventually they passed it on to Newman and Chiasson. Newman and Chiasson traded on the Dell and Nvidia quarterly earnings reports before they had been made public, making millions.

The government indicted—and, at trial, the jury returned guilty verdicts against—Newman and Chiasson for securities fraud. Newman was sentenced to prison for 54 months and fined $1 million. Chiasson received a 78 month prison term and a $5 million fine.

The Second Circuit’s ruling

On appeal, the Second Circuit relied on the Supreme Court’s seminal ruling in Dirks v. S.E.C., 463 U.S. 646 (1983) that a tippee’s liability does not derive solely from trading on material, non-public information, but rather the tipper’s breach of a fiduciary duty. The Second Circuit interpreted the Dirks’ test for determining a tipper’s breach of fiduciary duty as requiring evidence that the tipper personally benefited, directly or indirectly, from the disclosure: no personal gain, no breach. Non-pecuniary benefits such as personal favors would not be sufficient. The Second Circuit concluded that, even when a tipper breaches his fiduciary duty, a tippee is liable only if he knew or should have known of the tipper’s breach.

The Second Circuit found that both tippees, Newman and Chiasson, were three and four levels removed from the inside tippers, and that the government had failed to provide any evidence that either had known of the source of the inside information, or that the tippers had received any personal benefit.

In order to sustain an insider trading conviction against a tippee, the Second Circuit required that the government must prove beyond a reasonable doubt that:

  1. the corporate insider was entrusted with a fiduciary duty;
  2. the corporate insider breached his fiduciary duty by:
    1. disclosing confidential information to a tippee,
    2. 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 used that information to trade in a security or tip another individual for personal benefit.

The Second Circuit vacated Newman and Chiasson’s convictions and remanded to the district court with instructions to dismiss the indictments with prejudice.

The government’s argument

The government filed a writ of certiorari with the Supreme Court, arguing among other things that the Second Circuit’s decision conflicted with the Dirks decision. It argued that the Second Circuit disregarded the Dirks holding that a fiduciary duty and exploitation of non-public information exists when the tippee “gifts” the confidential information to a trading relative or friend so that the tippee essentially trades on the information himself and “gifts” the profits to the tippee. The government argued that, because the Second Circuit went too far when interpreting Dirks, it has now frustrated key purposes of the securities laws, disadvantaged legitimate analysts who rely on authorized information and blurs the line between legitimate and prohibited activity, thus expanding an opportunity for market abuse.

Implications

The government’s request for Supreme Court certiorari review illustrates that the government viewed the Second Circuit’s decision as a severe set back to its securities enforcement efforts. Although the government’s recent aggressive pursuit of insider trading cases may have suffered a setback; in this decision, insiders, public companies, financial institutions, hedge funds and portfolio managers—all of whom may come into possession of confidential, non-public information—still must guard against trading while in possession of confidential material non-public information.

Interested parties should contact Glenn Colton and Walter Van Dorn in our New York office, George Kostolampros in Washington, DC, Steve Senderowitz in Chicago and George Newhouse in Los Angeles or any other Dentons lawyers for further information and guidance.