Newman, Left Untouched by the Supreme Court, Reverberates Throughout Lower Courts
The Second Circuit’s decision in United States v. Newman is undoubtedly one of the biggest developments in insider trading law as demonstrated by the impact it continues to have on rulings in the nation’s lower courts. That case, decided by the Second Circuit in December 2014 and cemented by the Supreme Court’s denial of certiorari this year, has generated reverberations for insider trading cases throughout the country.
In Newman, the Second Circuit reversed the convictions of two hedge fund managers, finding that there was insufficient evidence to prove that the corporate insider “tippers” had obtained any personal benefit in exchange for the tips conveyed. In so doing, the court ruled that such remote tippees cannot be held liable for insider trading unless they knew the tipper was disclosing confidential information in exchange for a personal benefit. Friendship alone does not satisfy the “personal benefit.” Instead, under Newman, the government must provide “proof of a meaningful close personal relationship [between tipper and tippee] that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” This represents a sea change from past practice, in which it was deemed sufficient for prosecutors to allege only friendship as a personal benefit.
The impact of this decision, and of the denial of the U.S. Attorney’s petition for review, has been significant, with defendants withdrawing guilty pleas and the government seeking to dismiss actions where it lacked the requisite proof of a personal benefit or knowledge under the Newman standard. In one such case, the district court vacated guilty pleas for defendants alleged to have traded on inside information regarding IBM Corp’s $1.2 billion purchase of SPSS Inc. Shortly thereafter, the government sought to drop the charges against all five defendants in that case, and requested dismissal of the case without prejudice. United States v. Conradt, No. 12-887, 2015 U.S. Dist. LEXIS 16263 (S.D.N.Y. Jan. 22, 2015). And, this fall, the government dropped charges against a former portfolio manager of SAC Capital Advisors LP, who, along with cooperating witnesses, was convicted in 2013 of a scheme involving tech stocks that yielded over $1.8 million in profits. United States v. Steinberg, No. 14-2141 (S.D.N.Y.).
Notably, however, some courts have applied the standard articulated in Newman fairly flexibly in civil enforcement actions brought by the SEC. On December 28, 2015, a New York federal judge ruled that a jury should decide whether two individuals accused of insider trading knew that the individual who tipped them off about a pending deal received a personal benefit under Newman. SEC v. Payton, et al., Case No. 1:14-cv-4644 (S.D.N.Y). The two defendants allegedly received $290,000 in unlawful profits after learning about a deal between IBM and software firm SPSS Inc. prior to its public announcement. According to the government’s case, the tip originated from a law firm associate who set off a string of tippers that culminated in Daryl Payton and Benjamin Durant learning about the deal. Even though the tippees denied knowing whether their tipper received any benefit in exchange for the information, Judge Jed S. Rakoff denied their motion for summary judgment, holding that the “credibility of these statements remains a matter for the jury to assess,” as a jury could reasonably find that “it was more likely than not that the defendants made deliberate choices not to inquire further into the circumstances.” In a major win for the SEC, a jury found both Payton and Durant liable for insider trading in February 2016.
In July 2015, the Ninth Circuit entered the mix with its insider trading decision in United States v. Salman, which threw what the Wall Street Journal called a splash of “cold water” on the trend of post-Newman reversals and dismissals. In that case, the defendant sought to overturn his insider trading conviction on the grounds that he did not know of any tangible benefit received by the insider, his future brother-in-law, in exchange for the tip conveyed. The Ninth Circuit rejected that request, holding that, although it could not “lightly ignore the most recent ruling” of the Second Circuit inNewman, the gift of confidential information from an insider to a trading relative or friend meets the element of breach of fiduciary duty in an insider trading claim. Although the Supreme Court refused to hear a petition for certiorari of Newman, it recently agreed to hear an appeal of Salman’s case out of the Ninth Circuit. The case, which will be heard by the high court this year, turns on whether prosecutors are still required to show the exchange of a significant personal benefit where the tipper and tippee are close family or friends. Salman v. U.S., Case No. 15-628 (U.S. Supreme Ct.).
Importantly, recent rulings have also extended Newman’s personal benefit requirement to apply to both classic and misappropriation theories of insider trading. In September, an SEC administrative law judge dismissed insider trading charges brought against a former Wells Fargo trader on a misappropriation theory. Although the SEC had argued that it did not need to prove personal benefit at all in misappropriation cases, the judge ruled “[t]he personal benefit element applies in both classical and misappropriation cases,” and found that the government “did not satisfy its burden to establish that [the tipper] tipped Ruggieri for a personal benefit within the meaning of Dirks v. SEC ... and United States v. Newman.”
As insider trading continues to be a high priority and a high-profile area for prosecutors and the SEC nationwide, 2016 will likely see a number of additional rulings in the lower courts as they continue to interpret and apply Newman to pending cases on their dockets. Additional trends in this area include the use of advanced technology and undercover techniques by the government to unearth complex insider trading schemes, including wiretapping, search warrants, efforts to turn witnesses, and coordination with international regulatory enforcement counterparts to advance investigations.
Other Notable Insider Trading Cases
In 2015, the SEC has continued to show a strong interest in focusing on cases arising from tips of confidential information by professionals, in industries ranging from investment banking to medicine to law. According to one statement by an SEC official, “[w]e will continue to proactively identify and combat serial insider trading schemes, particularly when it involves industry professionals.”
In one such example, the SEC charged a law firm partner with insider trading in the stock of Harleysville Group., Inc., ahead of its announcement of a $760 million merger with Nationwide Mutual Insurance Company. The partner purportedly learned about the deal at his now-former firm, which was advising on the merger. He purchased Harleysville stock the day before the merger was announced, and, hours after the announcement, sold it for roughly $79,000 in illegal profits. The SEC charges were accompanied by criminal charges filed this summer by the DOJ. In February, the former law firm partner was convicted of insider trading.
Further, in July 2015, the SEC accused a former executive of Spanish bank Banco Santander, S.A., of trading on information about a proposed acquisition he learned of in connection with Banco Santander’s role as adviser and underwriter for the transaction. Interestingly, the executive purchased not stock, but contracts-for-difference (“CFDs”), which are highly leveraged securities that, while not traded in the U.S., mirrored the stock’s pricing. According to statements released by the SEC, the case demonstrates its resolve to hold accountable those who “think they can mask their insider trading by trading CFDs rather than the underlying equity security.” Less than a month later, the same executive was also charged with coordinating with a friend to purchase call options involving the same transaction, the day before the public announcement of the acquisition bid. See SEC v. Maillard, No. 15-cv-6380 (S.D.N.Y. 2015).
Pivoting to the healthcare industry, the SEC also brought charges in connection with information learned in advance of the merger of Clarient Inc. and GE Healthcare. In that case, a father, son, and family friend allegedly purchased substantial amounts of Clarient stock after a Clarient employee tipped the father off about the deal before its public announcement. After allegedly reaping more than $50,000 in illegal profits from the scheme, the three men paid approximately $170,000 this summer to settle the action.
And, on an even larger scale, in August, the SEC announced charges against a 27-year-old investment bank analyst for tipping confidential information he learned while working at J.P. Morgan’s San Francisco office. The analyst allegedly passed tips to friends about impending mergers between tech companies, including an old college friend—and, by using an account set up by his college friend, the analyst was able to circumvent J.P. Morgan’s pre-clearance rules. After trading on the information, the analyst and his friends allegedly earned over $672,000 in illegal profits. The case includes parallel criminal charges by the DOJ, and is currently pending in Los Angeles.
The New Convergence of Insider Trading and Cyber Theft
This year also saw classic insider trading schemes played out with the benefit of modern technology. In August, the SEC brought insider trading charges against an international hacking ring that constituted “one of the most intricate and sophisticated trading rings” to date. According to the SEC, two Ukrainian men spent approximately five years hacking into newswire services and stealing corporate earnings announcements prior to the newswires releasing that information publically. The men are alleged to have then transmitted the stolen data across the globe to traders, who then used it to make repeated illicit trades, funneling a portion of profits back to the hackers. The case evinces the government’s commitment to the intersection between cyber theft and traditional insider trading laws, and involves the use of unique analytical tools to both detect and prosecute suspicious trading.