In an important decision that clarifies insider trading rules, the U.S. Court of Appeals for the Second Circuit ruled recently in U.S. v. Newman that simply receiving and using nonpublic information about a company is not a criminal offense. In the case before the court, the defendants had received confidential business information about two high tech companies, Dell and NVIDIA, and managed to make profits of $72 million from trading on that information. After a trial, the defendants were convicted and sentenced to 54 and 78 months of imprisonment. Significant fines were also imposed on them.

The Court of Appeals reversed the convictions and ordered the trial court to enter a verdict of “not guilty” for both defendants.

The Court explained that, under US law, the criminal liability of a person who receives inside information derives only from the criminal liability of the person who disclosed the information. If the discloser did not commit a crime, the recipient also did not commit a crime. Importantly in this case, the Court held that if the recipient did not know that the discloser committed a crime, then the recipient cannot be guilty of a criminal act.

Under US law, the disclosure of inside information is not a crime unless (a) the person disclosing the information had a fiduciary duty to keep the information confidential, and (b) he profited from making the disclosure. If the discloser did not profit, he is not guilty of fraud, so there is no crime, and there can be no derivative liability of the recipient of that information .

Likewise, if the recipient of the information received it by word of mouth and not directly from the discloser, the defendant might be in a position where it is not possible to know if the discloser profited from making the information known. That was the case before the Court of Appeals, where the recipients were three and four people removed from the insider who disclosed the information. The Court held that they  could not have known if the discloser received personal benefit from making the disclosure, so they could not have been guilty of a crime.

Israeli law differs significantly from US law in this regard. Under Israeli law, a person who receives non-public information that he knows, or should have known, came from an insider cannot use the information to trade in the shares of the company .

Consider the following situation: a person overhears a conversation in an elevator between two people, one of whom he knows to be the CEO of a certain public company. He hears the CEO say that the earnings for the current quarter are going to be much higher than expected.

If the company is an American company traded in the US, the person hearing the conversation in the elevator can use the information  for  his  benefit. The discloser did  not profit from his disclosure, so there is no crime by the discloser and therefore no crime by the recipient.

On the other hand, if the company is an Israeli company traded in the Tel Aviv Stock Exchange, the person receiving the information, if he knows or should have known that it came from an insider is prohibited from trading on the basis of this information.

It is important to note that there is a fundamental difference between Israeli Law and American law in these matters. Under Israeli law, the criminal liability of the person trading on inside information will be analyzed only on the basis of his own actions, without regard to actions of the discloser.

Please click here to view the court decision.