On April 3, 2015, the U.S. Court of Appeals for the Second Circuit denied U.S. Attorney Preet Bharara's request that the court reconsider its landmark December 2014 ruling in United States v. Newman. By declining to reconsider its Newman decision, the Second Circuit left in place a sharply narrowed definition of insider trading that limits the government's ability to prosecute insider trading cases (at least in the Second Circuit). The government must now decide whether to appeal to the Supreme Court and/or rely on Congress to adopt legislation providing a statutory definition of illegal insider trading for the first time.
In Newman, the Second Circuit overturned the convictions of two hedge fund traders and, in the process, dramatically limited the Federal government's ability to prosecute insider trading cases. Mr. Bharara, supported by the Securities and Exchange Commission, requested a rehearing en banc before the full bench of the Second Circuit. Surprising many, the Second Circuit declined the request, leaving its Newman decision standing.
The Newman Decision
The government alleged in Newman that corporate insiders at two public technology companies disclosed confidential information about their companies' earnings to a hedge fund analyst and a businessman, who then passed the information to other analysts. After being shared further among several analysts, the confidential information was ultimately conveyed to the two defendants, Todd Newman and Anthony Chiasson, portfolio managers at separate hedge funds. Newman and Chiasson then executed trades for their hedge funds based on the confidential information.
After a jury trial in the Southern District of New York, Newman and Chiasson were convicted of illegal insider trading, despite the lack of evidence of them being aware that the corporate insiders had leaked the information and despite being several steps removed from the initial tips. The corporate insiders who leaked the confidential information were never charged, but all the tippers were charged and pleaded guilty. On appeal, the Second Circuit overturned the convictions of Newman and Chiasson, holding that:
- The trial court failed to instruct the jury that to convict it must find the defendants had knowledge of the insiders receiving a personal benefit for tipping the confidential information; and
- The government failed to establish that the insiders received a personal benefit.
In discussing the personal benefit requirement, the court opined that mere friendship between the tipper and tippee (particularly of a casual or social nature) was insufficient to establish that the tipper received a personal benefit. Rather, there must be "proof of a meaningfully close personal relationship [between the 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."
The Impact of Newman
Newman increases the government's evidentiary burden in insider trading prosecutions by requiring the government to prove:
- That a defendant alleged to have traded on confidential information leaked by a corporate insider was aware that the insider received a personal benefit for leaking the information; and
- That in exchange for disclosing the confidential information, the corporate insider received a personal benefit that was more than mere friendship.
These evidentiary thresholds will be difficult to satisfy in many situations. Mr. Bharara's office asserted in its rehearing request that if Newman stands, it will "dramatically limit the government's ability to prosecute some of the most common, culpable and market-threatening forms of insider trading." Indeed, the Department of Justice has dropped charges against several defendants already accused of insider trading, including some who pleaded guilty. Moreover, several individuals previously convicted of insider trading announced their intention to challenge their convictions in light of Newman.
The Future is Uncertain
To restore some of the government's lost powers to prosecute insider trading, Mr. Bharara could petition the Supreme Court to reverse Newman and/or Congress could act. Following the Newman decision, some (including Supreme Court Justice Antonin Scalia and SDNY Judge Jed Rakoff) have pressured Congress to pass a law defining illegal insider trading. Currently, no Federal statute defines insider trading. As a result, the law of insider trading developed over many years through judicial decisions and government regulation – hence the immense significance of the Newman decision.
The outcome of this important issue remains unclear and difficult to predict. Mr. Bharara has not indicated whether he will petition the Supreme Court to review the Newman decision. Efforts are underway in Congress to address the issue with the recent introduction of three bills designed to define the crime of insider trading. We will continue to monitor this issue and publish additional alerts when significant developments occur.