On Thursday, July 30, the Department of Justice (DOJ) filed its anticipated petition for writ of certiorari with the U.S. Supreme Court seeking review of the Second Circuit’s controversial decision in U.S. v. Newman. In Newman, the United States Court of Appeals for the Second Circuit reversed the insider trading convictions of former Level Global Investors LP manager Anthony Chiasson and former Diamondback Capital Management LLC manager Todd Newman, finding that the Government had failed to show that two tippers received significant personal benefits for tips and that the tippees – Chiasson and Newman – knew about the benefits.
The Second Circuit’s decision stems from the U.S. Supreme Court’s ruling inDirks v. SEC, in which the Supreme Court articulated the general principles of tipping liability: “Not only are insiders forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage, but they may not give such information to an outsider for the same improper purpose of exploiting the information for their personal gain.” The Supreme Court found that the test for determining whether the corporate insider has breached his fiduciary duty “is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty...[a]nd absent a breach by the insider, there is no derivative breach.”
Based on the language in Dirks, the Second Circuit ruled in Newman that “even in the presence of a tipper's breach, a tippee is liable only if he knows or should have known of the breach. … [W]ithout establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knew of a breach.” The Newman court held that the jury instructions failed to properly instruct the jury that the Government had a duty to prove beyond a reasonable doubt that Newman and Chiasson knew that the tippers received a personal benefit for their disclosure. In addition, the Court held that the Government failed to demonstrate that Newman and Chiasson had the requisite intent to commit insider trading.
Given the impact of the Second Circuit’s ruling on insider trading cases, it comes as no surprise that the DOJ would seek a reversal of the opinion. In its petition, the DOJ argues that the Second Circuit “broke with [the Supreme Court’s] ruling in Dirks v. SEC” by crafting a new, stricter personal-benefit test. According to the DOJ, Dirks established that an inference of a personal benefit to the insider arises when the insider expects something in return for the disclosure of confidential information or when the insider freely gives a gift of information to a trading friend or relative without any expectation of receiving money or valuables as a result. The DOJ argues that the Second Circuit inappropriately limited the personal-benefit test by finding that a personal benefit may not be inferred “in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” In its petition, the DOJ argues that this language by the Second Circuit eliminates the concept of a “gift” and means that an insider cannot be liable on a gift theory unless he receives something from the recipient of the information.
The DOJ goes on to argue that the Newman decision also conflicts with decisions from the Ninth and Seventh Circuit Courts of Appeals. In U.S. v. Salman, the Ninth Circuit rejected the defendant’s argument that, underNewman, the Government failed to carry its burden because there was no evidence that the tipper received a tangible benefit in exchange for the inside information or that the tippee/defendant knew of any such benefit. The Ninth Circuit held that “[t]o the extent Newman can be read to go so far, we decline to follow it. Doing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an “insider makes a gift of confidential information to a trading relative or friend.’”
In a 1995 ruling, the Seventh Circuit held in SEC v. Maio that “[a]bsent a legitimate purpose for a disclosure, the test is whether the disclosure will benefit the insider either directly or indirectly.” The DOJ argues that the Second Circuit’s ruling in Newman is contrary to the decisions of both the Seventh and Ninth Circuits in that it layers additional requirements on top of the Dirkspersonal-benefit test.
In sum, the DOJ argues that, if allowed to stand, the Newman decision will restrict enforcement of the ban on insider trading, create uncertainty in the financial community about the boundaries of legitimate conduct, and produce disparate results in different circuits in the application of the federal securities laws.