Second Circuit Decision Threatens Insider Trading Prosecutions

U.S. Attorney Preet Bharara’s insider trading victories came to a screeching halt earlier this month.

In a case that will have widespread implications, the Second Circuit Court of Appeals made it much more difficult for the government to prove insider trading cases involving “remote tippees” who do not have a direct relationship with the individual who disclosed the confidential information.

As previously discussed on the Scarinci Hollenbeck Business News Blog, Todd Newman, a portfolio manager at Diamondback Capital Management, and Anthony Chiasson, a co-founder of Level Global Investors, were convicted of trading on insider information about Dell Computer and Nvidia. They appealed their convictions based on the federal district court judge’s refusal to instruct the jury that they could not be convicted unless they knew the employees leaking the information had received a benefit when they violated their duty to their companies by providing the information.

The Second Circuit sided with the defendants and vacated the convictions. “[We] conclude that, in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit,” the court ruled.

In reaching its decision in United States v. Newman, the appeals court cited U.S. Supreme Court precedent holding that trading on inside information is legal unless it is obtained from an individual who violates a duty to keep it confidential and receives something of value in return for the information. As explained by the Second Circuit:

“First, the tippee’s liability derives only from the tipper’s breach of a fiduciary duty, not from trading on material nonpublic information. Second, the corporate insider has committed no breach of fiduciary duty unless he receives a personal benefit in exchange for the disclosure. Third, even in the presence of a tipper’s breach, a tippee is liable only if he knows or should have known of the breach.”

“We find no support for the government’ s contention that knowledge of a breach of the duty of confidentiality without knowledge of the personal benefit is sufficient to impose criminal liability. Although the government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets,” the court added.

The Second Circuit’s decision raises the bar for prosecutors and will have widespread implications on the government’s ability to impose insider-trading liability. In addition, at least one convicted insider trader stands to benefit from the new legal standard. Michael Steinberg, of SAC Capital Advisors, is appealing his conviction, which was based on the same jury instruction.