Second Circuit’s Game-Changing Insider Trading Decision Stands

The United States Court of Appeals for the Second Circuit will not reconsider its decision in United States v. Newman, which dramatically increased the difficulty of proving insider trading cases involving “remote tippees” who lack a direct relationship with the individual who disclosed the confidential information.

The appeals court recently denied the Justice Department’s request to reconsider its ruling.

The Second Circuit’s Decision

As previously discussed on the Scarinci Hollenbeck Business News Blog, the Second Circuit vacated the insider trading convictions of Todd Newman, a portfolio manager at Diamondback Capital Management, and Anthony Chiasson, a co-founder of Level Global Investors. On appeal, the two men argued that the district court erred in failing 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 agreed, ruling that in order to sustain a conviction for insider trading, the prosecution 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. With regard to establishing a personal benefit, the appeals court further ruled that the prosecution must provide “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.”

What’s Next for Insider Trading Prosecution?

The Newman decision is a serious blow to the federal government’s efforts to crack down on insider trading, particularly for Southern District U.S. Attorney Preet Bharara, who has secured a number of high-profile convictions that could be threatened by the ruling. Michael Steinberg, of SAC Capital Advisors, is appealing his conviction, which was based on the same jury instruction. Rajat K. Gupta, who famously provided inside information to Raj Rajaratnam, and Matthew Martoma, another SAC trader, have also sought to overturn their convictions.

To preserve the convictions, the federal government could file a further appeal with the U.S. Supreme Court. However, in reaching its decision, the Second Circuit relied on the Supreme Court’s decision thirty years ago in Dirks v. SEC, which established 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. So unless the Justices are willing to reconsider that precedent, they are unlikely to grant review.

The Court has also shown an unwillingness to sanction attempts by federal prosecutors to “creatively” widen the scope of criminal liability for business misdeeds. In Yates v. United States, the justices held that a Florida fisherman did not violate the Sarbanes-Oxley Act’s anti-shredding provision when he tossed undersize fish overboard in order avoid a fine from wildlife officials, rejecting the government’s argument that the statute generally prohibited the spoliation of evidence and broadly included all physical items that might be relevant to any matter under federal investigation.

Lastly, federal lawmakers are also considering several new bills that would address the Newman decision, including one that would expressly define the crime of insider trading. However, given the current state of Congress, the likelihood that any of these bills will ever become law is uncertain.