Insider Trading
Why The Second Circuit Refuses to Reconsider Its Newman Decision

Insider Trading
Why The Second Circuit Refuses to Reconsider Its Newman Decision

Jonathan N. Halpern
Ehren M. Fournier

On April 3, the Second Circuit let stand, without further review or dissent, its December ruling in United States v. Newman, 773. F.3d 438 (2d Cir. 2014).

The decision threw out two convictions and increased the government’s evidentiary burden in insider trading cases.

In its original decision, the Second Circuit held that the government is required to prove – and did not prove in Newman – that company insiders, who disclosed material non-public information (MNPI), received a consequential personal benefit for the tipped information and that the defendant tippees knew about that benefit.

The U.S. Attorney’s Office for the Southern District of New York had sought both review from the original three-member panel and en banc review from all the Second Circuit judges. In its petition, the prosecutors had warned that the original appellate opinion “threatened the effective enforcement of the securities laws” and would “dramatically limit the Government’s ability to prosecute some of the most common, culpable, and market-threatening forms of insider trading.”

Unmoved by such a dire forecast, the Second Circuit declined to revisit a ruling that it considered to be the natural legacy of – and wholly consistent with – established Supreme Court doctrine on actionable insider trading.

A Brief Legal Summary

At its core, the doctrine makes clear that not all trading on inside information is illegal. Rather, a tippee’s liability for insider trading stems from an insider’s breach of fiduciary duty, which occurs only when the insider “personally will benefit, directly or indirectly, from his disclosure.” Dirks v. SEC, 463 U.S. 646, 662 (1983).

In Newman, the government argued that the tippees could be found guilty on evidence of their knowing that the tippers had disclosed information in breach of a duty, even without knowing about any personal benefit. The Second Circuit disagreed, and held, “[f]or purposes of insider trading liability, the insider’s disclosure of confidential information, standing alone, is not a breach.

Thus, without 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 knows of a breach.” Newman, 773 F.3d at 448.

How the Trial Proceeded

At trial, the government presented evidence that tech company employees had provided nonpublic earning numbers to financial analysts who in turn passed the inside tips to portfolio managers – defendants Newman and Chiasson.

The managers then traded in Dell and NVIDIA stock and secured $4 million and $68 million for their respective funds. The prosecution presented no evidence that the defendants knew the source of the information. The defendants moved for a judgment of acquittal, arguing that there was no evidence that the insiders tipped in exchange for a personal benefit. They also argued that even if a personal benefit was exchanged, no evidence was presented that they had been aware of it.

The defendants also requested a jury instruction as to their knowledge of a personal benefit. Instead, the court’s jury instructions permitted the jury to convict if it found that the defendants only “[knew] that [the MNPI] was originally disclosed by the insider in violation of a duty of confidentiality.” The Second Circuit held that the jury instructions were erroneous and the evidence insufficient to sustain the defendants’ convictions. The court also held that there was no evidence that the defendants knew that they were trading on information obtained from insiders.

The Second Circuit Standard for Tippee Insider Trading

In Newman, the Second Circuit set out the following elements to convict a tippee of insider trading:

  1. the insider held a fiduciary duty;
  2. the insider breached his fiduciary duty by disclosing MNPI to a tippee in exchange for a personal benefit;
  3. the tippee knew of the tipper’s breach – i.e., that the insider knew the information was confidential and disclosed in exchange for a personal benefit; and, 
  4. the tippee used the MNPI to trade in a security or to tip another individual for a personal benefit.

Defining “Personal Benefit”

Newman also is important for its guidance on what does -- and more significantly what does not -- constitute a “personal benefit.” The court reaffirmed a broad definition not limited to pecuniary gain, but tightened some of its elasticity with specific examples. Merely sharing career advice or assistance in a casual friendship, such as among fellow alumni or members of social or church groups or as “family friends,” was held insufficient for a personal benefit.

More challenging for the court, however, was articulating a clear standard. In the context of a personal relationship between tipper and tippee, the court held that what was required for a personal benefit was 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 an apparent effort to simplify the standard, the court cited United States v. Jiau, 734 F.3d 147, 153 (2d Cir. 2013), and Dirks as to what the government must prove: “a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter].” [Ed: Emphasis added.]

However, it is clear that determining such an intention and whether a personal benefit was provided in a particular case will continue to be challenging fact-based issues for trial and appellate courts.                                                        

Here are the Consequences of the Newman Decision

The continued application of Newman no doubt will restrict the government’s ability to bring tippee insider trading prosecutions in the Second Circuit, especially in the Southern District of New York, where many Wall Street securities cases are brought.

Since Newman prosecutions under way in the SDNY and other districts have already have faced Newman challenges. There reportedly have been at least 12 cases in the SDNY and 18 more nationwide in which a defendant has challenged his conviction or charges in the district court or on appeal, including two SDNY cases that were pending sentencing. Earlier this year, in United States v. Conradt, 12 Cr. 887 (ALC) (SDNY), U.S. District Judge Andrew L. Carter, Jr., ruled that, in light of the Newman decision, there was no longer a sufficient factual basis to sustain four guilty pleas and vacated them.

Judge Carter rejected the government’s attempt to limit Newman’s application and held that the controlling rule in the Second Circuit is that the elements of tipping liability are the same for “classical” and “misappropriation” theories. The government ultimately filed a nolle prosequi motion to dismiss the indictments against all five defendants in the case.

The effects of the Newman decision have extended beyond federal court. Several challenges also have been lodged in SEC administrative proceedings before administrative law judges. The Newman ruling also may be instructive in enforcement of the STOCK Act, which was enacted in 2012, under which Members of Congress and employees of Congress are subject to insider trading proscriptions.

Of course, the government and the SEC may seek to bring criminal and civil securities fraud cases, respectively, where permissible, in other forums outside the Second Circuit. For the SEC, the ruling may further encourage the agency’s growing preference to initiate cases in administrative proceedings rather than in federal district court.

The Justice Department may consider petitioning the Supreme Court for review of Newman or turning to Congress to enact an insider trading statute. Several bills banning insider trading recently have been introduced. In the meantime, the principles of Newman will continue to be applied.

Whether government warnings about the effective enforcement of the securities laws post-Newman are realized, it is clear that, at least within the Second Circuit, prosecutors in insider trading cases will be required to hew more closely to traditional criminal prosecutions that require proof of a defendant’s knowledge as an essential element. As a result, tippees cannot be prosecuted for merely trading on inside information when they are unaware of a personal benefit to the insider.

Under such circumstances the tippees would not be aware of an insider’s breach of a fiduciary duty, if any actually occurred, and therefore could not be guilty of insider trading.

About the Authors

Jonathan Halpern

Jonathan Halpern is a litigation partner with Foley & Lardner LLP and leads the Government Enforcement, Compliance & White Collar Defense Practice in New York. A former federal prosecutor in the Southern District of New York, where he was chief of the Major Crimes Unit,  he counsels and defends corporate and individual clients in criminal and regulatory matters at trial, on appeal and before the Justice Department, U.S. Attorney’s Offices, the SEC, and Treasury Department.


Ehren Fournier is an associate and litigation lawyer with Foley & Lardner LLP and a member of the Business Litigation & Dispute Resolution Practice. Mr. Fournier also has worked with the firm’s Government Enforcement, Compliance & White Collar Defense Practice, on a variety of matters.


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