In its recent decision in United States v. Newman, the Second Circuit held that, in an insider trading case, the government must prove that the tippee, the individual who received nonpublic, material information from an inside source, knew that the corporate insider received a personal benefit in exchange for disclosing confidential company information. This holding will require the government to prove that the tippee was aware that the tipper, who provided the inside information, received a personal benefit for the disclosure. This holding will also likely limit the scope of liability for individuals, such as financial analysts and portfolio managers, who trade on information that is not publicly accessible but who have no direct relationship with the individuals who provided the inside information.
Todd Newman and Anthony Chiasson made millions of dollars for their hedge funds in 2008 by trading on inside information about the earnings for Dell and NVIDIA. Newman and Chiasson did not personally know the individual who had originally provided the nonpublic information about Dell and NVIDIA, and they had received information from various sources. Nevertheless, the trial court convicted Newman and Chiasson of securities fraud. The Second Circuit vacated Newman and Chiasson’s convictions because the court found that there was not enough evidence to prove beyond a reasonable doubt that Newman and Chiasson knew that the tipper had received a personal benefit for providing the inside information and that they were trading on information that the tipper had obtained by breaching his or her fiduciary duties to his or her employer.
An individual is not liable for insider trading simply because he or she traded on information that the individual knew was confidential and nonpublic. To be held liable, an individual must know or should have known that the individual who provided the insider information, who is known as the tipper, breached his or her fiduciary duty by providing the inside information and received a personal benefit for the disclosure. Thus, in light of the Newman decision, to convict a tippee of insider trading, the government must prove, beyond a reasonable doubt, that:
(1) The corporate insider or tipper owed a fiduciary duty to the company that he or she is disclosing nonpublic information about;
(2) The corporate insider breached his or her duty by disclosing confidential information to the tippee in exchange for a personal benefit;
(3) The tippee knew of the tipper’s breach, knew that the information was confidential and knew that the tippee shared the confidential information for a personal benefit; and
(4) The tippee used the information to trade in a security or provided the information to another individual for personal benefit.
Preet Bharara, United States Attorney for the Southern District of New York, has petitioned the Second Circuit for a rehearing in this case and argues that the court’s decision reflects a departure from precedent and may impede enforcement of securities laws.