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The Second Circuit Raises the Bar for Government Insider Trading Prosecutions

By Grant Fondo and Jessica Adams – February 24, 2015

On December 10, 2014, the U.S. Court of Appeals for the Second Circuit issued a much publicized decision, reversing two high-profile insider trading convictions in the Southern District of New York. In issuing its decision in United States v. Todd Newman & Anthony Chiasson, No. 13-1837, the court reaffirmed important limitations on the scope of insider trading liability under the federal securities laws—specifically making it more difficult for the government to bring insider trading liability charges against traders who are several levels removed from the corporate insider who was the original source of the information. While this holding is limited to the Second Circuit, the decision is a positive development for defendants and potential targets in all circuits, as well as the financial industry, among other industries. The impact of this ruling is already being felt—defendants and judges are requiring prosecutors to reevaluate their cases in light of this ruling. Overall, the Newman decision stands for the following:


First, the court affirmed that a recipient of nonpublic information—the “tippee”—may be found liable only if the initial source of the information—the insider who discloses the nonpublic corporate information in the first place (the “tipper”)—has breached a fiduciary duty to the company in disclosing its information and knew or should have known it constituted a breach. In other words, the tippee can be liable only if the original source of the information is liable for disclosing the information.


Second, the court ruled that the government must prove beyond a reasonable doubt that (1) the insider received an actual benefit for sharing the material nonpublic information  and (2) the ultimate tippee knew that the tipper had received that benefit. The court further clarified that simply being friends and socializing did not constitute a “personal benefit,” but rather the benefit must be of some consequence.


Third, perhaps most striking to those led to believe that all trading on “confidential information” violates the insider trading laws, the court explained that insider trading liability requires more than mere proof of trading on nonpublic information. Quoting the words used in another insider trading case some 20 years ago, the court explained:

[T]he policy rationale [for prohibiting insider trading] stops well short of prohibiting all trading on material non-public information. Efficient capital markets depend on the protection of property rights in information. However, they also require that persons who acquire and act on information about companies be able to profit from the information they generate.

Background of the Case

Todd Newman and Anthony Chiasson were convicted in the Southern District of New York, on May 9, 2013, for conspiracy to commit insider trading and insider trading in Dell and NVIDIA securities. Newman and Chiasson—both hedge fund managers—were three and four steps removed, respectively, from the corporate insiders who allegedly had the fiduciary duty to maintain the confidentiality of the company information at issue. The defendants did not know the insiders, much less the circumstances under which either insider allegedly had shared  material nonpublic information. The government, however, argued that it need only prove that Newman and Chiasson were aware of the insiders’ breach of fiduciary duty and did not need to prove that they knew the tippers had received a personal benefit in exchange for sharing the inside information. The lower court agreed, charging the jury on this basis, and the jury convicted. Newman and Chiasson then appealed.

On December 10, 2014, the Second Circuit Court of Appeals reversed both convictions. The court ruled that the evidence was insufficient to sustain the guilty verdicts because (1) the evidence did not show that the alleged insiders had received a benefit sufficient to establish their own liability; and (2) even if this evidence had been sufficient, the government had no evidence that Newman and Chiasson knew the tippers had received a personal benefit from disclosing the information in question.

What Qualifies as a Benefit?

Prior to the Second Circuit’s opinion, the parameters of what qualifies as a “personal benefit” sufficient for insider trading purposes had not been clearly defined, but they were not a high bar. The court made an effort to clarify this issue and made proof of personal benefit more difficult for the government.

The Second Circuit acknowledged that “personal benefit” may include not only monetary gain but also any reputational benefit that will translate into future remuneration. But the court made clear that “the mere fact of a friendship, particularly of a casual or social nature,” is not enough. The court then added, “[i]f that were true . . . the personal benefit requirement would be a nullity.”

In Newman’s case, the government argued that the friendship between the original tipper and an intermediate tippee (not Newman, but another analyst in the chain who had passed the information along) cleared the hurdle of establishing a personal benefit because they had known each other for years, attended the same business school, and worked together. The tipper also sought career advice and assistance from this intermediate tippee, and this tippee had advised the tipper on a range of topics, from how to pass the qualifying examination to become a financial analyst to editing the tipper’s résumé. In Chiasson’s case, the government pointed to the tipper and an intermediate tippee being family friends who occasionally socialized together.

The Second Circuit found the evidence in both cases insufficient to prove any personal benefit. The court stated, “If this was a ‘benefit,’ practically anything would qualify.” Instead, the court required

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 other words . . . this requires evidence of “a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter].”

Practical Implications of the Second Circuit’s Decision

The Second Circuit’s effort to limit the reach of the nation’s insider trading laws will affect prosecutors, defense lawyers, and the financial community. Insider trading liability has been expanded by the courts over the past two decades, with prosecutors exercising wide discretion in the targets they prosecuted. The Second Circuit has now reminded prosecutors that not all sharing of information is criminal and that trading on confidential information is not necessarily illegal insider trading.

The Newman decision is having an immediate impact in pending cases. One such case is United States v. Conradt, No. 1:12-cr-00887, in the U.S. District Court for the Southern District of New York. The Conradt case relates to an insider trading case also brought by the U.S. Attorney’s Office in the Southern District of New York, arising from trades made in relation to IBM Corporation’s acquisition of SPSS Inc. There, U.S. District Judge Andrew Carter, citing the Newman case, expressed concern about the factual basis for four previously entered guilty pleas. The pleas are those of former Royal Bank of Scotland Group PLC research analyst Trent Martin and former Euro Pacific Capital Inc. brokers Thomas Conradt, Daryl Payton, and David Weishaus. The defendants have been charged with participating in a scheme to trade ahead of IBM’s purchase of SPSS.

Judge Carter expressed concern about these four guilty pleas and has directed the government to file a brief to defend the pleas in light of the Newman decision. The U.S. Attorney’s Office has stated that it will assert that the IBM case was not affected by Newman because the initial tipper, alleged to be Martin, was not a corporate insider. In addition, a fifth defendant was scheduled to begin trial on January 12, 2015. Judge Carter delayed the trial date to permit the government and the defendant an opportunity to assess Newman’s impact on the case.

One case similarly undergoing reevaluation in the U.S. District Court for the Southern District of New York, and related to Newman, is United States v. Kuo, No. 1:12-cr-00121. Mr. Kuo was part of the now infamous “fight club”—also implicated in the Newman and Chiasson cases—that traded inside information among themselves, but Mr. Kuo was several steps removed from, and had no direct contact with, the corporate insider. On April 3, 2012, Mr. Kuo pled guilty to the insider trading charges, but at sentencing in July 2014, Judge Richard Sullivan expressed concern that the pending Newman decision may affect Mr. Kuo’s guilty plea. Specifically, Judge Sullivan (having presided over the underlying Newman and Chiasson district court cases) acknowledged the panel’s skepticism that friendship would stand to suffice as a personal benefit to the tipper. Judge Sullivan ultimately adjourned the sentencing, despite his initial suggestion that Mr. Kuo be sentenced to six months of imprisonment. On December 12, 2014, immediately following the issuance of the Newman decision, Judge Sullivan endorsed the government’s letter to the court requesting 45 days within which to provide the court with a proposed course of action. During this time, the parties stated that they intend to consider the effect of the Newman decision on Mr. Kuo’s case.

Former SAC Capital Advisors LP portfolio manager Michael Steinberg was convicted in early 2014 in the Southern District of New York. The Second Circuit granted his request to hold appeal in abeyance pending the government’s decision whether to appeal the Newman decision (see Second Circuit No. 14-2141). Like Mr. Kuo, Mr. Steinberg is alleged to have been entangled in the same insider trading ring but was several steps removed from the corporate insider. Another criminal case pending in the Southern District of New York, United States v. Riley, No. 1:13-cr-00339, seeks similar relief. In Riley, on December 29, 2014, former Foundry Networks Inc. executive David Riley filed a motion for acquittal and motion for new trial, requesting that the court overturn his recent insider trading conviction on the grounds that prosecutors had failed to prove he received a personal benefit as defined in Newman.

Outside the Second Circuit, in the Central District of California, defendants in an insider case involving former Baltimore Orioles third baseman Doug DeCinces have requested the dismissal of insider trading charges, on the grounds that the alleged personal benefit does not meet the stricter requirements of Newman. This case, United States v. DeCinces, No. 8:12-cr-00269, originates from the merger of Advanced Medical Optics Inc. and Abbott Laboratories.

The U.S. Attorney’s Office is not the only governmental actor affected by the decision. The Securities and Exchange Commission (SEC) is facing challenges from two alleged inside investors in a suit it brought in the Southern District of New York, in the matter of SEC v. One or More Unknown Traders, No. 1:13-cv-04645. In their December 16, 2014, letter to the court, the defendants seek reconsideration of a prior order on the grounds that the Newman decision “compels reconsideration of the Court’s conclusion that the SEC’s allegations support a plausible inference that defendants Jafar and Nabulsi knew they received material non-public information that had been leaked in breach of a fiduciary duty.”

While it is not clear how these various motions by defendants will fair, it is likely that the government will focus more on the original source of the nonpublic information—i.e., the initial tipper. (Over the past few years, the government has chosen to prosecute high-profile remote tippees without ever criminally pursuing the original source.) The closer the trader is to the original source of the nonpublic information, the greater the chance that the government may be able to prove with sufficient evidence that the trader knew both that the source breached a fiduciary duty in disclosing the information and also received the requisite personal benefit in doing so. The more steps in the chain between the original corporate insider and the ultimate trader—i.e., the greater the number of intermediate tippees—the harder it will be for the government now to bring a successful insider trading prosecution.

In the near term, the business community can expect prosecutors and other government enforcement lawyers to pause before bringing the next high-profile insider trading case. The U.S. Attorney’s Office for the Southern District of New York and the Department of Justice have not disclosed whether they intend to appeal. But the government has certainly expressed its disappointment with the decision. On the same date as the Newman decision was filed, Preet Bharara issued a statement, acknowledging the limitations it puts on the U.S. Attorney’s ability to prosecute insider trading cases:

Today’s decision by the Court of Appeals interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information. The decision affects only a subset of our recent cases, and in those cases—as in all our criminal cases—we investigated and prosecuted misconduct based on our good faith assessment and understanding of the facts and the law that existed at the time. We are still assessing the Court’s decision, which appears in our view to narrow what has constituted illegal insider trading, and are considering our options for further appellate review.

During a conference on December 11, 2014 in New York City, Mary Jo White, chair of the SEC, commented on the decision as well. She acknowledged the decision’s significance but shared her concern that it is an “overly narrow view of the insider trading law.”

Nevertheless, prosecutors are not likely to file cases vulnerable to the Newman holdings until a decision is made. Assuming the decision is not reversed, because the court of appeals has now sharply focused prosecutors on the original source of the corporate information and whether that tipper—as opposed to the remote tippee—is liable for insider trading, it is likely that the government will be more selective in bringing criminal insider trading suits—at least within the Second Circuit—than it has been in the recent past.

This decision thus represents some good news for the financial industry, especially hedge funds, arbitrage funds, and other financial entities that may come into possession of information about public companies where it is difficult to determine whether the information is nonpublic and where the ultimate source is unknown and may be several steps removed from the trader. Still, the financial industry should remain extremely cautious in regard to trading on any potentially nonpublic information. This is one decision from one court in a criminal case, where the standards of proof for the government are much higher than in a civil insider trading action: The SEC may seek to push the limits of this ruling in future civil enforcement actions.

Keywords: litigation, securities, insider trading, material nonpublic information, Todd Newman, Anthony Chiasson

Grant Fondo is a partner in Goodwin Procter’s Silicon Valley, California, office, and is a former Assistant U.S. Attorney with the Northern District of California. Jessica Adams, based in New York City, is an associate with Goodwin Procter.

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