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Second Circuit Issues Key Decision Clarifying What A Tippee Must Know To Be Held Liable For Criminal Insider Trading Liability

What are the requirements for establishing the criminal liability of a tippee for insider trading? What exactly constitutes a “personal benefit” and what level of knowledge must a tippee have of the personal benefit received by the tipper in order to be held liable?

Since the Supreme Court’s 1983 decision in the case of Dirks v. S.E.C.,[1] courts and commentators alike have noted the considerable uncertainty surrounding two key issues concerning tippee liability for insider trading:

  • First, what kind of “personal benefit” must the initial tipper receive in order to establish the tipper’s breach of duty when he makes the tip; and
  • Second, what level of knowledge (if any) must the tippee have of the personal benefit received by the tipper in order to be held derivatively liable for the alleged breach. [2]

In its December 10, 2014 decision in the case of U.S. v. Newman,[3] the Second Circuit clarified the requirements for tippee criminal liability. While there are still several questions that remain unanswered, securities traders (and the regulators) now know that a personal benefit to the tipper is a required element before imposing tippee criminal liability and that the tippee must have had actual knowledge, or have deliberately avoided knowledge, of the tipper’s receipt of such a benefit. The Court also went on to describe the type of benefit which would support a finding of criminal liability, rejecting the argument that the mere existence of a personal relationship between the tipper and tippee allowed for an inference of some intangible benefit.[4] The Second Circuit instead held that there must be “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”[5] Finally, the Second Circuit held that a tippee must have actual knowledge of the benefit (or purposefully avoid such knowledge) to be held criminally liable for insider trading.

These are very meaningful conditions and go a long way toward clarifying the law in this area.

Newman involved the transfer of confidential earnings-related information from two corporate insiders to several different layers of tippees.[6] The two defendants in the case, Todd Newman and Anthony Chiasson,[7] were portfolio managers at two different hedge funds and were several layers removed from the initial tippers.[8] The Defendants traded on the confidential information initially disclosed by the insiders and were subsequently convicted by a jury of several counts of insider trading.[9] They appealed their conviction on the ground that the jury instructions provided by the trial court misstated the legal requirements for tippee liability by not requiring the jury to find that the Defendants had knowledge of the personal benefit received by the tipper in order to be held criminally liable.[10] The Second Circuit agreed and reversed the conviction.

Citing the Supreme Court’s decision in Dirks, the Second Circuit confirmed that the tipper’s receipt of a personal benefit was an essential element of the tipper’s breach of his or her fiduciary duty.[11] In the absence of the receipt of a personal benefit, the tipper’s disclosure of insider information is a mere breach of confidentiality, but not his or her fiduciary duties to the company or its shareholders.[12] Because a tippee’s criminal liability for insider trading is derivative of the tipper’s breach of fiduciary duty, a tippee cannot be held criminally liable unless the government can show that the tipper received either a “pecuniary gain” or a “reputational benefit that will translate into future earnings.”[13] In finding that no such benefit existed in this case, the Second Circuit in Newman found that “the circumstantial evidence . . . was simply too thin to warrant the inference that the corporate insiders received any personal benefit in exchange for their tips.”[14] The tippers had casual personal relationships with the first-level tippees, however the Second Circuit concluded that if that alone were sufficient to establish an inference of a personal benefit, “practically anything would qualify.”[15] Instead, the Second Circuit defined personal benefit in such a way as to require an actual or potential pecuniary gain or something similarly valuable in nature.[16]

With respect to the tippee’s knowledge of the existence of the personal benefit received by the tipper, the Second Circuit again sided with the Defendants, concluding that “well-settled principles of substantive criminal law . . . require[] that the defendant know the facts that make his conduct illegal” and that such knowledge “is a necessary element in every crime.” [17] In finding that the government had failed to make such a showing in this case, the Court in Newman held that “the Government presented absolutely no testimony or any other evidence that Newman and Chiasson knew that they were trading on information obtained from insiders, or that those insiders received any benefit in exchange for such disclosures, or even that Newman and Chiasson consciously avoided learning of these facts.”[18] Rather, the evidence showed that the Defendants “knew next to nothing about the insiders and nothing about what, if any, personal benefit had been provided to them.”[19] In short, even if the tipper in Newman had received a personal benefit in exchange for the disclosure of confidential information, the Defendants could not be held criminally liable as tippees unless they had actual knowledge (or purposefully avoided knowledge) of the breach and the corresponding benefit received. This holding clarifies an area of law that had previously been open to interpretation and should serve to alleviate the concerns of many in the securities industry that mere negligence on the part of the tippee could support a finding of criminal insider trading liability.

Keep in mind that Newman is a criminal case. Despite clarifying several key questions pertaining to the imposition of tippee criminal liability, the Court in Newman did leave open the question of whether its holdings extend to cases involving civil liability. Because it was a criminal case, the Second Circuit did not need to address these same issues within the context of a civil insider trading enforcement action by the Securities and Exchange Commission.

In fact, the Court’s analysis appears to suggest that its holdings are limited to the criminal context. For example, the Court’s conclusions with respect to the required showing of knowledge on the part of the tippee are set against the backdrop of its discussion of “mens rea,” a distinct concept of criminal law.[20] At no point does the Court preclude the application of its rationale in Newman to the civil context, but it has left the door open for the government to argue that the high legal and evidentiary bars set in Newman do not pertain to the civil context. In short, the Securities and Exchange Commission and other law enforcement agencies could conceivably argue that Newman is limited to the criminal context and that more lenient standards should be applied in civil enforcement actions.

In sum, the Second Circuit has now held that the Government must show the following in order to establish criminal tippee liability for insider trading:

  • the corporate insider was entrusted with a fiduciary duty;
  • the corporate insider breached this duty by disclosing confidential information to a tippee in exchange for a personal benefit;
  • the tippee knew of the breach and that the information was confidential and divulged for the personal benefit of the tipper; and
  • the tippee still used that information to trade in a security or tip another individual for his or her own personal benefit.[21]

The government has requested an extra month to review the decision in Newman and could potentially decide to petition for a rehearing of the case by the entire Second Circuit or seek leave to appeal the decision directly to the U.S. Supreme Court. If its request for an extension is not granted, the government will have until December 24th to decide whether or not to appeal.


[1] 463 U.S. 646 (1983).

[2]See U.S. v. Newman, Case Nos. 13-1837, 13-1917, 2014 U.S. App. LEXIS 23190, *17 (2d Cir. Dec. 10, 2014) (noting that the court has been accused of being “somewhat Delphic in [its] discussion of what is required to demonstrate tippee liability”).

[3]Id.

[4]Id. at *30.

[5]Id. at *31.

[6]Id. at *5.

[7] Collectively, the “Defendants.”

[8]Id. at *2-3. In fact the chain was four levels: Choi (of the company’s finance unit) tipped Lim (a former executive a technology company that Choi knew from church), who then tipped Kuo (an analyst ) who then tipped friends, Tortora and Adonakis, who then turned the information over to Newman (the defendant in this case.)

[9] Id.

[10]
Id. at *8

[11]See id. at *14.

[12]See id.

[13]See id. at *30-31.

[14] See id. at *29.

[15]See id. at *30.

[16]See id. at *31.

[17] See id. at *24.

[18]Id. at *33.

[19]Id.

[20]See id. at *15-16.

[21]Id. at *25.


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Business Litigation Bulletin is a newsletter of Tannenbaum Helpern Syracuse & Hirschtritt LLP’s Litigation and Dispute Resolution practice. It provides strategic perspectives on legal cases that impact the business community.

12.10.2014  |  PUBLICATION: Business Litigation Bulletin  |  TOPICS: Investment Management, Litigation  |  INDUSTRIES: Private Investment Funds, Wealth Management

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