You may recall that back in December 2014, the Second Circuit Court of Appeals, in United States v. Newman, et al., significantly limited the circumstances under which tippees of inside information may be held liable for insider trading. At the time, most prosecutors and some commentators bemoaned that decision as an ill-advised extension of protection likely to facilitate inappropriate trading.
In October 2015, the United States Supreme Court declined to hear the Department of Justice’s petition for writ of certiorari. This means that the Newman decision stands as written and is binding precedent for cases brought in the Second Circuit (Connecticut, New York and Vermont). Furthermore, because the Second Circuit’s securities law decisions are widely followed, Newman is likely to have even broader influence.
The Newman decision…
In Newman, the Second Circuit reversed the conviction of two hedge fund portfolio managers who had been accused, as tippees, of violating federal insider trading laws. Though both managers apparently knew they were trading on information received from inside tippers at Dell, Inc. and NVIDIA Corporation, they were multiple levels removed from the initial communication of inside information from the tippers and, therefore, denied that they were liable for insider trading.
The Court dismissed the claims against the managers on two separate grounds:
- The government failed to show that the managers, as tippees, knew the inside tippers received “personal benefits” in exchange for the information on which they traded,
- The personal benefits received (in this case, casual friendship and career advice) by the tippers from the initial tippees were insufficient to establish an insider trading violation as a matter of law.
The Court specifically rejected the government’s contention that “the mere fact of friendship” is sufficient benefit for this purpose. Instead, there must be “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similar value,” or a “quid pro quo” between the inside tipper and the information recipient. As a result, the potential for tippee liability, particularly where the tippee is one or more levels removed from the tipper, has been significantly lessened.
What remains unresolved?
There is much uncertainty regarding what non-tangible gain by the tipper is sufficient to satisfy Newman’s “personal benefit” requirement. While Newman rejects the notion that a mere gift of inside information based on friendship is actionable in all cases, the particular facts of a case may color future decisions. For example, while the exchange of information among “friends” in routine business conversations (such as in Newman) was not a “personal benefit,” the answer may be different if the individuals have especially close relationships (for example, family members) and the information is transferred outside of routine, day-to-day business interactions.
Also uncertain is whether courts will apply Newman’s “personal benefit” standard when determining tipper (rather than tippee) liability.
What should companies do in response to Newman?
It is important to remember that a company insider remains liable if he or she:
- trades in the company’s securities while in possession of material non-public information, or
- discloses confidential company information to a third person in exchange for a personal benefit.
For this reason and due to the uncertainties noted above, companies should:
- stay committed to educating personnel about insider trading restrictions and vigorously enforcing existing policies,
- review their insider trading policies to determine whether any revisions are appropriate in light of the Newman decision, and
- be sure all insider trading training materials are current.