In a ground-breaking decision, the Second Circuit dealt a substantial blow to federal prosecutors’ epic crackdown on insider trading by raising the bar for the government’s burden of proof in “remote tippee” cases that have plagued the financial industry in recent years.
The decision in United States v. Newman (available here) places significant restrictions on the ability of prosecutors to impose liability on so-called remote tippees, or individuals who trade on inside information, but have at least one layer between them and the corporate insider who initially disclosed the tip. Such was the case in Newman, where the defendants—hedge fund managers who placed the allegedly infringing trades—were several layers removed from the corporate insiders who had first disclosed the material nonpublic information. At the district court level, the government obtained convictions of the defendants based in part on jury instructions requiring the jury to find that (1) corporate insiders breached their fiduciary duties by disclosing material non-public information for their own benefit; and (2) that the defendants knew that confidential information had been disclosed in breach of this duty. On appeal, the defendants asserted that the jury instructions were wrong, in that they should have required a finding that defendants also knew that a personal benefit had been obtained by the corporate insiders in exchange for releasing the confidential information.
On Wednesday, a unanimous Second Circuit panel agreed with the defendants, holding that to be guilty of insider trading, a remote tippee must not only have knowledge that a corporate insider breached his fiduciary duty not to disclose confidential information, but also have knowledge that the corporate insider did so in exchange for a personal benefit. This decision resolves a previous ambiguity that the government had sought to capitalize on in Newman: whether the tipper’s derivation of a personal benefit is what actually creates the breach of duty. The government argued that personal benefit is a separate element of the tipper’s insider trading offense, and thus it could establish that the tippee knew of the insider’s breach, without necessarily establishing that the tippee knew the insider did so in exchange for a personal benefit.