Second Circuit Expresses Skepticism toward Government's Theory of Insider Trading Cases against Downstream Tippees

On April 22, 2014, a three-judge panel for the Second Circuit Court of Appeals heard oral arguments in United States v. Newman. The issue on appeal is whether, in order to convict a downstream tippee of insider trading, the government must prove that the recipient of material, nonpublic information knew that the insider who leaked the information received a personal benefit for doing so. In light of the tendency of the SEC and Department of Justice to bring charges against the downstream recipients of inside information, the Court's ruling could have significant consequences for the future of insider trading prosecutions and enforcement actions.

In Newman, the U.S. Attorney's Office for the Southern District of New York prosecuted several members of an alleged insider trading ring, including Anthony Chiasson and Todd Newman. Chiasson and Newman each received and traded on material, nonpublic information about Dell and NVIDIA. Each defendant was four or five degrees removed from the original sources of the inside information. Chiasson did not even know the identity of the sources. At trial, both Chiasson and Newman were convicted after the Court gave the jury an instruction which did not require the government to prove that Chiasson and Newman knew that the insiders received a benefit for tipping the information.

On appeal, the defendants argued that, if the government is not required to prove a downstream tippee's knowledge of the benefit to the original tipper, "a defendant could be convicted merely if he knew that an insider had divulged information that was required to be kept confidential." (See Brief for Appellant-Defendant Anthony Chiasson at 50; Brief for Appellant-Defendant Todd Newman.) Such a result, they argued, violates the maxim that the securities laws do not contain a general prohibition against trading on material nonpublic information. The government, on the other hand, argued that Supreme Court precedent requires only that the government prove the tipper received a personal benefit - not that the downstream tippee knew of such benefit. (See Brief for the United States of America.) In the government's view, if a tippee knew that information had been leaked in violation of a duty (e.g., a confidentiality policy), a fact finder has enough information to infer that the tippee's trading violated Rule 10b-5 ("Employment of Manipulative and Deceptive Devices").

The panel of judges expressed skepticism toward the government's position. Judge Parker characterized the government's theory of tippee liability as "amorphous," observing that, if it were adopted, the government could impose criminal liability merely by demonstrating that a defendant traded upon material, nonpublic information that was leaked from a company. In other words, the government effectively would be relieved of its duty to show that the leak constituted the fraudulent breach of a duty of trust and confidence. Judge Parker voiced his worry that acceptance of the government's arguments would leave financial professionals "at the mercy of the government [prosecutors]," who might choose which prosecutions to bring purely on political grounds, such as the size of a given hedge fund or public sentiment against an institution. Appearing to agree with counsel for Chiasson and Newman, Judge Parker observed that financial professionals should have a "bright line" against which to judge the legality of their trading. The panel also expressed concern that the prosecution may have forum-shopped its cases in the district court for the purpose of avoiding several judges who had already rejected the government's position concerning tippee liability.

See also: U.S. v. Chiasson Brief for Defendant; U.S. v. Newman Brief for Defendant; U.S. v. Newman Brief for United States.
See generally: Cabinet Insider Trading Materials (accessible to Cabinet subscribers only).

For more information, please contact Jodi Avergun, Brad Bondi or Douglas Fischer.