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An Introduction to the Law of Corporations: Cases and Materials, Fall 2017

A note on US v Newman

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The classic tipper-tippee scenario in insider trading prosecutions involves a corporate insider who, in exchange for a personal benefit, discloses material nonpublic information to an outsider, who then later trades in reliance on this inside information. For many years, courts leaned on increasingly vague assertions of “personal benefit” received by tippers to assign liability to remote tippees. In some cases, courts have been willing to “daisy chain” to recipients of inside information who are extremely remote from the original source.

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In United States v. Newman the Second Circuit reduced the liability of remote tippees by holding that a tippee cannot be convicted unless the tippee “knows of the personal benefit received by the insider in exchange for the disclosure.” In addition, Newman held the “personal benefit” received by the tipper “must be of some consequence” and must be a true quid pro quo, rejecting the notion that mere friendship and association could meet this requirement.

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From the Newman opinion:

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[T]he Government presented evidence that a group of financial analysts exchanged information they obtained from company insiders, both directly and more often indirectly. Specifically, the Government alleged that these analysts received information from insiders at Dell and NVIDIA disclosing those companies' earnings numbers before they were publicly released in Dell's May 2008 and August 2008 earnings announcements and NVIDIA's May 2008 earnings announcement. These analysts then passed the inside information to their portfolio managers, including Newman and Chiasson, who, in turn, executed trades in Dell and NVIDIA stock, earning approximately $4 million and $68 million, respectively, in profits for their respective funds.

Newman and Chiasson were several steps removed from the corporate insiders and there was no evidence that either was aware of the source of the inside information. With respect to the Dell tipping chain, the evidence established that Rob Ray of Dell's investor relations department tipped information regarding Dell's consolidated earnings numbers to Sandy Goyal, an analyst at Neuberger Berman. Goyal in turn gave the information to Diamondback analyst Jesse Tortora. Tortora in turn relayed the information to his manager Newman as well as to other analysts including Level Global analyst Spyridon "Sam" Adondakis. Adondakis then passed along the Dell information to Chiasson, making Newman and Chiasson three and four levels removed from the inside tipper, respectively. ...

Newman and Chiasson moved for a judgment of acquittal pursuant to Federal Rule of Criminal Procedure 29. They argued that there was no evidence that the corporate insiders provided inside information in exchange for a personal benefit which is required to establish tipper liability under Dirks v. S.E.C.,463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). Because a tippee's liability derives from the liability of the tipper, Newman and Chiasson argued that they could not be found guilty of insider trading. Newman and Chiasson also argued that, even if the corporate insiders had received a personal benefit in exchange for the inside information, there was no evidence that they knew about any such benefit. Absent such knowledge, appellants argued, they were not aware of, or participants in, the tippers' fraudulent breaches of fiduciary duties to Dell or NVIDIA, and could not be convicted of insider trading under Dirks. ...

In light of Dirks, we find no support for the Government's contention that knowledge of a breach of the duty of confidentiality without knowledge of the personal benefit is sufficient to impose criminal liability. Although the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation's securities markets. The Supreme Court explicitly repudiated this premise not only inDirks, but in a predecessor case, Chiarella v. United States. In Chiarella, the Supreme Court rejected this Circuit's conclusion that "the federal securities laws have created a system providing equal access to information necessary for reasoned and intelligent investment decisions.... because [material non-public] information gives certain buyers or sellers an unfair advantage over less informed buyers and sellers." 445 U.S. at 232, 100 S.Ct. 1108. The Supreme Court emphasized that "[t]his reasoning suffers from [a] defect.... [because] not every instance of financial unfairness constitutes fraudulent activity under § 10(b)." Id. See also United States v. Chestman, 947 F.2d 551, 578 (2d Cir. 1991) (Winter, J., concurring) ("[The policy rationale [for prohibiting insider trading] stops well short of prohibiting all trading on material nonpublic 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....")]. Thus, in both Chiarella and Dirks, the Supreme Court affirmatively established that insider trading liability is based on breaches of fiduciary duty, not on informational asymmetries. This is a critical limitation on insider trading liability that protects a corporation's interests in confidentiality while promoting efficiency in the nation's securities markets.

As noted above, Dirks clearly defines a breach of fiduciary duty as a breach of the duty of confidentiality in exchange for a personal benefit. ... Accordingly, we conclude that a tippee's knowledge of the insider's breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit. In reaching this conclusion, we join every other district court to our knowledge—apart from Judge Sullivan—that has confronted this question. ...

Our conclusion also comports with well-settled principles of substantive criminal law. As the Supreme Court explained in Staples v. United States, under the common law, mens rea, which requires that the defendant know the facts that make his conduct illegal, is a necessary element in every crime. Such a requirement is particularly appropriate in insider trading cases where we have acknowledged "it is easy to imagine a ... trader who receives a tip and is unaware that his conduct was illegal and therefore wrongful." United States v. Kaiser. This is also a statutory requirement, because only "willful" violations are subject to criminal provision. See United States v. Temple ("`Willful' repeatedly has been defined in the criminal context as intentional, purposeful, and voluntary, as distinguished from accidental or negligent").

In sum, we hold that to sustain an insider trading conviction against a tippee, the Government must prove each of the following elements beyond a reasonable doubt: that (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper's breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit.

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