2nd Circuit Deals Significant Blow to Government in Insider Trading Cases

The 2nd Circuit’s Dec. 20, 2014, opinion in United States v. Newman and Chiasson has significantly raised the bar for federal prosecutors in insider trading cases. The 2nd Circuit dismissed the indictments against two defendants who had been convicted of insider trading at trial because the government failed to prove that they knew that the insiders who tipped them the information received a “personal benefit” in exchange for the tips. In dismissing the indictments, the 2nd Circuit raised the bar on the definition of “personal benefit,” holding that a “personal benefit” to the tipper is sufficient to sustain a conviction of the tipper or tippee only if it “generates an exchange that is objective, consequential and represents at least a potential gain of a pecuniary or similarly valuable nature.”

The decision deals a significant blow to the government’s prosecution of insider traders. Before this ruling, the U.S. Department of Justice and the Securities and Exchange Commission often relied on proof of “reputational benefit” to the tipper, such as friendship, advice or mentoring. As of the result of Newman, the government now must prove (at least in the 2nd Circuit but perhaps beyond as the case law develops) an objective, consequential exchange with at least a potential for pecuniary or similar gain, as well as the tippee’s knowledge of that benefit to the insider. As the court noted, if proof of friendship, career advice or other “reputational benefit” were a “benefit” under the law, “practically anything would qualify.” Id. at 21.

Some legal commentators have described the decision as a “roadmap” for insider traders because it may authorize casual sharing of inside information among friends, as long as there is no potential for pecuniary gain.  Other commentators have noted that the prohibition on insider trading comes only from the general securities fraud statute, not from any specific statute, so it is fitting that the courts are more restrictive as to criminal liability. Preet Bharara, the U.S. Attorney for the Southern District of New York, responded in a statement that the decision “will limit the ability to prosecute people who trade on leaked information, [though it] affects only a subset of our recent cases.” On Jan. 23, Mr. Bharara’s office sought rehearing and a rehearing en banc of the decision, describing the new standard in the filing as “deeply confounding.”