The significant impact on insider trading prosecutions following the Second Circuit’s landmark ruling in United States v. Newman, 773 F.3d 438 (2d Cir. 2014) continues. In that case, the Second Circuit vacated insider trading convictions of two hedge fund managers, and directed that the charges against them be dismissed with prejudice. In reversing the convictions, the Second Circuit held that to establish tippee liability, the government must prove that the tippee knew both that the tipper breached a fiduciary duty by disclosing material, nonpublic information and that the tipper received a personal benefit by disclosing the information. Newman, 773 F.3d. at 450.
The Second Circuit also clarified what qualifies as a “personal benefit” to the tipper. A personal benefit, although admittedly broadly defined, may not be established “by the mere fact of a friendship, particularly of a casual or social nature.” Instead, the government must present some proof “of a meaningful close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” Newman, 773 F.3d. at 452-53.
On Monday, January 26, the government filed a petition seeking a rehearing and a rehearing en banc in Newman, and the SEC petitioned to file an amicus brief in support of the government’s position.
The litigants in United States v. Conradt, 12 Cr. 887 (ALC) (S.D.N.Y. 2015), felt the impact of Newman almost immediately, as one week after the Second Circuit’s ruling Judge Carter announced that as a result of Newman, he was “inclined to vacate” the guilty pleas submitted by four of the five defendants in Conradt. The government submitted a brief, arguing that the standard delineated in Newman with regard to a tipper’s personal benefit and a tippee’s knowledge of that personal benefit applies only to the “classical” theory of insider trading, and was therefore inapplicable to the defendants in Conradt, which involved the misappropriation theory of liability.
Judge Carter disagreed and vacated the guilty pleas after finding them to be “insufficient in light of Newman’s clarification of the personal benefit and tippee knowledge requirements of tipping liability for insider trading.” Conradt, 12 Cr. 887, *2 (S.D.N.Y. Jan. 22, 2015). Importantly, the court echoed the Second Circuit’s pronouncement that “the elements of tipping liability are the same, regardless of whether the tipper’s duty arises under the ‘classical’ or the ‘misappropriation’ theory.” Id. (quoting Newman, 773 F.3d. at 446).
On Wednesday, January 28, following the rejection of the defendant’s guilty pleas, the government requested Judge Carter to dismiss the insider trading charges against each of the five defendants. In making the letter request, the government acknowledged that in light of Newman it did not have the requisite evidence to establish one of the elements of the crime, namely the substantial personal benefit to the tippers in exchange for the inside information. And just yesterday, Judge Carter indicated that he would dismiss the case if he receives a formal request by February 4, but will allow the government to refile the charges if the Second Circuit reverses its position in Newman.
Without question, Newman has significantly raised the bar to secure a conviction for insider trading against remote tippees. As evidenced by Conradt, the government’s success in having Newman overturned or modified will have far reaching implications. We will continue to monitor these matters and other developments impacting the law of insider trading as they unfold.