On July 31, the Solicitor General filed a petition for a writ of certiorari in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), asking the United States Supreme Court to address the standard for insider trading in a tipper-tippee scenario. Specifically, the Solicitor General argues that the Second Circuit’s Newman decision is in conflict with the Supreme Court’s 1983 decision in Dirks v. SEC, 463 U.S. 646 (1983), and the Ninth Circuit’s recent decision in United States v. Salman, No. 14-10204 (9th Cir. July 6, 2015). Because the Supreme Court grants certiorari in nearly three out of four cases filed by the Solicitor General, the likelihood of a cert grant in Newman is particularly high.
Companies, their employees, and investment advisors should monitor these developments closely because they have important implications for maintaining “best practices” in-house compliance programs, not to mention the impact of any Supreme Court decision in this area on the types of insider trading prosecutions and administrative proceedings that may be brought by the Securities and Exchange Commission and the Department of Justice.
At issue in Newman is what is commonly referred to as a tipper-tippee arrangement. The classic scenario involves a corporate insider, referred to as the tipper, who has a fiduciary duty to his company but nonetheless agrees to provide material non-public information to an outsider, referred to as the tippee. The tippee then trades on the basis of this information or provides the information to other downstream tippees (or both). To secure a conviction for insider trading in this scenario under Dirks, the Government must demonstrate that the tippee knew the insider breached a duty by disclosing this information. Key to the Dirks analysis was that the tippee in that case did not “breach a duty” because he did not reveal confidential information in exchange for personal benefit—he was trying to expose accounting fraud. Of late, the DOJ and the SEC have aggressively pursued remote tippees based on increasingly vague articulations of what constitutes a “personal benefit.”
In Newman, the Second Circuit held the Government failed to adequately prove personal benefit. The Government brought criminal charges against tippees who were three or four levels removed from the initial tippers—company employees who passed the information along to friends (in one case, a former classmate and co-worker and, in the other case, a church friend). The trader-defendants (who received the information indirectly from the initial tippees) asserted they could not be convicted because the tippers did not receive any personal benefit and, even if the tippers had, there was no indication the defendants knew the tippers would receive such benefit. As it did before the district court, the Government asserted under the Supreme Court’s decision in Dirks that it need only demonstrate the tippees “traded on material, nonpublic information they knew insiders had disclosed in breach of a duty of confidentiality,” not that the tippee did so for “personal benefit.” The Second Circuit rejected that contention, holding that the Government must establish both that (1) the insider disclosed confidential information in exchange for a personal benefit and (2) that the remote tippees were aware of this fact. The Court in Newman went on to define “personal benefit,” explaining that it includes family relationship, pecuniary gain or reputational benefits that will translate into future earnings, but not the mere fact of friendship between tipper and tippee absent “proof of a meaningfully close relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”
Earlier this month, the Ninth Circuit addressed a similar insider trading case, United States v. Salman. There, the defendant, a remote tippee who knew the tipper provided the confidential information to his own brother, asserted that Newman precluded liability because there was no showing the tipper received a tangible personal benefit. Interestingly, Judge Jed Rakoff—a judge on the Southern District of New York who was sitting by designation on the Ninth Circuit—authored an opinion distinguishing the relationship at issue in Salman from that in Newman, noting that it qualified as the sort of “meaningfully close relationship” identified by the Second Circuit. He added, however, that “[t]o the extent” Newman could be construed as standing for the proposition that such a relationship, on its own, is not sufficient to create liability, the Ninth Circuit would decline to follow it.
Against this backdrop, the Government has now filed a certiorari petition, calling the Second Circuit’s ruling a “roadmap for unscrupulous traders.” The petition contends that the court’s definition of “personal benefit” cannot be squared with the Supreme Court’s decision in Dirks, which “did not require an ‘exchange’ to find liability for a gift of inside information and did not impose amorphous standards for the relationships that can support liability.” Specifically, the Solicitor General argues that Dirks allows for liability when either an exchange occurs irrespective of the nature of the relationship or a gift is given to a trading friend or relative even without any expectation of remuneration. In addition, the Government asserts that the “meaningfully close” requirement identified by Newman finds no support in Dirks and should be rejected.
The Government’s petition is also notable for what it does not request: it does not ask the Court to revisit the requirement that a tipper receive a personal benefit in order to breach a fiduciary duty and it does not take issue with the requirement that the tippee/trader know that the tipper received a benefit. If the Court grants certiorari, it is possible, however, that it could adopt a position on personal gain different than the one advocated by the Government or articulated in Newman given that Dirks involved very different facts and did not delve as deeply into the issue and related policies as would be required if the Court hears Newman.
We expect to learn sometime this fall whether the Supreme Court will accept the case. If so, oral argument will likely be held early in 2016, with a decision issued by the following June. At the same time these developments are occurring on the judicial front, there is movement in Congress. In response to Newman, three bills were introduced in Congress that would prohibit anyone from trading on confidential information, regardless of whether he or she knows who the inside source is or whether the inside source received a personal benefit in exchange for disclosing the confidential information. Of course, given the current polarization in Congress and the fact that it historically has, for the most part, declined to legislate in the insider trading arena, the prospect for passage of any law is uncertain.
Orrick will continue to monitor the Newman case as well as the status of related legislation and report any developments that may shed light on the standard to be applied for insider trading going forward. The firm frequently advises and is available to consult with investment and other financial firms on how to craft and maintain policies to address the use of material non-public information and respond to possible instances of impermissible trading.