Second Circuit Limits Insider Trading Law for Remote Tippees
Matt Levine is a big jerk. He just sits there at Bloomberg following events in finance and securities enforcement, and then writes interesting things about those events really quickly and with insight that no one else has thought of yet. It’s so obnoxious. Today he struck again with this piece about the Second Circuit’s huge insider trading case issued this morning, and if you want to stop reading this and go straight to that, it won’t be the worst decision you made today. Anyway, like we said: big jerk.
But here’s what happened: Today the U.S. Court of Appeals for the Second Circuit decided the case of two hedge fund managers convicted for insider trading in May 2013. The two fund managers, Todd Newman and Anthony Chiasson, were prosecuted as part of U.S. Attorney Preet Bharara’s recent and extremely successful insider trading crackdown. The government alleged that Newman and Chiasson got information from financial analysts and company insiders, including earnings information prior to company announcements. Specifically, Newman and Chiasson received early information on earnings for Dell and NVIDIA, which allowed them to make trades earning $4 million and $68 million, respectively. But they weren’t exactly first in line to get the information.
In one representative trade in Dell shares, for example, the inside information allegedly originated with a Dell employee who tipped a bank analyst, who tipped an analyst at Newman’s hedge fund, who tipped Newman and another analyst, who then tipped Chiasson. Though Newman and Chiasson were three or four levels removed from the original insider, the government argued that they were sophisticated traders who should have known the information was disclosed as a result of insider trading. This didn’t satisfy the Second Circuit. Newman and Chiasson had never heard of the insiders, and they certainly weren’t aware of any personal benefit to them.
And in a tipper/tippee case, there must be material nonpublic information leaked by the tipper in violation of a fiduciary duty, which results in the tipper receiving some personal benefit. Here, though, the court made clear that the tippee must be aware of that benefit. The tippee’s liability, as the Second Circuit notes, comes onlyfrom the tipper’s breach of a fiduciary duty. There is no liability simply for trading on material, non-public information.
Maybe more importantly, the court determined that there wasn’t any personal benefit in the first place. This is important, as courts have typically construed “personal benefit” very broadly: it can be a bag of cash (pretty clear!) or the prospect of future business (not as clear, but good enough). This case really tightens up what a personal benefit to the original tipper can be. The bar has been set pretty low. But the Second Circuit says the “warm glow that comes from helping a friend,” for example, probably isn’t an improper benefit. The mere existence of a friendship, especially a casual one, doesn’t show that there was a personal benefit. The Court emphasizes the quid pro quo aspect inherent in a personal benefit, noting that the benefit “must be of some consequence.” It also helps if the benefit is immediate. Here, one of the analysts received “career advice” – that wasn’t enough to qualify. That’s a big deal! The SEC and the Justice Department have been living off that loose definition for years, and now they can’t. Even though this is a criminal case, we don’t see how the SEC’s enforcement program escapes this decision. It will be interesting to see how it tries.