DealBook reports that:
What constitutes insider trading has always been open to interpretation. Now, the Supreme Court is being asked to decide a knotty question: How much of a benefit does the source of confidential information have to receive in order to convict those who trade on it?
This week, the Justice Department filed a petition with the Supreme Court asking for review of the decision in United States v. Newman, which overturned the insider trading convictions of two hedge fund managers. The move comes after the United States Court of Appeals for the Second Circuit ruled that the government had not proved the tipper received a benefit, rejecting a request to revisit its ruling. ...
The Newman case involved insider trading based on information passed along by employees at Dell and Nvidia about earnings announcements that were not yet public. The two defendants, Todd Newman and Anthony Chiasson, got secondhand information from analysts at their hedge funds and traded on it. They never dealt directly with the employees who tipped off others, nor did they speak to those who initially received the illegal tips.
The United States Court of Appeals for the Second Circuit in Manhattan reversed the convictions last December. Its rationale was that the jurors were not told they had to find that the two defendants knew the tippers received a benefit in exchange for revealing the confidential information. The Justice Department did not challenge that part of the ruling in the Supreme Court, so at a minimum, Mr. Newman and Mr. Chiasson will have their convictions overturned.
The appeals court did not stop there, however. It also ruled that the government could not retry the defendants because the evidence was so deficient about the benefit provided to the tipper that no reasonable jury could find them guilty. It was this issue that has the Justice Department so upset, because in a brief description of what constitutes a sufficient benefit, the appeals court raised the bar for proving a violation of the securities laws in other cases.
The issue is not the sufficiency of the evidence, however, but rather "whether the court of appeals erroneously departed from this Court’s deci- sion in Dirks by holding that liability under a gifting theory requires 'proof of a meaningfully 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.'"
I've written a lot about Newman over the years (here's a list of prior posts) so I won't rehash the issues and facts generally. Instead, I'll comment on the specifics of the government's cert petition.
The government argues that:
In the guise of interpreting this Court’s opinion, the court of appeals crafted a new, stricter personal-benefit test, stating that “[t]o the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades ‘resemble trading by the insider himself followed by a gift of the profits to the recipient,’ * * * we hold that such an inference is impermissible in the absence of proof of a meaningfully 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.” App., infra, 26a.
That new “exchange” formulation erases a form of personal benefit that this Court has specifically identified. Under Dirks, an inference of a personal benefit to the insider arises in two situations: when the insider expects something in return for the disclosure of the confidential information, or when the insider freely gives a gift of information to a trading friend or relative without any expectation of receiving money or valuables as a result.
The problem elided by the government is that Dirks does require proof of a relationship between the tipper and tippee that rises to the level of a "relative or friend." Implicit in that requirement is a proof close personal relationship. Hence, as Adam Pritchard has demonstrated at length, "Newman’s knowledge standard is the correct reading of Dirks, and that its requirement of a 'meaningfully close personal relationship' is consistent with, if not compelled by, the rule laid down in Dirks." In particular, as Pritchard explains:
The ... counter‐argument to the government’s position – that only a minimal relationship is required – is that the personal benefit element requires the government to prove that the tipping insider disclosed the information for the purpose of receiving a personal benefit, direct or indirect. Would the existence of a casual friendship or acquaintance warrant the inference that the insider breached a duty of confidentiality for the purpose of bestowing a gift? ...
Giving away corporate information to strangers might make you feel like a bigshot, but the standard is self‐dealing: the gift needs to be an indirect personal benefit, which suggests a close relationship, not a casual one.
Second,the government mischaracterizes Dirks's personal benefit test. It argues that:
... an insider need not be specially attached to his friends and relations in order to decide for his own personal reasons to confer on them a gift of inside information (which, of course, requires no monetary outlay).
But this ignores what Dirks actually said:
The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.
Third, a critical point obfuscated by the government is that Justice Powell's majority opinion in Dirks was driven in large part by the need to protect securities analysts and, more specifically, analysts who interview corporate employees in hopes of gaining useful information:
Imposing a duty to disclose or abstain solely because a person knowingly receives material nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes is necessary to the preservation of a healthy market. It is commonplace for analysts to “ferret out and analyze information,” 21 S.E.C., at 1406, and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that the analysts obtain normally may be the basis for judgments as to the market worth of a corporation's securities. The analyst's judgment in this respect is made available in market letters or otherwise to clients of the firm. It is the nature of this type of information, and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporation's stockholders or the public generally.
Dirks v. S.E.C., 463 U.S. 646, 658-59 (1983). This is essentially what the defendants in Newman did, except at a distance and indirectly.
In addition, as Pritchard details, the government's argument in this case is tainted by the fact that the government has consistently tried to undermine the Dirks case:
The SEC was not happy with the constraints imposed on it by Dirks, and the agency worked hard to loosen those fetters. The agency initially sought to expand the definition of reputational benefit in ways that cannot be squared with Dirks. ... [T]he SEC also persuaded lower courts to adopt broad interpretations of Dirks’ personal benefit requirement.
Newman thus simply returned the law to where it stood before the SEC started trying to gut Dirks.
The government also relies on its tired argument that insider trading "strips investors of confidence that the markets are fair and open." As I have demonstrated elsewhere, "insider trading does not seriously threaten the confidence of investors in the securities markets." Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189, 1243 (1995).
Bottom line? Once again the government is trying to undermine the framework created by Justice Powell, with the chutzpah to do so in the Supreme Court itself.
