On 10 December 2014, in a widely reported decision, a panel of the federal appellate court based in New York overturned the insider trading convictions of two hedge fund portfolio managers, including a Shearman & Sterling client. The court in United States v. Newman clarified an important legal issue by holding that a tippee (i.e., recipient) of material non-public information cannot be liable for trading based on that information unless the tippee knows that the insider disclosed the information in exchange for a personal benefit.
Even before this ruling, the law was clear that a corporate insider's disclosure of material non-public information cannot be the basis for insider trading liability unless that individual received a personal benefit in exchange for the disclosure. The court here clarified "that a tippee's knowledge of the insider's breach necessarily requires knowledge that the insider disclosed confidential information in exchange for a personal benefit."
The court also rejected the government's argument that the "specificity, timing, and frequency" of the information that the defendants received were "so 'overwhelmingly suspicious'" that they must have known that insiders disclosed it in exchange for a personal benefit. Because the type of information at issue regularly comes from non-confidential sources, it cannot support such an inference.
As a separate basis for its conclusion, the court determined that the government failed to prove that the corporate insiders who disclosed the confidential information received any benefit in the first place. "[T]he mere fact of friendship, particularly of a casual or social nature," is not enough of a benefit because then "practically anything would qualify" as a personal benefit. Rather, information must be disclosed in "an exchange that is objective, consequential, and represents at least a potential[ly]" valuable gain.
This decision thus defines the type of benefit a tipper must receive in order for insider trading liability to arise. In addition, while the decision that a tippee must have knowledge of the tipper's benefit might have less of an impact on those who are closer to the original source of information, the court here noted that it had not "found a single case in which tippees as remote as [the defendants] have been held criminally liable for insider trading." If this decision is not altered by the pending appeals to the appellate court or a subsequent appeal to the United States Supreme Court, it will make it more difficult for the government to bring insider trading charges against tippees who are far removed from the original source of inside information. Although the decision is technically limited to the three states over which the appellate court has jurisdiction (including New York, where the largest number of insider trading prosecutions have been brought), it is likely to be influential elsewhere as well.
For more information on the Newman decision, please see our press release and CNBC's interview of our partner Stephen Fishbein at: http://www.shearman.com/en/newsinsights/news/2014/12/newman-insider-trading-conviction-overturned.
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