In United States v. Newman1 the Second Circuit raised the bar virtually beyond reach, for all practical purposes, for proving remote tippee criminal liability in connection with tips of “inside” (material, non-public) information by corporate insiders, and others with a fiduciary duty to the source of the information.
Under Newman, the prosecution must now show that: (i) the person providing the information, the “tipper”, received a tangible benefit, a quid pro quo, not just gratitude, in exchange for the tip; and (ii) the person receiving the tip, the “tippee”, actually knew of the tipper’s concrete benefit.
In October 2015, the U.S. Supreme Court declined2 to hear the government’s appeal of the Newman decision. In doing so, the Court has, for now at least, effectively made Newman’s clear benefit and actual knowledge requirements the most influential rulings on the subject.
Given the difficulty of proving actual knowledge of a tangible benefit, Newman has prompted the dismissal of five recent cases, including some in which the defendants had pled guilty, and threatens many other recent convictions.
For all practical purposes Newman bars prosecution of persons who don’t receive inside information directly from insiders, aka “remote tippees”, including even people who traffic in inside information, but who don’t know who the tipper is, and if he/she received a benefit.
On January 19, 2016, Supreme Court agreed to hear3 the government’s appeal of United States v. Salman4 in which the Ninth Circuit, in an opinion written by U.S. District Judge Jed S. Rakoff*, rejected the Second Circuit’s reasoning in Newman, and held that a corporate insider’s gift of market sensitive information satisfied the requirement under Dirks v SEC5 that the tipper gain something “directly or indirectly” from the tip. In Newman the Second Circuit read the Dirks standard narrowly as requiring a quid pro quo exchange of a tangible benefit.
A fair inference from the Supreme Court’s decision to hear Salman is that it is set to strictly limit remote tippee liability.
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The impact of Newman, which involved criminal liability, on civil SEC enforcement actions against remote tippees may be limited. Criminal insider trading liability requires proof that the defendant acted “willfully”. However, to succeed in a civil enforcement action, the SEC need only show that a defendant acted “recklessly,” which is a lesser burden. As a result, the SEC may have more success asserting that remote tippees’ had constructive, culpable knowledge; i.e. as “sophisticated traders” the tippees should have been aware that the information originated from a corporate insider who disclosed it in breach of a fiduciary duty to his or her company.
This seems to be the view taken by Southern District of New York Judge Jed S. Rakoff in SEC v. Payton6, when he denied a motion to dismiss an SEC civil enforcement action against two former brokers, one of whose guilty plea for the same conduct was reversed in light of Newman. Although criminal prosecution of some alleged insider traders may not be possible under a standard of “willfulness,” Judge Rakoff found that the SEC had sufficiently alleged that related conduct of the two brokers at the end of the tip line was “reckless,” satisfying the SEC’s lower civil standard.
Assuming the Supreme Court does limit remote tippee criminal liability in deciding Salman, it remains to be seen what impact such a decision might have on SEC civil enforcement cases.
- 773 F.3d 438 (2nd Cir. 2014)
- U.S. v. Newman, U.S. Supreme Court, No. 15-137.
- Salman v. United States, No. 15-628, Jan. 19, 2016.
- United States v. Salman, No. 14-10204 (9th Cir. 2015).* U.S. District Court, SDNY, Sitting by Designation
- Dirks v. SEC, 463 U.S. 646 (1983).
- 14 Civ. 4644 (SDNY) Apr. 6, 2015.