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03/25/2015

Insider Trading Law After the Newman Decision: What Does It Mean to Financial Industry Professionals?


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In December 2014, the United States Court of Appeals for the Second Circuit issued what has been described as a landmark decision in United States v. Newman.  In its decision, the Court vacated the insider trading convictions and sentences of Anthony Chiasson and Todd Newman, two hedge fund professionals convicted of insider trading after trial in federal court in Manhattan.  The decision has been greeted by the white collar defense bar as an important repudiation of the Government’s heavy handed pursuit of insider trading. 

However, for those currently in the financial services industry, it would be a huge mistake to think that this case makes any difference in how one goes about his or her business.  While it narrows the ability of the U.S. Department of Justice (“DOJ”) and Securities and Exchange Commission (“SEC”) to prosecute remote tippees of inside information, it does not generally permit trading on material non-public information (“MNPI”) obtained in breach of a duty.  Rather, a finance professional who determines to trade on MNPI in hopes of relying on the Newman decision may instead find himself or herself embroiled in a costly and time consuming investigation and prosecution.  Even if one were to prevail, the collateral damage – to one’s reputation, career and finances – would be onerous.  While useful for understanding the current state of insider trading law, the Newman decision should not be mistaken for a case permitting trading on MNPI and should not change the way responsible finance professionals go about their business.

Summary of Newman

In Newman, Newman and Chiasson were hedge fund managers who traded on specific earnings information about Dell Inc. and NVIDIA Corporation.  Both Newman and Chiasson were remote tippees, meaning that they were several degrees removed from the original corporate insiders who passed material information about the companies to others, who in turn passed the information to other individuals until it eventually arrived down the chain at Newman and Chiasson.  The defendants purportedly did not even know the identity of the original tippers, and also did not know what personal benefit, if any, the tippers received in exchange for providing information to the initial tippees.  A personal benefit can include obvious benefits such as payments from the tippee back to the tipper, but also nonmonetary benefits such as appreciation where a family member tips a sibling, or a reputational benefit among those in business.

Following their convictions at trial, the defendants argued on appeal that a remote tippee must know that the original tipper received a personal benefit.  Because the Government failed to prove that Newman and Chiasson knew the tippers, or knew of any personal benefit received by the tippers for passing on the information to the tippees, the defendants argued that the Government failed to prove its case.  In its December 10, 2014 decision, the Second Circuit agreed stating, “[We] conclude that, in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.”  Because there was no evidence that Newman or Chiasson knew of any exchange between the tipper and tippee that personally benefited the tipper, the prosecution’s case failed. 

In addition, the Court of Appeals went on to state that the personal benefit must be of some consequence.  It must be of greater consequence than mere friendship and limited socializing.  Because the Government failed to show that the tipper personally benefited in any real way, it failed to prove the elements of the crime of insider trading.

What This Means to Financial Industry Professionals

Make no mistake, the Newman decision is important because it clearly limits the DOJ and SEC’s ability to prosecute insider trading cases against remote tippees.  Where a trader is far removed from the initial source of the information, it will be more difficult for the prosecutors to prove that the trader knew that the original tipper received a personal benefit of some consequence in exchange for passing information on to a tippee.

However, this limitation should not provide traders with significant comfort.  If one receives information that is clearly non-public and material, there remain significant risks in trading on that information even if the trader does not know the identity of the original tipper and tippee, their relationship, or any benefit exchanged between them.  In the event that one trades on such information and the Government inquires about the trader’s conduct, the investigatory process is burdensome, time consuming, anxiety inducing, and expensive.  In some cases, traders lose their jobs based on the initiation of an investigation or prosecution, prior to any finding of wrongdoing.  If the matter becomes public, it can also have significant reputational repercussions.  Hiring a lawyer to defend against an insider trading case or prosecution is expensive, even if one ultimately prevails.  In addition, even if the Government chooses not to proceed on the insider trading case, it is possible that the Government uncovers some other problematic conduct that would not have been found in the absence of this additional inquiry.  Simply put, no one needs this kind of scrutiny.

While Newman narrows the DOJ and SEC’s ability to prosecute remote tippees of inside information, it does not generally permit trading on MNPI obtained in breach of a duty.  Rather, a finance professional who determines to trade on MNPI in hopes of relying on the Newman decision may instead find himself or herself embroiled in a costly and time consuming investigation or prosecution.  Even if one were to prevail, the collateral damage – to one’s reputation, career and finances – would likely be onerous.  While useful for understanding the current state of insider trading law, the Newman decision should not be mistaken for a case permitting trading on MNPI, and should not change the way responsible finance professionals go about their business.

–Steven D. Feldman is a partners at Murphy & McGonigle, P.C., a securities litigation firm.  A former federal prosecutor in the Securities & Commodities Fraud Task Force for the U.S. Attorney’s Office in Manhattan, Steven focuses his practice on White Collar Criminal litigation. He represents companies and individuals accused of business crimes, public corruption, securities law violations and fraudulent practices by the U.S. Attorney's Office, State Attorney General, District Attorney, Securities and Exchange Commission, and Commodity Futures Trading Commission.

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Comments

Thanks a lot for this contribution! It's been very useful for me. Everything is very open and represents very clear explanation of issues.

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