The basis for imposition of tipping liability for insider trading has been clarified by the Second Circuit.
In United States of America v. Todd Newman, Anthony Chiasson (Nos. 13-1837-cr (L), 13-1917 cr), the Second Circuit has vacated convictions for insider trading for two hedge fund portfolio managers convicted of trading on information obtained from analysts who had received nonpublic and material information about public companies in the technology sector. The Second Circuit held that in order to hold the trader liable for insider trading, the Government had to 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.” p.4. This is a significant reversal for the United States Attorney’s Office for the Southern District of New York, which has been very aggressive of late in pursuing insider trading violations.
In this matter, the Government charged that analysts obtained information from company insiders at Dell and Nvidia about upcoming company earnings before the earnings were released to the public, and then shared that information with the portfolio managers. The portfolio managers then traded that information and earned profits between $4 and $68 million. While there was no evidence that the portfolio managers were aware of the source of the inside information, the portfolio managers were charged on the basis that “they must have known that [the] information was disclosed by insiders in breach of a fiduciary duty” because of the their sophistication as traders, and they were charged, among other things, on the basis of “tipping liability.”
Tipping liability is liability that accrues to a trader who trades on material, nonpublic information that he is “tipped to” by a tipper who has a fiduciary duty to keep that information confidential. When the tipper discloses that information – and when the tipper obtains a personal benefit from the disclosure – then tipping liability results.
Prosecutors contended that the State met its burden by showing simply that trading took place on confidential information that the traders knew had been disclosed in a breach of a duty of confidentiality. The Second Circuit rejected that, holding that (1) the tippee’s liability is derived from the breach of fiduciary duty on the part of the tipper and (2) that the tipper must have received a personal benefit in order to have breached his or her fiduciary duty. p.13-14. “[E]ven in the presence of a tipper’s breach, a tippee is liable only if he knows or should have known of the breach.” p.14.
The court held that in order to show that the tippee has knowledge of the breach the Government must show that the tippee knows of the personal benefit received by the tipper. Without that showing, “the Government cannot meet its burden of showing that the tippee knew of a breach.” p. 14. This is so because access to confidential information itself is an insufficient basis upon which to establish insider trading. Insider trading liability “is based on breaches of fiduciary duty, not on informational asymmetries.” p.16.
Indeed, the Court holds that such knowledge is a critical element of proving criminal intent – mens rea – and that the Government has the burden of proving that the trader knew that his trade was made on illegally and wrongfully obtained information.
The Court held:
In sum, … to sustain an insider trading conviction against a tippee, the Government must prove each of the following elements beyond a reasonable doubt: that (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit. See Jiau, 734 F.3d at 152 – 53; Dirks, 463 U.S. at 659 – 64.
The Court then concluded that the Government failed to prove beyond a reasonable doubt that the tippers received any personal benefit and that the traders knew anything at all about the tippers. Accordingly, the Court vacated the convictions and remanded the matter to the District Court with the instruction to dismiss the indictments.