McGraw-Hill. (2011, July 23).Insider trading(Links to an external site.)[Video file]. Retrieved from http://www.viddler.com/embed/1f5a9785/?f=1&autoplay=0&player=full&secret=97426822&loop=0&nologo=0&hd=0

Tippee liability continues to evolve. The following case note includes two cases: United States v. Newman and United States v. Salman. In Newman, the Second Circuit Court of Appeals applied the elements for tippee liability as set forth in Dirks v. SEC to determine the fate of two hedge fund analysts criminally charged with insider trading. The court ultimately held that there was no personal benefit received by the tippers, and thus there could be no tipper liability from which the purported tippee liability would derive. This case is included because it shows how difficult prosecutions are in remote tippee scenarios and the struggle courts have in determining how broad insider trading liability should extend. In Salman, the Supreme Court rejected the Second Circuit's reading of Dirks and reestablished the personal gain or benefits element as originally understood. The note following the cases suggests more uncertainty to come.

Extent of Liability for Insider Trading Section 20A of the 1934 Act allows persons who traded in the securities at about the same time as the insider or tippee to recover damages from the insider or tippee. Although there may be several persons trading at about the same time, the insider or tippee's total liability cannot exceed the profit she has made or the loss she has avoided by trading on inside information.

This limitation, which merely requires disgorgement of profits, has been assailed as not adequately deterring insider trading because the defendant may realize an enormous profit if her trading is not discovered but lose nothing beyond her profits if it is. In response to this issue of liability, Congress passed an amendment to the 1934 Act permitting the SEC to seek a civil penalty of three times the profit gained or the loss avoided by trading on inside information. This treble penalty is paid to the Treasury of the United States. The penalty applies only to SEC actions; it does not affect the amount of damages that may be recovered by private plaintiffs. The 1934 Act also grants the SEC power to award up to 10 percent of any triple-damage penalty as a bounty to informants who helped the SEC uncover insider trading.

United States v. Newman773 F.3d 438 (2d Cir. 2014)

This case arises from the government's ongoing investigation into suspected insider trading activity at hedge funds. In January 2012, the government unsealed charges against Todd Newman, Anthony Chiasson, and several other investment professionals. In February 2012, a grand jury returned an indictment.

At trial, the government presented evidence that a group of financial analysts exchanged information they obtained from company insiders, both directly and more often indirectly. Specifically, the government alleged that the analysts received information from insiders at Dell and NVIDIA, disclosing those companies' earnings numbers before they were publicly released in Dell's May 2008 and August 2008 earnings announcements and NVIDIA's May 2008 earnings announcement. The analysts then passed the inside information to their portfolio managers, including Newman and Chiasson, who, in turn, executed trades in Dell and NVIDIA stock, earning approximately $4 million and $68 million, respectively, in profits for their respective funds.

Newman and Chiasson were several steps removed from the corporate insiders, and there was no evidence that either was aware of the source of the inside information. However, the government charged that Newman and Chiasson were criminally liable for insider trading because, as sophisticated traders, they must have known that information was disclosed by insiders in breach of a fiduciary duty and not for any legitimate corporate purpose.

At the close of evidence, Newman and Chiasson moved for a judgment of acquittal, arguing that there was no evidence that the corporate insiders provided inside information in exchange for a personal benefit, which is required to establish tipper liability under Dirks v. SEC. Newman and Chiasson also argued that, even if the corporate insiders had received a personal benefit in exchange for the inside information, there was no evidence that they knew about any such benefit. Absent such knowledge, appellants argued, they were not aware of, or participants in, the tippers' fraudulent breaches of fiduciary duties to Dell or NVIDIA and could not be convicted of insider trading under Dirks. In the alternative, Newman and Chiasson requested that the court instruct the jury that it must find that they knew that the corporate insiders had disclosed confidential information for personal benefit in order to find them guilty. However, the district court did not give Newman and Chiasson's proposed jury instruction. In December, 2012, the jury returned a verdict of guilty on all counts.

Parker, Judge

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. The insider trading case law is not confined to insiders or misappropriators who trade for their own accounts. Courts have expanded insider trading liability to reach situations where the insider or misappropriator in possession of material nonpublic information ( "the tipper") does not himself trade but discloses the information to an outsider (a "tippee") who then trades on the basis of the information before it is publicly disclosed. See Dirks, 463 U.S. [646, 659 (1983)]. The elements of tipping liability are the same, regardless of whether the tipper's duty arises under the "classical" or the "misappropriation" theory.

The Supreme Court was quite clear in Dirks of what is required to demonstrate tippee liability. First, the tippee's liability derives only from the tipper's breach of a fiduciary duty, not from trading on material, non-public information. Second, the corporate insider has committed no breach of fiduciary duty unless he receives a personal benefit in exchange for the disclosure. Third, even in the presence of a tipper's breach, a tippee is liable only if he knows or should have known of the breach.

Dirks counsels us that the exchange of confidential information for personal benefit is not separate from an insider's fiduciary breach; it is the fiduciary breach that triggers liability for securities fraud under Rule 10b5. For purposes of insider trading liability, the insider's disclosure of confidential information, standing alone, is not a breach. Thus, without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knew of a breach.

In light of Dirks, we find no support for the Government's contention that knowledge of a breach of the duty of confidentiality without knowledge of the personal benefit is sufficient to impose criminal liability. Although the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation's securities markets. The Supreme Court has affirmatively established that insider trading liability is based on breaches of fiduciary duty, not on informational asymmetries. This is a critical limitation on insider trading liability that protects a corporation's interests in confidentiality while promoting efficiency in the nation's securities markets.

As noted above, Dirks clearly defines a breach of fiduciary duty as a breach of the duty of confidentiality in exchange for a personal benefit. Accordingly, we conclude that a tippee's knowledge of the insider's breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit.

In sum, we hold that 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.

In this case both Chiasson and Newman contested their knowledge of any benefit received by the tippers and, in fact, elicited evidence sufficient to support a contrary finding. Moreover, we conclude that the Government's evidence of any personal benefit received by the insiders was insufficient to establish tipper liability from which Chiasson and Newman's purported tippee liability would derive.

We have observed that a personal benefit is broadly defined to include not only pecuniary gain, but also any reputational benefit that will translate into future earnings and the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend. This standard, although permissive, does not suggest that the Government may prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature. If that were true, and the Government was allowed to meet its burden by proving that two individuals were alumni of the same school or attended the same church, the personal benefit requirement would be a nullity. To 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.

Judgment vacated as to the convictions; remanded to the district court to dismiss the indictment with prejudice as it pertains to Newman and Chiasson.

Assume Ken Hastings (cookout host) and Tim Daniels (Ken's tennis partner) both bought stock in New World Industries as soon as the market opened on Monday and all profited 30% after the press announcement by Mrs. Chen. Pursuant to their agreement, Tim Daniels paid Ken Hasting 5% of the profit he made on the transaction.

With regard to Judith Chen, Steve Chen, Ken Hastings and Tim Daniels,

1. which of these parties could be considered an "insider" under rule 10(b)(5) of the Securities Act of 1934? Explain why or why not.
2. Which of these parties could have tipper or tippee liability in this case?
3. Did Judith Chen's actions in telling her husband about the settlement breach her fiduciary duty? And
4. Who actually obtained a personal benefit from the tip and how?