Editorial

Citation

Rutledge, G.P. (2015), "Editorial", Journal of Financial Crime, Vol. 22 No. 2. https://doi.org/10.1108/JFC-03-2015-0014

Editorial

Article Type: Editorial From: Journal of Financial Crime, Volume 22, Issue 2

On December 10, 2014, the US Court of Appeals for the Second Circuit in New York issued a decision in USA v. Newman which was an appeal from a criminal conviction of Todd Newman and Anthony Chiasson for tippee insider dealing. In the USA, the offence of insider dealing is based upon decades of judicial interpretations by the federal courts of the anti-fraud provisions of US Securities and Exchange Commission Rule 10b-5.

Newman and Chaisson were portfolio managers at separate private investment firms. Because Newman and Chaisson executed trades in securities of Dell and NVIDIA allegedly based upon material non-public information originally tipped by insiders at these companies, the US Government claimed they were criminally liable for tippee insider dealing because, as sophisticated traders, they must have known that the material non-public information they received and traded upon had been disclosed in breach of the employees’ fiduciary duty to their employers.

Observing that, under the chain of tipping for both the Dell and NVIDIA transactions, Newman and Chaisson were at least three or four levels removed from the inside corporate tippers, the court held that, based on the evidence presented by the Government, they could not be held criminally liable for tippee insider dealing because the Government had not proven beyond a reasonable doubt that Newman and Chaisson knew that the corporate insiders had breached their fiduciary duty to their respective employers.

In summary, the court stated that, to sustain a criminal conviction for tippee insider dealing, the prosecutor must prove beyond a reasonable doubt that:

1. the corporate insider was entrusted with a fiduciary duty;

2. the corporate insider breached his fiduciary duty by:

• disclosing confidential information to a tippee; and

• in exchange for a personal benefit;

3. the tippee knew of the tipper’s breach (i.e. the tippee knew the information was divulged by the tipper for his personal benefit); and

4. the tippee, with such knowledge, still used such information to trade in a security or to tip another individual for personal benefit.

The court went on to state that the “personal benefit” element of the offence requires evidence of a relationship between the insider and recipient that suggests a quid pro quo from the latter or an intention to benefit the latter. The court noted that evidence of a personal relationship between the tipper and the tippee is insufficient, absent 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 (e.g. reputational enhancement).

Some legal commenters have expressed concern that the Newman decision provides a “roadmap” whereby, if individuals can insulate themselves sufficiently with layers of intervening tippers/tippees and demonstrate that the material non-public information took a sufficiently circuitous route from the original corporate insider, such individuals might be able to trade on the basis of such information without fear of criminal liability for tippee insider dealing. Indeed, within a little over a month from issuance of the Newman decision, a lower federal court in New York, in USA v. Conradt which allegedly involved a fact pattern similar to Newman, threw out guilty pleas of four individuals who had pled guilty to insider trading and scheduled a hearing to determine dismissal of their criminal indictments.

Even if such tippees may not face criminal liability in future, they still might face civil suits for disgorgement of profits gained by trading on material non-public information originating with corporate insiders based upon another 2014 decision by the same US Court of Appeals. In SEC v. Contorinis, which was a civil suit filed by the SEC after a criminal proceeding for insider dealing, the court ruled that the SEC could pursue disgorgement of illegal profits from an individual who engaged in insider dealing even where he used funds he did not own and produced illegal profits that he did not personally realize. Hence, Contorinis was held liable for disgorgement of the illegal profits gained by his insider dealing activities even though his firm received all the profits gained from those activities.

The Newman decision may discourage similar prosecutions for tippee insider dealing or result in reversal of similar convictions already obtained due to the court’s unusually overt chastisement of the Government for the “doctrinal novelty of its recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders”.

In light of Newman, some commenters have called for creating a separate statutory offence of insider dealing. Crafting such language might prove extremely difficult and doubtless would result in a new set of judicial interpretations. Current proceedings related to insider dealing based upon SEC Rule 10b-5 and appeals therefrom would have to be grandfathered appropriately. Subsequent definitional changes would require successful navigation of the laborious federal legislative process. On the other hand, SEC Rule 10b-5 has a long and proven history of being sufficiently prophylactic to address the new and novel. In this context, it may be wise to remember the American folk proverb: “If it ain’t broke, don’t try to fix it”.

G. Philip Rutledge, Bybel Rutledge LLP[1]

Note

1. The views expressed herein are solely those of the author and not Bybel Rutledge LLP or any members or clients of Bybel Rutledge LLP.