Breaking from precedent, the Second Circuit sets a new standard for the personal benefit element of insider trader liability.

On December 10, 2014, the United States Court of Appeals for the Second Circuit reversed the high-profile convictions of two former hedge fund managers, Todd Newman and Anthony Chiasson. The court held that the government failed to make a sufficient showing of “personal benefit” to the insider tipper and that the jury should have been instructed that “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.” This case represents an important clarification of the relatively low standard courts have used to establish the “personal benefit” element for over 30 years, since the Supreme Court’s seminal decision in Dirks v. SEC, 463 U.S. 646 (1983). Under the Second Circuit’s new ruling, the mere act of giving a gift of confidential information to a trading relative or friend is no longer sufficient to establish the existence of a “personal benefit.” Instead, there must now be “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.”

Background -

In December of 2012, Newman and Chiasson were convicted in the United States District Court for the Southern District of New York (SDNY) on charges of securities fraud in violation of sections 10(b) and 32 of the Securities Exchange Act of 1934, SEC Rules 10b-5 and 10b5-2, 18 U.S.C. § 2, and conspiracy to commit securities fraud in violation of 18 U.S.C. § 371. The government alleged that analysts at various hedge funds and investment firms obtained material, non-public 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 announcements. The government further alleged that these analysts then passed the inside information to Newman and Chiasson, who, in turn, executed trades in Dell and NVIDIA stock, earning approximately US$4 million and US$68 million, respectively, in profits for their respective funds. Newman and Chiasson were four levels removed from the insider tippers and the court found no evidence that either was aware of the source of the inside information. The government charged Newman and Chiasson with wilfully participating in this insider trading scheme by trading in securities based on the inside information these analysts had illicitly obtained.