DOJ files for cert in Newman

Since the financial crisis in 2008, the DOJ has been teaching yet another generation of insider traders the important lesson that one shall not trade on confidential inside information.  However, that campaign took a big - one might say devastating - hit when the Second Circuit overturned Judge Rakoff and threw out insider trading convictions in US v Newman. In Newman, the court held:

 [W]e hold that the evidence was insufficient to sustain a guilty verdict against Newman and Chiasson for two reasons. First, the Government's evidence of any personal benefit received by the alleged insiders was insufficient to establish the tipper liability from which defendants' purported tippee liability would derive. Second, even assuming that the scant evidence offered on the issue of personal benefit was sufficient, which we conclude it was not, the Government presented no evidence that Newman and Chiasson knew that they were trading on information obtained from insiders in violation of those insiders' fiduciary duties.

Under Dirks, in order for an insider to generate 10b-5 liability, they have to breach their fiduciary duty by receiving some personal benefit.  Until Newman, courts have generally construed the personal benefit requirement fairly broadly. So, where friends share inside information until Newman courts have generally agreed with the government's position that that was sufficient for purposes of Dirks' personal benefit requirement.  Newman narrowed that area of agreement significantly: 

We have observed that "[p]ersonal benefit is broadly defined to include not only pecuniary gain, but also, inter alia, 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." Jiau, 734 F.3d at 153 (internal citations, alterations, and quotation marks deleted). 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," see463 U.S. at 664, 103 S.Ct. 3255, 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. In other words, as Judge Walker noted in Jiau, this requires evidence of "a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter]."

I suppose an explicit quid pro quo requirement is consistent with where the US Supreme Court has been going in recent years in its political corruption cases, so one shouldn't be too surprised that a circuit court also goes this way.  

Judge Rakoff who heard the Newman case at the District Court level was obviously none to happy with being overruled.  Why do I say that? Well, because of a Ninth Circuit case handed down this past June.  In US v. Salman, the Ninth Circuit, in an opinion written by ... Judge Rakoff sitting by designation, declined to follow Newman:

[Appellant] Salman reads Newman to hold that evidence of a friendship or familial relationship between tipper and tippee, standing alone, is insufficient to demonstrate that the tipper received a benefit. In particular, he focuses on the language indicating that the exchange of information must include "at least a potential gain of a pecuniary or similarly valuable nature," id. at 452, which he reads as referring to the benefit received by the tipper. Salman argues that because there is no evidence that Maher received any such tangible benefit in exchange for the inside information, or that Salman knew of any such benefit, the Government failed to carry its burden.

To the extent Newman can be read to go so far, we decline to follow it. Doing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an "insider makes a gift of confidential information to a trading relative or friend." Dirks, 463 U.S. at 664. Indeed, Newman itself recognized that the "`personal benefit is broadly defined to include not only pecuniary gain, but also, inter alia, . . . the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend.'" Newman, 773 F.3d at 452(alteration omitted) (quoting United States v. Jiau, 734 F.3d 147, 153 (2d Cir. 2013)).

In our case, the Government presented direct evidence that the disclosure was intended as a gift of market-sensitive information. Specifically, Maher Kara testified that he disclosed the material nonpublic information for the purpose of benefitting and providing for his brother Michael. Thus, the evidence that Maher Kara breached his fiduciary duties could not have been more clear, and the fact that the disclosed information was market-sensitive — and therefore within the reach of the securities laws, see O'Hagan, 521 U.S. at 656 — was obvious on its face. If Salman's theory were accepted and this evidence found to be insufficient, then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return. Proof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading.

And just like that - a circuit split! According to Alison Frankel, the DOJ has just filed for cert in Newman to resolve this split. No doubt, this is going to be the biggest and most consequential insider trading case before the Supreme Court in recent years if the court decides to grant cert. 

-bjmq