White Collar Crime: Insider Trading And Tippee Liability
Todd Newman, Anthon Chiasson
2014 WL 6911278
Decided December 11, 2014
Second Circuit Court of Appeals.
Issue: Whether the trial court erred when it failed to instruct the jury that the defendants had to be aware of a benefit received by the tippers in order for the tippees (defendants) to be found guilty of insider trading. And, whether the evidence presented by the prosecution was insufficient.
Holding: The Second Circuit found that the trial court erred in its instructions and that the tippees (receivers of inside information) must be aware that the tippers received some benefit in exchange for that information, in order to hold defendants criminally liable for insider trading. Additionally, the Second Circuit found that the evidence was not sufficient to prove insider trading and dismissed the case with prejudice.
Facts: Defendants Todd Newman and Anthony Chiasson. Six‐week jury trial on charges of securities fraud in violation of Sections 10(b) and 32 of the Securities Exchange Act of 1934, Securities and Exchange Commission (SEC) Rules 10b‐5 And 10b5‐2, U.S.C. § 2, and conspiracy to commit securities fraud in violation of 18 U.S.C. § 371.
The Government alleged that a cohort of analysts at various hedge funds and investment firms obtained material, nonpublic information from employees of publicly traded technology companies, shared it amongst each other, and subsequently passed this information to the portfolio managers at their respective companies. The Government charged Newman, a portfolio manager at Diamondback Capital Management, LLC (“Diamondback”), and Chiasson, a portfolio manager at Global Investors, L.P. (“Level Global”), with willfully participating in this insider trading scheme by trading in securities based on the inside information illicitly obtained by this group of analysts. On appeal, Newman and Chiasson challenge the sufficiency of the evidence as to several elements of the offense, and further argue that the district court erred in failing to instruct the jury that it must find that a tippee knew that the insider disclosed confidential information in exchange for a personal benefit.
Legal Analysis: 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. 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 insidersin violation of those insiders’ fiduciary duties.
The Second Circuit reversed the convictions with instructions to dismiss the indictment as it pertains to them with prejudice. A group of financial analysts exchanged information they obtained from company insiders, from insiders at Dell and NVIDIA. These analysts then passed the inside information to their portfolio managers, including Newman and Chiasson, who, in turn, executed trades in Dell and NVIDIA stock. 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. Tipping chain. Rob Ray of Dell’s investor relations department tipped information regarding Dell’s consolidated earnings numbers to Sandy Goyal, an analyst at Neuberger Berman. Goyal in turn gave the information to Diamondback analyst Jesse Tortora. Tortora in turn relayed the information to his manager Newman as well as to other analysts including Level Global analyst Spyridon “Sam” Adondakis. Adondakis then passed along the Dell information to Chiasson, making Newman and Chiasson three and four levels removed from the inside tipper, respectively.
NVIDIA tipping chain: Chris Choi of NVIDIA’s finance unit tipped inside information to Hyung Lim, a former executive at technology companies Broadcom Corp. and Altera Corp., whom Choi knew from church. Lim passed the information to co‐defendant Danny Kuo, an analyst at Whittier Trust. Kuo circulated the information to the group of analyst friends, including Tortora and Adondakis, who in turn gave the information to Newman and Chiasson, making Newman and Chiasson four levels removed from the inside tippers.
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.
On the issue of the appellants’ knowledge, the district court instructed the jury:
To meet its burden, the [G]overnment must also prove beyond a reasonable doubt that the defendant you are considering knew that the material, nonpublic information had been disclosed by the insider in breach of a duty of trust and confidence. The mere receipt of material, nonpublic information by a defendant, and even trading on that information, is not sufficient; he must have known that it was originally disclosed by the insider in violation of a duty of confidentiality.
District court sentenced Newman to an aggregate term of 54 months’. The district court sentenced Chiasson to an aggregate term of 78 months’ imprisonment. We conclude that the jury instructions were erroneous and that there was insufficient evidence to support the convictions, we address only the arguments relevant to these issues.
The Second Circuit reviewed the jury instructions de novo with regard to whether the jury was misled or inadequately informed about the applicable law.
- The Law of Insider Trading
Section 10(b) of the 1934 Act, 15 U.S.C. § 78j(b), prohibits the use “in connection with the purchase or sale of any security . . . [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe . . . .” Although Section 10(b) was designed as a catch‐all clause to prevent fraudulent practices, Ernst & Ernst v. Hochfelder,
425 U.S. 185, 202‐06 (1976), neither the statute nor the regulations issued pursuant to it, including Rule 10b‐5, expressly prohibit insider trading. Rather, the unlawfulness of insider trading is predicated on the notion that insider trading is a type of securities fraud proscribed by Section 10(b) and Rule 10b‐5. See Chiarella v.
United States, 445 U.S. 222, 226‐30 (1980).
- The “Classical” and “Misappropriation” Theories of Insider Trading
The classical theory holds that a corporate insider (such as an officer or director) violates Section 10(b) and Rule 10b‐5 by trading in the corporation’s securities on the basis of material, nonpublic information about the corporation. Id. at 230. Under this theory, there is a special “relationship of trust and confidence between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position within that.
In accepting this theory of insider trading, the Supreme Court explicitly rejected the notion of “a general duty between all participants in market transactions to forgo actions based on material, nonpublic information.” Id. at 233. Instead, the Court limited the scope of insider trading liability to situations where the insider had “a duty to disclose arising from a relationship of trust and confidence between parties to a transaction,” such as that between corporate officers and shareholders. Id. at 230.
An alternative, but overlapping, theory of insider trading liability, commonly called the “misappropriation” theory, expands the scope of insider trading liability to certain other “outsiders,” who do not have any fiduciary or other relationship to a corporation or its shareholders. Liability may attach where an “outsider” possesses material non‐public information about a corporation and another person uses that information to trade in breach of a duty owed to the owner. United States v. O’Hagan, 521 U.S. 642, 652‐53 (1997); United States v. Libera, 989 F.2d 596, 599‐600 (2d Cir. 1993). In other words, such conduct violates Section 10(b) because the misappropriator engages in deception by pretending “loyalty to the principal while secretly converting the principal’s information for personal gain.” Obus, 693 F.3d at 285 (citations omitted).
Courts have expanded insider trading liability to reach situations where the insider or misappropriator in possession of11 Nos. 13‐1837‐cr; 13‐1917‐cr 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. at 659. 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 held that “[t]he tippee’s duty to12 Nos. 13‐1837‐cr; 13‐1917‐cr disclose or abstain is derivative from that of the insider’s duty.” Id. at 659. Because the tipper’s breach of fiduciary duty requires that he “personally will benefit, directly or indirectly, from his disclosure,” id. at 662, a tippee may not be held liable in the absence of such benefit. Moreover, the Supreme Court held that a tippee may be found liable “only when the insider has breached his fiduciary duty . . . and the tippee knows or should know that there has been a Breach”.
- Mens Rea
Liability for securities fraud also requires proof that the defendant acted with scienter, which is defined as “a mental state embracing intent to deceive, manipulate or defraud.” Hochfelder, 425
U.S. at 193 n.12. In order to establish a criminal violation of the securities laws, the Government must show that the defendant acted “willfully.” 15 U.S.C. § 78ff (a). We have defined willfulness in this context “as a realization on the defendant’s part that he was doing a wrongful act under the securities laws.”
- The Requirements of Tippee Liability tippee liability requires proof of a personal benefit to the insider.
First, the tippee’s liability derives only from the tipper’s breach of a fiduciary duty, not from trading on material, non‐public information. See Chiarella, 445 U.S. at 233 (noting that there is no “general duty between all participants in market transactions to forgo actions based on material, nonpublic 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 10b‐5. 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, the Second Circuit found 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. The Supreme Court explicitly repudiated this premise not only in Dirks, but in a predecessor case, Chiarella v. United States.
Dirks clearly defines a breach of fiduciary duty as a breach of the duty of confidentiality in exchange for a personal benefit. See Dirks, 463 U.S. at 662. The Second Circuit concluded that a tippee’s knowledge of the insider’s breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit.
Our conclusion also comports with well‐settled principles of substantive criminal law. As the Supreme Court explained in Staples v. United States, 511 U.S. 600, 605 (1994), under the common law, mens rea, which requires that the defendant know the facts that make his conduct illegal, is a necessary element in every crime. Such a requirement is particularly appropriate in insider trading cases where we have acknowledged “it is easy to imagine a . . . trader who receives a tip and is unaware that his conduct was illegal and therefore wrongful.”
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. See Jiau, 734 F.3d at 152‐53; Dirks, 463 U.S. at 659‐64.
The Second Circuit found that the district court’s instruction failed to accurately advise the jury on the law. The district court charged the jury that the Government had to prove: (1) that the insiders had a “fiduciary or other relationship of trust and confidence” with their corporations; (2) that they “breached that duty of trust and confidence by disclosing material, nonpublic information”; (3) that they “personally benefited in some way” from the disclosure; (4) “that the defendant . . . knew the information he obtained had been disclosed in breach of a duty”; and (5) that the defendant used the information to purchase a security. Under these instructions, a reasonable juror might have concluded that a defendant could be criminally liable for insider trading merely if such defendant knew that an insider had divulged information that was required to be kept confidential. But a breach of the duty of confidentiality is not fraudulent unless the tipper acts for personal benefit, that is to say, there is no breach unless the tipper “is in effect selling the information to its recipient for cash, reciprocal information, or other things of value for himself. . . .”
Dirks, 463 U.S. at 664 (quotation omitted). Thus, the district court was required to instruct the jury that the Government had to prove beyond a reasonable doubt that Newman and Chiasson knew that the tippers received a personal benefit for their disclosure.
Insufficiency of the Evidence
As a general matter, a defendant challenging the sufficiency of the evidence bears a heavy burden, as the standard of review is exceedingly deferential. United States v. Coplan, 703 F.3d 46, 62 (2d Cir. 2012). Specifically, we “must view the evidence in the light most favorable to the Government, crediting every inference that could have been drawn in the Government’s favor, and deferring to the jury’s assessment of witness credibility and its assessment of the weight of the evidence.”
However, if the evidence “is nonexistent or so meager,” such that it “gives equal or nearly equal circumstantial support to a theory of guilt and a theory of innocence, then a reasonable jury must necessarily entertain a reasonable doubt”.
The circumstantial evidence in this case was simply too thin to warrant the inference that the corporate insiders received any personal benefit in exchange for their tips.
Here the “career advice” that Goyal gave Ray, the Dell tipper, was little more than the encouragement one would generally expect of a fellow alumnus or casual acquaintance. Crucially, Goyal testified that he would have given Ray advice without receiving information because he routinely did so for industry colleagues. Thus, it would not be possible under the circumstances for a jury in a criminal trial to find beyond a reasonable doubt that Ray received a personal benefit in exchange for the disclosure of confidential information.
The evidence of personal benefit was even more scant in the NVIDIA chain. Lim testified that he did not provide anything of value to Choi in exchange for the information.
Moreover, the evidence established that NVIDIA and Dell’s investor relations personnel routinely “leaked” earnings data in advance of quarterly earnings. Appellants introduced examples in which Dell insiders, including the head of Investor Relations, Lynn
Tyson, selectively disclosed confidential quarterly financial information arguably similar to the inside information disclosed by Ray and Choi to establish relationships with financial firms who might be in a position to buy Dell’s stock.
No reasonable jury could have found beyond a reasonable doubt that Newman and Chiasson knew, or deliberately avoided knowing, that the information originated with corporate insiders.