Insider Trading – Tippee Liability Clarified? by John M. Richilano (February 13, 2015)
For over 30 years at least, since the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983), the level of scienter – guilty knowledge – required for a downstream tippee of inside information on a stock has been a disputed question. Trading on material, non-public information in and of itself is not illegal (Chiarella v. United States., 445 U.S. 222 (1980). It is only when such inside information is improperly used that it becomes illegal. The tipper -- the inside source of the information -- typically has a duty to the shareholders of the company not to disclose. Improper disclosure necessarily means disclosure in violation of that duty. The Supreme Court in Dirks held that a breach of duty occurs when the insider discloses for personal benefit and not for the benefit of the shareholders to whom the duty is owed.
Because tippee liability, if any, is derived solely from the liability of the original tipper, many have argued that Dirks requires that the tippee know of the tipper’s breach – that is, know that the disclosure was made for personal gain, and know what that gain is. Otherwise, derivative liability would be turned on its head because it would be easier to convict the tippee than the tipper. Others, notably the SEC and federal prosecutors, have argued the opposite – that the government need only prove that tipper breached her duty and the tippee acted “knowingly.”
Thus it is no surprise that the government and SEC are up in arms over the Second Circuit’s recent decision in United States v. Newman, 773 F.3d 438 (2nd Cir. 2014). In Newman, the second circuit panel unanimously held that, in order to convict a downstream tippee of insider trading, the government must prove that the tippee “knew that the insider disclosed confidential information for a personal benefit.” Id. at 442
For insightful analysis of this issue, see Jodi L. Avergun & Douglas H. Fischer, Friends With Benefits: Second Circuit Overturns Fund Managers’ Convictions And Raises the Government’s Burden in Insider Trading Cases Against Tippers, 96 Crim. L. Rep. 368 (2015) and 96 Crim. L. Rep. 360 (2015) (News feature) (both copyright 2015 by the Bureau of National Affairs, Inc.).
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