In December 2014, the US Court of Appeals for the Second Circuit handed down a landmark insider trading decision in United States v. Newman. This decision seemingly curbed the Government's ability to prosecute insider trading cases by increasing the Government's burden of proof.
This April, the same three-judge panel that handed down the decision in December denied the Justice Department's request to reconsider the Court's decision.
The Second Circuit held that a "tippee" who was tipped inside information by an insider of a company could only be held criminally liable for insider trading if (i) the insider breached a fiduciary duty by disclosing the inside information to the tippee in exchange for a personal benefit, and (ii) the tippee knew of the tipper's breach and of the personal benefit conveyed to the insider.
The Court also suggested that the Government can no longer infer a personal benefit from a personal relationship between the tipper and tippee, and must demonstrate proof of a meaningfully close personal relationship that is objective and consequential. The Government essentially held that a personal benefit could not be inferred from "the mere fact of a friendship" between the tipper and tippee.
Mark Ruddy is an attorney and founder of Ruddy Law Office, PLLC in Washington DC. In his view, the Newman ruling has made life more difficult for the US Government.
"It is my understanding that the Government is evaluating its investigations that may be filed in the Second Circuit, and, where possible, determining whether it would be strategically advantageous to bring certain cases in other circuits where the law is more favourable.
"However, the fact that most insider trading cases are brought in the Second Circuit means that, if another circuit is chosen, the Second Circuit's decision may be persuasive in guiding the decisions of the other circuits. They will look to what the Second Circuit has done or has said," explains Ruddy.
In an unlikely scenario, the US Government may be assisted by the support of Congress if any of the recently introduced insider trading bills makes their way into law. On April 3, 2015, the New York Times reported that lawmakers have introduced three bills in response to Newman. Ruddy points out that members of Congress are working to establish a "Newman fix."
"The securities laws are supposed to be construed in a flexible manner and developed by the courts so that they can evolve with time. The minute you introduce a bright line rule is the minute that someone exploits a loophole," remarks Ruddy.
Nevertheless, the Newman ruling should not be interpreted by fund managers to mean that it is now acceptable to loosen their policies governing the use of inside information. Its applicability is limited in numerous ways.
First, Newman only applies to the Second Circuit; it has yet to be seen whether other circuits will fully embrace this standard. Second, the SEC's burden of proof in a civil enforcement proceeding is substantially lower than the Government's burden of proof in a criminal matter ("recklessly" vs. "willfully"). Third, even the appearance of impropriety or the public announcement of an SEC investigation is sufficient to cause significant harm to a fund manager's business.
In short, says Ruddy, fund managers should view Newman as a defence to insider trading and not an "invitation to amend or expand current policies regarding the use of information resources.
