The Government filed its long awaited Petition for a Writ of Certiorari with the Supreme Court in the Newman insider trading case. The Petition presents three key issues which were generally presaged in the request for rehearing en banc: 1) The Second Circuit’s decision is contrary to Dirks, adding an impermissible gloss to the personal benefit test; 2) Newman conflicts with decisions in other circuits; and 3) policy reasons counsel that the Court reverse the decision and remand it to the lower courts for reconsideration. Petition for a Wirt of Certiorari filed in US. v. Newman (S.Ct. Filed August 31, 2015).
The Petition
The sole question presented for resolution by the High Court “is whether the court of appeals erroneously departed from this Court’s decision in Dirks by holding that liability under a gifting theory requires ‘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,” according to the Petition.
Following a lengthy recitation of the facts, which centered on trading in the shares of Dell and NVIDIA by down the chain tippees, the Petition argues that Newman added an impermissible “gloss” to Dirks. Trading on the basis of inside information by a corporate insider “qualifies as a deceptive device, within the meaning of Section 10(b), because it violates the relationship of trust and confidence that exists between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position . . .” the Petition states (citations and internal quotations omitted). A corporate insider must either publically disclose the information or abstain from trading.
Dirks focused on the scope of “tipper-tippee” insider trading liability. While the securities laws do not require a parity of information, they do bar some tipping. The key is whether the insider will personally benefit from the disclosure, the Government told the Court while quoting Dirks: “The Court identified two different sets of cases in which a factfinder may infer from ‘objective facts and circumstances’ the existence of such a benefit . . . First, ‘there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient.’” That could be a pecuniary gain or reputational benefit that will translate into future earnings. “Second, ‘[t]he elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend,’ as [t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient . . .’” the Petition notes, quoting Dirks.
Newman is “irreconcilable” with the test enunciated by Dirks. The Second Circuit altered the Dirks test by holding that while a personal benefit may be inferred from the “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 . . . 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 lest a potential gain of a pecuniary or similarly valuable nature,’” the Petition argues while quoting Newman. It is this new formulation of the Dirks test which presents the difficulty. Dirks, the Petition argues, allowed a inference of a personal benefit when either the insider expects something in return or there is a gift. While Newman acknowledged both, the Government argues that it eliminated the second by tying the “gift” theory to receiving something – essentially a quid pro quo. Newman also limited this category by requiring that the relationship be “meaningfully close,” another restriction which is contrary to Dirks.
The Second Circuit’s decision also conflicts with that of other circuits. The primary case cited is U.S. v Salman, 2015 WL 4068903 (9th Cir. July 6, 2015). There, in an opinion by Judge Rakoff sitting by designation (here), the court rejected the notion that “unless the government proves that the insider receives something consequential for disclosing confidential information . . .” the proof is not sufficient. While Defendant Salman relied on Newman in arguing that evidence of friendship or familial relation alone is not sufficient, and that there must be a tangible benefit between the tipper and tippee, the Ninth Circuit rejected the proposition, creating a conflict.
Similarly, the Seventh Circuit in SEC v. Maio, 51 F. 3d 623 (7th Cir 1995) rejected that notion. There the court found that an insider’s disclosure of inside information was an improper gift. In reaching its conclusion the court rejected a defense contention that the disclosure was not improper because the insider did not receive any direct or indirect personal benefit as a result of the tip.
Finally, the Petition argued that the “erroneous redefinition of personal benefit” will harm the securities markets. By eliminating the use of inside information for personal advantage Dirks sought to ensure the fair and honest workings of the securities markets. Newman undercuts this goal. The decision will also negatively affect the activities of analysts. This is because if “certain analysts sidestep [the hard job of analyzing a company] by siphoning secret information from insiders. . . then other analysts will be discouraged . . .” Accordingly, Newman should be reversed and remanded the government told the High Court.
Analysis
The views of the Government, presented in the Petition, contrast sharply with those of the Newman court on the record as well as the actual holding and meaning of Dirks. The Petition contains a lengthy recitation of the record which contrasts sharply on key points with Newman. For example, in discussing the questions of what Messrs. Newman and Chiasson knew about the source of the information for Dell the Petition states: “Respondents had ample reason to conclude that the Dell information came from insiders who disclosed it for personal reasons rather than to advance the interest of Dell or its shareholders.” The Petition contains a similar statement regarding their knowledge of NVIDIA and, at one point in note 6, claims that transcript cites by the Second Circuit on the question of the defendants’ knowledge do not support the court’s statements.
The facts recited by the Second Circuit diverge sharply on key points from those presented in the Petition. For example, after concluding that the instructions were erroneous, the Court examined the evidence in detail, adopting the view most favorable to the government. Yet the Court found that “[t]he 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.” The Court amplified this conclusion: “Even assuming that the scant evidence described above was sufficient to permit the inferences of a personal benefit, which we conclude it was not, the Government presented absolutely no testimony or any other evidence that Newman and Chiasson knew that they were trading on information obtained from insiders, or that those insiders received any benefit in exchange for such disclosures. . .”
Petition’s discussion of Dirks and its characterization of Newman’s holding als differs markedly from that of the Second Circuit. The Petition repeatedly contends that the Circuit Court put an “impermissible” gloss on the Dirks personal benefit test by requiring evidence of actual benefit and a meaningful relationship. That view is perhaps highlighted in the discussion of Maio where the Petition notes that: “And the inference that Maio drew – that a personal benefit for the insider can often be inferred from the absence of a ‘legitimate reason’ for a disclosure . . . would be unavailable under the Second Circuit’s analysis, which imposes additional artificial barriers to proving a personal benefit.”
The Newman Court, in contrast, presented its holding as fitting squarely within Dirks: “While we have not yet been presented with the question of whether the tippee’s knowledge of a tipper’s breach requires knowledge of the tipper’s personal benefit, the answer follows naturally from Dirks. Dirks counsels us that the exchange of confidential information for personal benefit is not separate from an insider’s fiduciary breach . . . the insider’s disclosure of confidential information, standing alone, is not a breach. Thus, without establishing that the tippee knows of the personal benefit . . .the Government cannot meet its burden . . .” The court then went on to note that the concept of a personal benefit is “broadly defined” and includes a pecuniary gain, a reputational benefit that could translate into future earnings and the “benefit one would obtain from simply making a gift of confidential information to a trading relative or friend.”
While the Petition’s views of the record and Dirks contrasts sharply with that of the Newman court, it overlooks one key point Dirks and Newman share: Dirks sought to create a limiting principle on the theory of tippee liability for the protection of analysts. Newman sought to create a limiting principle on tippee liability: “We note that the Government has not cited, nor have we found, a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading.”
