United States v. Newman: Second Circuit Ruling Portends Choppier Waters for Insider Trading Charges Against Downstream Tippees

December 15, 2014

On December 10, 2014, the United States Court of Appeals for the Second Circuit issued its much-anticipated decision in United States v. Newman, which vacated the convictions of and dismissed with prejudice the indictments against two high-profile insider trading defendants–Anthony Chiasson and Todd Newman.  In overturning their convictions the Second Circuit both clarified the heavy evidentiary burden needed to convict downstream tippees who are several levels removed from the original tipper, and returned life to the "personal benefit" test for when a tipper breaches a fiduciary duty.  This ruling likely will have significant repercussions for criminal and civil insider trading cases in the Second Circuit. 

The Trial and Convictions

Chiasson and Newman were successful hedge fund managers who traded in technology stocks.  Chiasson co-founded Level Global Investors, and Newman was a portfolio manager at Diamondback Capital, both prominent hedge funds in New York.  On November 22, 2010, the FBI executed search warrants at both hedge funds.  Although neither Chiasson nor Newman was arrested at the time, their hedge funds suffered significant reputational and financial harm, and by the end of 2012, both were shuttered. 

On January 18, 2012, Chiasson and Newman were arrested for allegedly trading Dell and Nvidia stock based on material nonpublic information that originated from insiders at those companies.  Their hedge funds were alleged to have reaped $72 million in illicit profits, which made the case one of the largest insider trading prosecutions to date.  Chiasson and Newman both proceeded to trial.  After six days of trial and two days of deliberations, the jury returned guilty verdicts against Chiasson and Newman on multiple counts of securities fraud.  Chiasson and Newman were sentenced to 6 ½ years and 4 ½ years in prison, respectively.

At trial, the evidence showed that both Chiasson and Newman traded on information provided by insiders at Dell and Nvidia, that the tips were relayed to them from their respective analysts, and that as a result, Chiasson and Newman were multiple levels removed from the original tippers.  The Dell tip originated from an employee in Dell’s investor relations department, who disclosed Dell’s earnings information to Sandy Goyal, an analyst at another investment manager, who in turn provided the information to Jesse Tortora, an analyst at Diamondback.  Tortora then relayed the information to his portfolio manager, Newman, and other analysts, including Sam Adondakis at Level Global.  Adondakis then shared the information with Chiasson.  Thus, Newman and Chiasson were respectively three and four levels removed from the original Dell insider.  The Nvidia tip originated from an employee at Nvidia’s finance unit, who disclosed Nvidia’s earnings information to a social friend from church, who in turn shared the information with Danny Kuo, an analyst at Whittier Trust.  Kuo then tipped the information to a group of analysts, including Tortora and Adondakis, who shared the information with Newman and Chiasson.  Thus, Newman and Chiasson were both four levels removed from the original Nvidia tipper.

The Appeal

Chiasson and Newman on appeal challenged the sufficiency of the evidence at trial as well as the jury instructions.

            Sufficiency of the Evidence

Chiasson and Newman argued that the evidence at trial was insufficient to show that the insiders at Dell and Nvidia breached their fiduciary duties to their respective companies.  At trial, the Government offered evidence that Goyal had provided "career advice" to the Dell inside tipper in exchange for disclosing Dell earnings.  But Goyal testified that he gave the Dell insider career advice before he even received inside information about Dell, and that he would have given the advice even if the Dell insider had never shared the information.  With respect to the Nvidia tipper, though, the Government claimed that the tipper gifted the inside information to his church friend, and did not present evidence that the friend provided anything of value in return.  Chiasson and Newman argued that neither the Nvidia tipper nor the Dell tipper received a "personal benefit" to have breached their fiduciary duties under the Supreme Court’s ruling in Dirks v. SEC, 463 U.S. 646 (1983).

In Dirks, the Supreme Court held that tippers are liable only where they breach a fiduciary duty to the company’s shareholders.  The test for whether the tipper breached his fiduciary duty is "whether the insider personally will benefit, directly or indirectly, from his disclosure."  463 U.S. at 662.  The Court further held that a tippee’s duty to disclose or abstain from trading on material, nonpublic information is derivative of the tipper’s duty–meaning, that where a tipper breaches his duty to company shareholders by tipping inside information in exchange for a personal benefit, the recipient of the information (the tippee) similarly breaches a duty to the shareholders by trading on the inside information without disclosure.  Id. at 659-62.

In Newman, the Second Circuit held that the Government failed to present sufficient evidence that either corporate tipper received a "personal benefit" to trigger a breach of a fiduciary duty under Dirks.  The Court explained that the Government must prove 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."  Though the tipper’s gain "need not be immediately pecuniary," it must be "of some consequence."  The Court rejected the argument that the "mere fact of a friendship, particularly of a casual or social nature" is sufficient to show a benefit to the tipper, noting that "[i]f this was benefit, practically anything would qualify."  The Court accordingly found that the "career advice" the Dell insider received from Goyal was "little more than the encouragement one would generally expect of a…casual acquaintance," and that there was no quid pro quo because Goyal provided the Dell insider career advice irrespective of any tip.  Similarly, the Court found that the Nvidia insider and his church friend were "merely casual acquaintances" and that the evidence did not establish a history of personal favors between the two that would suggest a breach of a fiduciary duty.

            Jury Instructions

Chiasson and Newman also argued that, even if there was sufficient evidence of a benefit to the tippers, the District Court’s jury instructions erroneously permitted conviction without any proof that Chiasson and Newman, as downstream tippees, knew that the tip was provided by the corporate insider in exchange for a benefit.  The Second Circuit agreed, holding that the District Court should have instructed the jury that the Government must prove beyond a reasonable doubt that Chiasson and Newman had knowledge that the insider provided a tip in exchange for a personal benefit.  The Court rejected the notion that sophisticated traders like Chiasson and Newman "must know" that certain information is disclosed in breach of a fiduciary duty, and not for any legitimate corporate purpose.  The Court instead concluded that Chiasson and Newman knew "next to nothing" about any personal benefit to the insiders at Dell and Nvidia and emphasized that companies often authorize employees to "selectively disclose[]" corporate information for the company’s benefit.


Until the Newman decision, the Government had chipped away at the Dirks benefit test, including by deeming the test satisfied where the tip was in exchange for "maintaining a useful networking contact," as in United States v. Whitman, 904 F. Supp. 2d 363, 372 n.7 (S.D.N.Y. 2012), or merely "making a gift of information to a friend," as in SEC v. Obus, 693 F.3d 276, 291 (2d Cir. 2012) (finding that the fact that the tipper and tippee were friends from college was sufficient to send the personal benefit question to the jury).  Newman should now re-invigorate the original meaning of the Dirks benefit test, making it harder for the Justice Department and the SEC to prevail where evidence of a pecuniary benefit to the tipper is not readily provable.  Allegations of intangible future benefits, such as reputational benefits that do not result in "at least a potential gain of a pecuniary or similarly valuable nature," may be insufficient to prove insider trading against a tipper, and in turn, against the tippee.

Moreover, the Second Circuit has clarified that with respect to remote tippees, the Government must prove that the tippee had knowledge of a personal benefit to the tipper in addition to knowledge that the trading is based on material nonpublic information.  While the Second Circuit left open the possibility of satisfying this standard with evidence that the remote tippee consciously avoided learning of the personal benefit, this clarification nonetheless raises the bar for this relatively new trend in remote-tippee prosecutions.  It is thus no surprise that top prosecutors and regulators–including United States Attorney Preet Bharara and SEC Chair Mary Jo White–have already spoken out against the ruling, with Bharara warning that the ruling "will limit the ability to prosecute people who trade on leaked inside information."

Bharara already has hinted that he may urge the Solicitor General to approve a motion for review of Newman by the full court, as the decision puts a significant crimp in his Office’s efforts to expand insider trading liability to remote tippees.  His Office in fact had argued in Newman that Second Circuit cases such as Obus already endorsed the government’s expansive view of the law.  If the government seeks en banc review, it can be expected to repeat that argument, despite major differences between the two cases.[1]  As it stands, Newman presents significant challenges to future insider trading investigations and prosecutions and may put certain insider trading convictions in jeopardy.

[1] Among other things, Newman and Obus address different aspects of insider trading (personal benefits vs. breach of fiduciary duty) under different theories (classical vs. misappropriation) in different types of proceedings (appeal of criminal conviction vs. review of summary judgment in a civil enforcement action).  If the government nonetheless persists in making such an argument, it will not come before the Court through the Obus case because Obus and his co-defendants prevailed over the SEC at a jury trial last May in the Southern District of New York.  Gibson Dunn attorneys defended Nelson Obus against the SEC’s insider trading allegations for thirteen years, obtaining a complete defense verdict at the trial.  See Gibson Dunn Client Alert, "SEC v. Obus: A Case Study on Taking the Government to Trial and Winning," Nov. 20, 2014.

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