In December of 2014, a federal appeals court in Manhattan reversed the convictions of two hedge fund managers for insider trading in United States v. Newman. The court held the evidence was insufficient to sustain a guilty verdict for two reasons. First, the Government provided insufficient evidence of any personal benefit received by the alleged insiders, meaning there was not enough evidence to “establish the tipper liability from which defendants’ purported tippee liability would derive.” Second, the Government did not provide any evidence that “the defendants knew that they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.”
This reversal troubled prosecutors and the Securities and Exchange Commission, as it makes it more difficult to prove an insider trading case by requiring proof that a tipper received a tangible benefit in exchange for providing inside information to the tippee. Following this decision, it seemed as if all prominent insider trading convictions would be reexamined and overturned.
In Newman , the government needed to establish that the tipper had received an impermissible benefit (i.e., something more than a casual friendship between the tipper and tippee). The court urged for proof of a “meaningfully close personal relationship” in which there was “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” Such an open-ended ruling leaves room for prominent insider trading defendants like Raj Rajaratnam and Mathew Martoma to argue that the evidence in their respective cases was similarly insufficient.
Luckily for prosecutors and the SEC, the United States Court of Appeals for the Ninth Circuit in California recently decided United States v. Salman, somewhat narrowing the scope of Newman. While the opinion did not directly reject Newman, this ruling adopted a more favorable standard for proving an insider trading violation when such information is passed along family members. The decision distinguishes between tipping information between family members versus tipping information among social acquaintances, as was the case in Newman. In Salman, tipping information was exchanged between very close family members, and therefore the government was able to establish that there was a benefit received for the insider information in the form of love and affection.
Oddly, the Salman opinion was written by Jed S. Rakoff, a United States District Court judge in Manhattan, who had earlier expressed concern with the Newman decision. Newman and Salman both set limits to the benefit prong of the tipping test, however, in substantively different ways. According to Newman, if the defendants are just casual acquaintances or friends, then the benefit to the tipper must have a tangible value. According to Salman, if the defendants are close relatives, then the benefit is presumed (i.e., love and affection), and additional evidence beyond their close relationship is unnecessary. The Newman and Salman decisions are not directly contradictory, but are not harmonious, either. It will be interesting to see how future courts apply the Newman and Salman rulings to various insider trading cases.