In recent times, there has been a lot of discussion about how the regulators and the prosecution have been enormously successful in obtaining convictions in insider trading cases in the U.S. That momentum may have been somewhat restrained by a ruling of the United States Court of Appeals for the Second Circuit in United States v. Newman, et. al.
In that case, analysts at several hedge funds allegedly obtained material, nonpublic information from the employees of certain publicly traded companies which was not only shared amongst these analysts but also passed on to portfolio managers who traded in the securities of those companies. The persons who traded in the shares were “tippees” who were fed this information from “tippers” who were insiders of the companies. Crucially, the tippers and tippees were separated by several layers of intermediaries through whom the information passed before reaching the tippees. In an influential ruling, the Second Circuit Court of Appeals overturned the conviction of two portfolio managers Newman and Chiasson. The Court arrived at its conclusion after considering two significant decisions on insider trading issued by the U.S. Supreme Court, notably those in Dirks v. S.E.C., 463 U.S. 646 (1983) and Chiarella v. United States, 445 U.S. 222 (1980).
The Court’s ruling is important as it clearly circumscribed the situations in which tippee liability for insider trading arises. It observed:
In sum, we hold that to sustain an insider trading conviction against a tippee, the Government must prove each of the following elements beyond a reasonable doubt: that (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit.
The conditions for invocation of insider trading liability for tippees have been made quite stringent. Not only must the tippee be aware of the tipper’s breach of fiduciary duty due to disclosure of the information but also that the tippee knew that the tipper divulged it for personal benefit. This can often be difficult for the prosecution to demonstrate, particularly when the tipper and tippee have no direct relationship and are several layers removed.
Apart from circumscribing the legal principle as above, the Court’s ruling in Newman also has the effect of imposing more onerous requirements for discharging the burden of proof to establishing tippee liability for insider trading. Although the possibility of using circumstantial evidence to adduce proof insider trading was not disturbed, the Court refused to merely rely upon relationships between various persons as indicative of exchange of information for personal benefits. Hence, mere friendship or other social relationship would not indicate receipt of personal benefits, which must be specifically proven.
This ruling is important in as much as it narrows the scope of insider trading liability for tippees. At the same time, regard must be had to the fact that the ruling was delivered in the context of specific facts and circumstances that involved remote relationships (via intermediaries) between the tippers and the tippees. If a closer relationship exists, the outcome could be different.
Although the ruling in Newman has been delivered in the context of insider trading law as it applies in the U.S., the decision is likely to have a tangential impact on Indian insider trading law. Increasingly, orders of the Securities and Exchange Board of India (SEBI) and the Securities Appellate Tribunal (SAT) have been closely referring to and following the decisions of the U.S. courts as the jurisprudence in this area of the law has evolved substantially in that jurisdiction. While the proposed regulations on insider trading in India are likely to expand the scope of insider trading in the Indian context, the implementation of those regulations by the regulators and courts may be confronted by situations such as those presented in Newman.