Recently, the United States Court of Appeals for the Second Circuit overturned two high-profile insider trading convictions in United States v. Newman. This came as a surprise to many, none more so than the Securities and Exchange Commission (“SEC”) as it is predicted that this decision will make it more difficult to prosecute insider trading cases. However, this does not mean that firms should relax their policies and procedures in this important area. Rather, firms may consider the task of identifying and managing material nonpublic information (“MNPI”) more complex than ever.
The key facts of the case are as follows:
- An employee, Rob Ray (“Ray”), of Dell’s investor relations department disclosed earnings numbers to a former colleague and friend, Sandy Goyal (“Goyal”). Goyal was an analyst at Neuberger Berman;
- Goyal then shared this information with another analyst, Jesse Tortora (“Tortora”), at Diamondback Capital LLC (“Diamondback”);
- Tortora knew that the information originated with a Dell insider (he did not know who exactly at Dell the insider was) and shared that information, as well as where it originated, with Diamondback manager Todd Newman (“Newman”);
- Tortora also shared this information with a friend and analyst at Level Global Investors LP, who similarly shared it with his manager, Anthony Chiasson (“Chiasson”);
- Newman and Chiasson both traded on this information with great success and ultimately profited over $72 million.
At trial, these facts led the jury to convict Newman and Chiasson of insider trading. However, the Second Circuit concluded that the government failed to prove two key elements of insider trading. First, to establish tippee (Newman and Chiasson) liability, there had to be proof that the tipper (Ray) received a benefit from the disclosure of this information. Second, the court held that the government had to prove that the tippees were aware of the benefit to the tipper. In this case, proving that knowledge would be extremely difficult because the information passed through at least two other people before reaching Newman and Chiasson.
Nevertheless, the SEC is still vigorously investigating insider trading and bringing both civil and criminal actions and will no doubt have the 2nd Circuit’s holding in mind as it collects evidence. For compliance staff, this may mean more robust policies and procedures rather than relaxing controls around potential MNPI. For example:
- Any information that may have come, even indirectly, from an insider at a public company should be escalated to compliance immediately;
- If the firm wishes to trade on that information, it should be subject to a diligence and preapproval process led by the compliance department;
- Firms should use Restricted and Watch lists to manage all potential MNPI, including any information that it is diligencing;
- Purposefully avoiding knowledge (aka “willful blindness”) to assert that the firm was unaware of the source of the information, will not suffice and may well lead to an investigation;
- While there may be circumstances in which the distance between the source of the information and the ultimate traders is relevant, firms should not rely on this as a strategy to manage potential MNPI; and
- A firm culture, starting from the top, that encourages caution and thoughtfulness will help traders stay clear of any potential insider trading violations.
The Newman decision brings the law of insider trading back to the core elements established in Dirks v. SEC, correctly requiring the government to prove each of the distinct, yet inter-related, elements. The overall landscape, however, remains changed. Firms must still identify and manage their risks, establish and enforce policies and, perhaps more than previously, take a proactive approach to identify and manage MNPI. Even if the government cannot prove a criminal case, civil enforcement is available to the SEC and insider trading will always be a high priority. If anything,Newman calls upon the SEC to be more diligent in collecting and assembling information during the critical investigation phase.