On January 22, 2015, a federal district court, in U.S. v. Conradt, vacated the guilty pleas of four men accused of insider trading. This decision is the first to follow U.S. v. Newman, the recent landmark appellate ruling limiting the government’s ability to pursue insider trading cases.
In the course of granting the defendants’ motions to vacate their pleas, the court in Conradt rejected an attempt by the government to limit the application of Newman to insider trading cases brought under the “classical theory” of insider trading, where a corporate insider discloses material non-public information in breach of a duty, which Newman was. The Conradt court found that the standards governing tipper-tippee liability announced in Newman apply equally to cases brought under the classical theory and the “misappropriation theory” of liability.
As discussed in a recent Kleinberg Kaplan alert titled “Second Circuit Narrows Definition of Insider Trading and Potentially Limits Future Actions Against Tippees,” in Newman, a criminal action, the U.S. Court of Appeals for the Second Circuit clarified the standard of liability for insider trading cases and held that the government needs to establish that (i) the tipper and tippee had a “meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of pecuniary or similarly valuable nature” in order to show the requisite personal benefit to the tipper, and (ii) the tippee knew that the tipper received a personal benefit in exchange for the tips.
The government adopted an aggressive stance this month in Conradt, asserting that, at a minimum, the Newman decision does not apply to misappropriation cases, where a person misappropriates confidential information for trading purposes in breach of a duty owed to the source of the information. In Conradt, a misappropriation case, four defendants had entered into guilty pleas but had recently sought to withdraw their pleas in light of Newman. In response, the government opposed the defendants’ efforts and argued that “[t]he Newman decision dramatically (and, in our view, wrongly) departs from thirty years of controlling Supreme Court authority and, in so doing, legalizes manipulative and deceptive conduct that no court has ever sanctioned.”
The court in Conradt rejected the prosecutors’ objections and found that “as indicated in Newman, the controlling rule of law in the Second Circuit is that ‘the elements of tipping liability are the same, regardless of whether the tipper’s duty arises under the classical or the misappropriation theory.'” As a result, the Conradt court gave a broad reading to the decision in Newman. The decisions in Newman and Conradt serve to sharpen (and narrow the scope of) the definition of insider trading as applied in the Second Circuit.
Meanwhile, on January 23, 2015, the U.S. Attorney for the Southern District of New York filed a petition for rehearing and rehearing en banc before the Second Circuit, challenging the Newman decision, claiming that it “breaks with Supreme Court and Second Circuit precedent, conflicts with the decisions of other circuits, and threatens effective enforcement of the securities laws.” And only time will tell how other federal courts outside of the Second Circuit respond to the Newman decision, and how the Securities and Exchange Commission proceeds with respect to civil insider trading cases where the standard of liability is lower than in criminal matters.