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S4 | Monday, July 7, 2014 | White-Collar Crime
| nylj.com

‘Newman’ Addresses

Insider Trading
Divisive Question

that, at least with respect to tippee scienter,
By BenJaMin Gruenstein the difference between misappropriation and
and Jeff izant
classical insider trading cases is immaterial,”
Sullivan held “Obus clearly applies” and does
IUnited States v. Newmannot require a tippee to have knowledge that
n ,1 the U.S. Court
of Appeals for the Second Circuit will likely the insider obtained a personal benefit.7
answer a question that has divided courts Although this disagreement between Whit-
in insider trading cases: whether, under the man and Newman appears to center on the
so-called “classical” theory of insider trad- tippee’s state of mind, what these and other
ing—in which a corporate insider breaches cases illustrate is that the dispute ultimately
a duty owed to shareholders not to trade on boils down to the issue of what constitutes
material, nonpublic information or disclose the tipper’s breach. The fundamental question
such information to others who trade based that appears to be dividing these courts, as

on it—a tippee must have knowledge of the well as the government and the defendants in
personal benefit the tipper derived from the these cases, is whether the tipper’s derivation
scheme. As discussed below, this question of a personal benefit is: (1) what creates the
ultimately turns on whether the tipper’s per- tipper’s fiduciary breach; or (2) a separate
sonal benefit is what constitutes the breach of element of the offense. if the tipper’s per-
fiduciary duty by the tipper, or whether it is sonal benefit is what creates the breach of
a separate element of the offense altogether. a fiduciary duty, then in order for the tippee
To answer that question, the court will have to have knowledge of the breach, the tippee
to resolve seemingly conflicting lines of prec- must have knowledge of the tipper’s personal

edent from cases that have arisen not only benefit. however, if the tipper’s breach of fidu-
under the classical theory but also under ciary duty and personal benefit are separate
the “misappropriation” theory of insider elements of the crime, it does not necessarily
trading, in which an outsider who has been follow that the tippee must have knowledge
entrusted with material, nonpublic informa- of the tipper’s personal benefit to have knowl-
tion breaches a duty owed to the source of edge of the breach.
that information by trading on it or disclosing on appeal in Newman, the appellants
it to others who trade.
have argued for the first position (benefit
Court-watchers have suggested that the as a requirement of the breach), while the

panel in Newman expressed skepticism at oral government appears to support the second
argument towards the government’s position (benefit as a separate element). for example,
that it was required to prove only that the Chiasson—Newman’s co-defendant—has
tipper had received a personal benefit, but argued that “[a] tippee who does not know
not that the tippee had knowledge of this that the tipper has exchanged information for
benefit. if the court does rule that knowledge personal gain does not know that a fraudu-
of the tipper’s benefit is required to prove the lent fiduciary breach has taken place, and
tippee’s guilt, questions will likely remain as therefore cannot be held liable as a knowing

district courts consider how to apply such a participant in such a breach.”8 By contrast,
requirement in the future.
the government contends that “[e]stablish-
ing that Newman and Chiasson understood
‘United States v. Newman’
their conduct was wrongful (and thus will-
ful) required no more than showing that they
it is well-established that for a tippee to traded on material, nonpublic information
be guilty of insider trading, the alleged tip- they knew insiders had disclosed in violation
per must have breached a “duty to protect of a duty of confidentiality.”9
confidential information” and benefitted in support of their arguments, both the

personally from providing the tip.2 moreover, government and the defendants rely on Dirks
courts agree that tippees must have knowl- v. SEC,10 the case in which the U.S. Supreme
edge of the tipper’s duty and breach. But in knowledge of the tipper’s personal benefit.3 Therefore, in the case at hand, he held “the Court first set forth the elements of an insider
SEC v. Obus, a civil case brought under the The question subsequently posed by New- tippee must have knowledge that such self- trading violation under the classical theory.
misappropriation theory, the Second Circuit man, however, is whether this knowledge is dealing occurred, for, without such a knowl- There, the court explained that “some tippees
articulated the elements of tippee liability required in a criminal prosecution brought edge requirement, the tippee does not know must assume an insider’s duty to the share-
without mentioning that the tippee must have
under the classical theory.
if there has been an ‘improper’ disclosure of holders not because they receive inside infor-
in another recent case, United States v. inside information.”5 By contrast, Judge rich- mation, but rather because it has been made

Whitman, Judge Jed S. rakoff—who observed ard J. Sullivan, the district judge in Newman, available to them improperly.”11 it explained:
BenJaMin Gruenstein is a partner in the investiga- that the Second Circuit in Obus was “some- read Obus as making “clear that the tipper’s whether disclosure is a breach of
tions and white-collar criminal defense practice at what Delphic” on this point—distinguished breach of fiduciary duty and receipt of a per- duty ... depends in large part on the pur-
Cravath, Swaine & Moore. Jeff izant is an associate Obus on the basis that, in classical cases, sonal benefit are separate elements and that poses of the disclosure. ... [A] purpose
at the firm. GreGG fish, a summer associate, assisted “the purpose of a prosecution ... is to pro- the tippee need know only of the former.”6 of the securities laws was to eliminate
in the preparation of this article.
tect shareholders against self-dealing.”4
Noting further that “Obus strongly suggests
“use of inside information for personal