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.
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.
is important as it clearly circumscribed the situations in which tippee
liability for insider trading arises. It observed:
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
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.
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.
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.
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.