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From Securities Regulation Daily, July 30, 2015

U.S.: Government takes ‘unprecedented’ Newman case to high court

By Mark S. Nelson, J.D.

The U.S. government formally asked the Supreme Court to review the Second Circuit’s Newman opinion, which limited some insider trading prosecutions in the Second Circuit and which, if left alone, may eventually influence courts outside that circuit’s reach. The government’s certiorari petition argues that the Newman panel misread the high court’s Dirks opinion by adopting a “novel” test based on its view that the “gift” theory of insider trading requires a personal relationship that is based on a meaningful “exchange” (U.S. v. Newman, July 30, 2014).

Convictions tossed. In Newman, the Second Circuit reversed criminal insider trading convictions and told the district court judge there to dismiss the indictment with prejudice on remand because of a defective jury instruction and weak evidence. The court said the government failed to prove beyond a reasonable doubt that the tippees knew an insider disclosed confidential information in exchange for a personal benefit. The court also explained that, despite other Second Circuit cases applying the Supreme Court’s Dirks opinion, “the personal benefit received in exchange for confidential information must be of some consequence.”

The Newman panel and the full Second Circuit both declined to rehear the case this past April. But in June, U.S. Solicitor General Donald B. Verrilli, Jr. secured more time for government lawyers to mull if they would appeal Newman when Justice Ruth Bader Ginsburg granted the solicitor’s request and extended the time during which the government could file a certiorari petition until August 1, 2015, in a ruling entered in the high court’s docket.

Gift or exchange? The government wants the Supreme Court to reverse Newman in order to restore the “gift” theory of insider trading announced by the high court in Dirks. Under Dirks, the government said, an insider must personally benefit from the disclosure either through a quid pro quo or by giving confidential information to a trading relative or friend. The Dirks Court explained that the tip and trade would be akin to trading by the insider, with the profits given to the recipient.

According to the government, the Newman panel’s tougher standard wrote the “gift” theory out of Dirks. The government cited Webster’s dictionary for the proposition that an “exchange” involves a quid pro quo (“something for something”), while “gift” means a voluntary transfer without compensation.

“If the personal-benefit test cannot be met by a gift-giver unless an ‘exchange’ takes place, then Dirks’s two categories of personal benefit are collapsed into one—and the entire ‘gift’ discussion in Dirks becomes superfluous,” said the government.

The government also faulted the Newman panel for imposing a new requirement to the extent the gift theory had endured. Specifically, the government argued that Newman’s “meaningfully close” test for the relationship between an insider and a friend or relative added a requirement that was not part of Dirks. Moreover, the government said the Newman court failed to explicitly define “meaningfully close.”

On a more theoretical plane, the government’s brief reminds the justices that the Dirks Court acknowledged “some tippee trading” would be subject to civil enforcement or criminal prosecution. But according to the government, Dirks shied away from requiring informational equality for all traders because such a broad theory could disrupt market analysts’ legitimate activities. The government also noted that Dirks’s “guiding principle” has roots in common law fiduciary practice.

The government further explained that the Newman panel may have been needlessly worried about expanding insider liability despite the limits imposed by Dirks. “The Second Circuit’s departure from Dirks seems to have reflected concern that inferring personal benefit from friendship between an insider and his tippee would transform every selective disclosure of inside information into a securities-law violation.”

Moreover, the government cited its worries that Newman also conflicts with decisions issued by other federal appeals courts that have applied Dirks and that Newman could harm markets by obscuring lawful from illegal insider trading. “It licenses trading by insiders’ favored tippees, thereby shifting losses to investors who lack access to confidential corporate information and eroding public confidence in the integrity of securities markets,” said the government.

Congressional solution? The Newman opinion has generated significant legislative interest in the current Congress. Although prior attempts by lawmakers to statutorily define insider trading have withered, three bills introduced in the current session would reiterate the criminal nature of insider trading and provide varying definitions of the term. Still, if the Supreme Court agrees to hear the case, the Newman opinion may find itself running on parallel judicial and legislative tracks.

Representative Jim Himes (D-Conn) introduced the Insider Trading Prohibition Act (H.R. 1625) in March. This is the most comprehensive of the three bills. The Stop Illegal Insider Trading Act (S. 702), introduced by Sen. Jack Reed (D-RI), and the Ban Insider Trading Act of 2015 (H.R. 1173), introduced by Rep. Stephen F. Lynch (D-Mass), also would spell out what it means to trade on material inside information.

The case is No. 15-137.

Attorneys: Donald B. Verrilli Jr., Solicitor General, U.S. Department of Justice, for the U.S.

Companies: Dell; NVIDIA

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