Opinion ID: 2759189
Heading Depth: 2
Heading Rank: 2

Heading: The Requirements of Tippee Liability

Text: The Government concedes that tippee liability requires proof of a personal benefit to the insider. Gov’t Br. 56. However, the 13 Nos. 13‐1837‐cr; 13‐1917‐cr Government argues that it was not required to prove that Newman and Chiasson knew that the insiders at Dell and NVIDIA received a personal benefit in order to be found guilty of insider trading. Instead, the Government contends, consistent with the district court’s instruction, that it merely needed to prove that the “defendants traded on material, nonpublic information they knew insiders had disclosed in breach of a duty of confidentiality . . . .” Gov’t Br. 58. In support of this position, the Government cites Dirks for the proposition that the Supreme Court only required that the “tippee know that the tipper disclosed information in breach of a duty.” Id. at 40 (citing Dirks, 463 U.S. at 660) (emphasis added). In addition, the Government relies on dicta in a number of our decisions post‐Dirks, in which we have described the elements of tippee liability without specifically stating that the Government must prove that the tippee knew that the corporate insider who disclosed confidential information did so for his own personal benefit. Id. at 41‐44 (citing, inter alia, United States v. Jiau, 734 F.3d 147, 152‐53 (2d Cir. 2013); Obus, 693 F.3d at 289; S.E.C. v. Warde, 151 F.3d 42, 48‐49 (2d Cir. 1998)). By selectively parsing this dictum, the Government seeks to revive the absolute bar on tippee trading that the Supreme Court explicitly rejected in Dirks. Although this Court has been accused of being “somewhat Delphic” in our discussion of what is required to demonstrate tippee liability, United States v. Whitman, 904 F. Supp. 2d 363, 371 n.6 (S.D.N.Y. 2012), the Supreme Court was quite clear in Dirks. First, the tippee’s liability derives only from the tipper’s breach of a fiduciary duty, not from trading on material, non‐public information. See Chiarella, 445 U.S. at 233 (noting that there is no “general duty between all participants in market transactions to forgo actions based on material, nonpublic information”). Second, the corporate insider has committed no breach of fiduciary duty 14 Nos. 13‐1837‐cr; 13‐1917‐cr unless he receives a personal benefit in exchange for the disclosure. Third, even in the presence of a tipper’s breach, a tippee is liable only if he knows or should have known of the breach. While we have not yet been presented with the question of whether the tippee’s knowledge of a tipper’s breach requires knowledge of the tipper’s personal benefit, the answer follows naturally from Dirks. Dirks counsels us that the exchange of confidential information for personal benefit is not separate from an insider’s fiduciary breach; it is the fiduciary breach that triggers liability for securities fraud under Rule 10b‐5. For purposes of insider trading liability, the insider’s disclosure of confidential information, standing alone, is not a breach. Thus, without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knew of a breach. The Government’s overreliance on our prior dicta merely highlights the doctrinal novelty of its recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders. By contrast, our prior cases generally involved tippees who directly participated in the tipper’s breach (and therefore had knowledge of the tipper’s disclosure for personal benefit) or tippees who were explicitly apprised of the tipper’s gain by an intermediary tippee. See, e.g., Jiau, 734 F.3d at 150 (“To provide an incentive, Jiau promised the tippers insider information for their own private trading.”); United States v. Falcone, 257 F.3d 226, 235 (2d Cir. 2001) (affirming conviction of remote tipper where intermediary tippee paid the inside tipper and had told remote tippee “the details of the scheme”); Warde, 151 F.3d at 49 (tipper and tippee engaged in parallel trading of the inside information and “discussed not only the inside information, but also the best way to profit from it”); United States v. Mylett, 97 F.3d 663 (2d Cir. 1996) (tippee acquired 15 Nos. 13‐1837‐cr; 13‐1917‐cr inside information directly from his insider friend). We note that the Government has not cited, nor have we found, a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading. Jiau illustrates the importance of this distinction quite clearly. In Jiau, the panel was presented with the question of whether the evidence at trial was sufficient to prove that the tippers personally benefitted from their disclosure of insider information. In that context, we summarized the elements of criminal liability as follows: (1) the insider‐tippers . . . were entrusted the duty to protect confidential information, which (2) they breached by disclosing [the information] to their tippee . . . , who (3) knew of [the tippers’] duty and (4) still used the information to trade a security or further tip the information for [the tippee’s] benefit, and finally (5) the insider‐tippers benefited in some way from their disclosure. Jiau, 734 F.3d at 152‐53 (citing Dirks, 463 U.S. at 659‐64; Obus, 693 F. 3d at 289). The Government relies on this language to argue that Jiau is merely the most recent in a string of cases in which this Court has found that a tippee, in order to be criminally liable for insider trading, need know only that an insider‐tipper disclosed information in breach of a duty of confidentiality. Gov’t Br. 43. However, we reject the Government’s position that our cursory recitation of the elements in Jiau suggests that criminal liability may be imposed on a defendant based only on knowledge of a breach of a duty of confidentiality. In Jiau, the defendant knew about the benefit because she provided it. For that reason, we had no need to reach the question of whether knowledge of a breach requires that a tippee know that a personal benefit was provided to the tipper. In light of Dirks, we find no support for the Government’s contention that knowledge of a breach of the duty of confidentiality 16 Nos. 13‐1837‐cr; 13‐1917‐cr without knowledge of the personal benefit is sufficient to impose criminal liability. Although the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets. The Supreme Court explicitly repudiated this premise not only in Dirks, but in a predecessor case, Chiarella v. United States. In Chiarella, the Supreme Court rejected this Circuit’s conclusion that “the federal securities laws have created a system providing equal access to information necessary for reasoned and intelligent investment decisions . . . . because [material non‐public] information gives certain buyers or sellers an unfair advantage over less informed buyers and sellers.” 445 U.S. at 232. The Supreme Court emphasized that “[t]his reasoning suffers from [a] defect. . . . [because] not every instance of financial unfairness constitutes fraudulent activity under § 10(b).” Id. See also United States v. Chestman, 947 F.2d 551, 578 (2d Cir. 1991) (Winter, J., concurring) (“[The policy rationale [for prohibiting insider trading] stops well short of prohibiting all trading on material nonpublic information. Efficient capital markets depend on the protection of property rights in information. However, they also require that persons who acquire and act on information about companies be able to profit from the information they generate . . . .”). Thus, in both Chiarella and Dirks, the Supreme Court affirmatively established that insider trading liability is based on breaches of fiduciary duty, not on informational asymmetries. This is a critical limitation on insider trading liability that protects a corporation’s interests in confidentiality while promoting efficiency in the nation’s securities markets. As noted above, Dirks clearly defines a breach of fiduciary duty as a breach of the duty of confidentiality in exchange for a personal benefit. See Dirks, 463 U.S. at 662. Accordingly, we conclude that a tippee’s knowledge of the insider’s breach necessarily requires knowledge that the insider disclosed 17 Nos. 13‐1837‐cr; 13‐1917‐cr confidential information in exchange for personal benefit. In reaching this conclusion, we join every other district court to our knowledge – apart from Judge Sullivan3 – that has confronted this question. Compare United States v. Rengan Rajaratnam, No. 13‐211 (S.D.N.Y. July 1, 2014) (Buchwald, J.); United States v. Martoma, No. 12‐973 (S.D.N.Y. Feb. 4, 2014) (Gardephe, J.); United States v. Whitman, 904 F. Supp. 2d 363, 371 (S.D.N.Y. 2012) (Rakoff, J.); United States v. Raj Rajaratnam, 802 F. Supp. 2d 491, 499 (S.D.N.Y. 2011) (Holwell, J.); State Teachers Retirement Bd. v. Fluor Corp., 592 F. Supp. 592, 594 (S.D.N.Y. 1984) (Sweet, J.),4 with United States v. Steinberg, No. 12‐121, 2014 WL 2011685 at  (S.D.N.Y. May 15, 2014) (Sullivan, J.), and United States v. Newman, No. 12‐121 (S.D.N.Y. Dec. 6, 2012) (Sullivan, J.).5 3 Although the Government argues that district court decisions in S.E.C. v. Thrasher, 152 F. Supp. 2d 291 (S.D.N.Y. 2001) and S.E.C. v. Musella, 678 F. Supp. 1060 (S.D.N.Y. 1988) support their position, these cases merely stand for the unremarkable proposition that a tippee does not need to know the details of the insider’s disclosure of information. The district courts determined that the tippee did not have to know for certain how information was disclosed, Thrasher, 152 F. Supp. 2d at 304‐05, nor the identity of the insiders, Musella, 678 F. Supp. at 1062‐63. This is not inconsistent with a requirement that a defendant tippee understands that some benefit is being provided in return for the information. 4 See also United States v. Santoro, 647 F. Supp. 153, 170‐71 (E.D.N.Y. 1986) (“An allegation that the tippee knew of the tipper’s breach necessarily charges that the tippee knew that the tipper was acting for personal gain.”) rev’d on other grounds sub nom. United States v. Davidoff, 845 F.2d 1151 (2d Cir. 1988); Hernandez v. United States, 450 F. Supp. 2d 1112, 1118 (C.D. Cal. 2006) (“[U]nder the standard set forth in Dirks” a tippee can be liable under Section 10(b) and Rule 10(b)‐5 “if the tippee had knowledge of the insider‐tipper’s personal gain.”). 5 We note that Judge Sullivan had an opportunity to address the issue in Steinberg only because the Government chose to charge Matthew Steinberg in the same criminal case as Newman and Chiasson by filing a superseding indictment. Notably, the Government superseded to add Steinberg on March 29, 2013, after the conclusion of the Newman trial, after Judge Sullivan refused to give the defendants’ requested charge on scienter now at issue on this appeal, and at a time when there was no possibility of a joint trial with the Newman defendants. 18 Nos. 13‐1837‐cr; 13‐1917‐cr Our conclusion also comports with well‐settled principles of substantive criminal law. As the Supreme Court explained in Staples v. United States, 511 U.S. 600, 605 (1994), under the common law, mens rea, which requires that the defendant know the facts that make his conduct illegal, is a necessary element in every crime. Such a requirement is particularly appropriate in insider trading cases where we have acknowledged “it is easy to imagine a . . . trader who receives a tip and is unaware that his conduct was illegal and therefore wrongful.” United States v. Kaiser, 609 F.3d 556, 569 (2d Cir. 2010). This is also a statutory requirement, because only “willful” violations are subject to criminal provision. See United States v. Temple, 447 F.3d 130, 137 (2d Cir. 2006) (“‘Willful’ repeatedly has been defined in the criminal context as intentional, purposeful, and voluntary, as distinguished from accidental or negligent”). In 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 personal benefit. See Jiau, 734 F.3d at 152‐53; Dirks, 463 U.S. at 659‐64. In view of this conclusion, we find, reviewing the charge as a whole, United States v. Mitchell, 328 F.3d 77, 82 (2d Cir. 2003), that the district court’s instruction failed to accurately advise the jury of the law. The district court charged the jury that the Government had to prove: (1) that the insiders had a “fiduciary or other relationship of trust and confidence” with their corporations; (2) that they “breached that duty of trust and confidence by disclosing material, 19 Nos. 13‐1837‐cr; 13‐1917‐cr nonpublic information”; (3) that they “personally benefited in some way” from the disclosure; (4) “that the defendant . . . knew the information he obtained had been disclosed in breach of a duty”; and (5) that the defendant used the information to purchase a security. Under these instructions, a reasonable juror might have concluded that a defendant could be criminally liable for insider trading merely if such defendant knew that an insider had divulged information that was required to be kept confidential. But a breach of the duty of confidentiality is not fraudulent unless the tipper acts for personal benefit, that is to say, there is no breach unless the tipper “is in effect selling the information to its recipient for cash, reciprocal information, or other things of value for himself. . . .” Dirks, 463 U.S. at 664 (quotation omitted). Thus, the district court was required to instruct the jury that the Government had to prove beyond a reasonable doubt that Newman and Chiasson knew that the tippers received a personal benefit for their disclosure. The Government argues that any possible instructional error was harmless because the jury could have found that Newman and Chiasson inferred from the circumstances that some benefit was provided to (or anticipated by) the insiders. Gov’t Br. 60. We disagree. An instructional error is harmless only if the Government demonstrates that it is “clear beyond a reasonable doubt that a rational jury would have found the defendant guilty absent the error[.]” Neder v. United States, 527 U.S. 1, 17‐18 (1999); accord Moran‐ Toala, 726 F.3d at 345; United States v. Quattrone, 441 F.3d 153, 180 (2d Cir. 2006). The harmless error inquiry requires us to view whether the evidence introduced was “uncontested and supported by overwhelming evidence” such that it is “clear beyond a reasonable doubt that a rational jury would have found the defendant guilty absent the error.” Neder, 527 U.S. at 18. Here both Chiasson and Newman contested their knowledge of any benefit received by the 20 Nos. 13‐1837‐cr; 13‐1917‐cr tippers and, in fact, elicited evidence sufficient to support a contrary finding. Moreover, we conclude that the Government’s evidence of any personal benefit received by the insiders was insufficient to establish tipper liability from which Chiasson and Newman’s purported tippee liability would derive.