U.S. Second Circuit - The FindLaw 2nd Circuit Court of Appeals Opinion Summaries Blog

2nd Cir. Massively Limits Insider Trading Prosecutions

The Second Circuit called it "doctrinal novelty." Others might have called it made-up law.

The U.S. Attorney's Office for the Southern District of New York, led by Preet Bharara, called it insider trading despite increasingly tenuous connections between the traders and the tipsters, and a complete and utter lack of proof that the traders knew that the tippers benefited from the trades.

In short, it was a crime without a mens rea. The USAO stretched insider trading prosecutions as far as they could possibly go -- until the Second Circuit snapped back.

3 to 4 Degrees of Separation

Todd Newman and Anthony Chiasson were traders. They traded on insider information. The information was leaked from insiders who were three to four degrees removed from the traders -- friends of friends of friends of friends, in other words. Both received multi-year prison sentences after being convicted of insider trading on a tenuous, novel theory of prosecution.

The biggest issue: There was a lack of clear evidence that the two knew that the tipsters received any benefit from their leaks.

Knowledge of a Violated Duty and a Benefit Required

In its opinion, the Second Circuit admitted that it had been far from clear in past cases regarding the elements required for tipee liability, calling its past opinions "somewhat Delphic." This time, the court made it clear that the USAO's novel interpretation went too far.

"First, the tippee's liability derives only from the tipper's breach of a fiduciary duty, not from trading on material, nonpublic information," Judge Barrington Parker began. "Second, the corporate insider has committed no breach of fiduciary duty 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."

Bharara, in a statement, defended his office's work, saying that his team "investigated and prosecuted misconduct based on our good faith assessment and understanding of the facts and the law that existed at the time," reports CNBC.

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