US v. Newman and the Rewriting of the Law of Insider Trading (Part 1)

In US v. Newman, a panel of the Second Circuit dismissed a conviction for insider trading against two defendants.  The Government has sought rehearing en banc and the Commission has filed an amicus brief supporting the efforts.  A small group of law professors (Professors Bainbridge, Macey and Henderson) have filed an amicus brief arguing that the decision is correct.  

The case is worthy of consideration for a number of reasons.  First, it reflects a substantial rewriting of the law of insider trading.  The decision essentially eliminated the gift analysis from Dirks and removed from the prohibition on insider trading tips of information to family and friends absent the presence of an exchange "that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature."  Given that many "tips" to friends and family will not be motivated by the potential for pecuniary gain, the court has essentially eliminated from the prohibition on insider trading the exchange of information by family members.   

Second, the panel in Newman consisted of three judges appointed by Republican presidents, two of them senior judges (Winter and Parker) and one active (Hall).  The en banc court, however, includes 13 full time judges, with eight appointed by Democratic presidents.  To the extent that the case goes en banc and is decided along party lines (based upon the political party of the appointing president), the decision will be reversed.      

Finally, the opinion is of interest because of other areas where the Second Circuit seems to be rewriting the law under Rule 10b-5.  In ParkCentral v. Porsche, for example, a panel of the Second Circuit essentially reinstated an “affects test” for determining the extraterritorial application of Rule 10b-5 in a manner that can only be used to deny, rather than grant, jurisdiction.   

In contending that the Second Circuit was incorrect (in both Newman and Porsche), the conclusion is based upon the law as it is.  Given, however, a desire by some on the Supreme Court to narrow the application of Rule 10b-5 (see Janus, Morrison and Stoneridge), the Second Circuit’s rewriting of the law may well be approved if it makes it to the Supreme Court.    

With respect to Newman, the decision and the request for rehearing en banc is posted, along with the SEC’s amicus brief, at the DU Corporate Governance web site.  

J Robert Brown Jr.