In what is possibly a harbinger of how other courts will interpret the U.S. Court of Appeals for the Second Circuit’s landmark insider trading ruling in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), Judge Andrew Carter of the U.S. District Court for the Southern District of New York recently rejected the Government’s arguments that tipping liability was different in insider trading cases based on the “misappropriation theory” – which provides that individuals who trade on confidential information in breach of a duty of trust and confidence owed to the source of the information can face liability even though they are not corporate insiders – and vacated the guilty pleas of a former Bank of Scotland research analyst (Trent Martin) and three Euro Pacifica Capital Inc. brokers (Thomas Conradt, David Weishaus, and Daryl Payton).

The charges against the four individuals stem from allegations that an associate at the law firm Cravath Swaine & Moore LLP provided Martin with material, non-public  information about a planned acquisition of SPSS Inc. by Cravath’s client IBM with the expectation that Martin would keep the information confidential and not use it for his own benefit.  The associate was not charged and there was no allegation that he traded SPSS stock or in any way benefited from the information conveyed to Martin.  As soon as practically possible, and while in possession of the material non-public information, Martin brought SPSS stock and then tipped Euro Pacific broker Conradt, who in turn told Euro Pacific brokers Payton and Weishaus.  All four individuals entered guilty pleas and were awaiting sentencing when Newman was issued.

Within days of the Second Circuit’s ruling, Judge Carter expressed his skepticism that the guilty pleas were sufficient in light of the recently clarified standard for tipping liability.  Order at 1-2, United States v. Conradt, et al., 12 Cr. 887 (ALC) (S.D.N.Y. Jan. 22, 2015), ECF No. 166.   The Government’s subsequent briefing, which argued that the “personal benefit” requirement of Newman only applied in cases involving the “classical theory” (i.e., a corporate insider who trades on confidential information) and not in “misappropriation theory” cases, did not persuade Judge Carter who found that tippee liability was not dependent on the theory under which the tipper’s duty arises.  Id. at 2.  Significantly, Judge Carter’s interpretation of Newman will require the Government to prove that Conradt, Weishaus and Payton knew that Martin divulged the material, nonpublic information for personal benefit.  Interestingly, Martin’s guilty plea was also vacated.  While Newman requires that the government prove that a tippee know that the tipper received a personal benefit even where the tipper misappropriated the material, nonpublic information, it seems unlikely that Newman also requires that the government prove that the person from whom the information was misappropriated also received a benefit in order to establish the guilt of the misappropriating tipper.   If Judge Carter’s interpretation ofNewman extinguishes liability as to Martin because the Cravath associate as the initial “tipper” did not receive a “personal benefit” as a result of transmitting the information to Martin, it would be very difficult for the Government to ever prove insider trading against a misappropriator, and Judge Carter most likely vacated Martin’s guilty plea because he only plead guilty to conspiracy based on his tipping of Conradt rather than substantive securities fraud.

While the continued viability of the charges against these individuals remains before the Court and it is unclear what impact Judge Carter’s decision will have on related civil actions brought by the SEC (three of which have been settled), the rejection of these guilty pleas indicates that at least some district court judges are willing to interpret Newman broadly. In fact, and in response to the perceived threat such interpretations pose to the criminal enforcement strategy pursued over the last few years, the Government highlighted Judge Carter’s decision in its recent petition to the Second Circuit seeking rehearing en banc in Newman.  These developments ensure that the debate will continue as to whether Newman is a proper response to prosecutorial over-reach or an unnecessary limitation on efforts to curtail conduct negatively impacting financial markets.