The Securities and Exchange Commission recently revealed details of an insider trading case against a gambler named William Walters, who allegedly engaged in insider trading based on information he obtained from Thomas Davis, a former member of the board of dairy company Dean Foods. More notable than the announcement of formal charges against Walters, however, was the government's failure to pursue charges against two individuals who allegedly received and traded on the information Walters received from Davis—investor Carl Icahn and professional golfer/celebrity Phil Mickelson. News outlets clamored at the failure to charge the celebrity defendant who allegedly earned nearly a million dollars based on the inside information he purportedly received from Walters about Dean Foods. Instead, Mickelson was named as a “relief defendant,” which is an alleged recipient of illicit profits to which that person had no legitimate claim. Essentially, the relief defendant is encouraged by the SEC to return the ill-gotten money, which in Mickelson’s case, was an alleged $931,000. The obvious question is: Why not charge Mickelson?

The answer can be found in the US Court of Appeals for the Second Circuit decision US v. Newman, 773 F.3d 438 (2d Cir. 2014), cert denied, 136 S.Ct. 242 (2015). The so-called Newman decision was actually a series of decisions that culminated in an opinion from the Second Circuit Court of Appeals on December 10, 2014.

The decision focuses on what is commonly referred to as “tipper/tippee” liability under Section 10b of the Securities and Exchange Act of 1934—a type of “insider trading” liability. The “tipper” is a person who is an insider or misappropriator of material nonpublic information who then discloses the information to an outsider (a “tippee”) who then trades on the basis of the information before it is publicly disclosed. See Newman, 773 F.3d at 446. In this case, Walters is an alleged tipper, and Mickelson is an alleged tippee. In order to find Mickelson liable for insider trading under Newman, however, the government needed to show that the alleged tipper, Walters, and the company insider, Davis (also an alleged tipper), received a personal benefit for passing material nonpublic information to the tippee, and that the tippee was aware that Davis and Walters both received such a benefit. See id. at 450.

In the SEC’s complaint, Mickelson allegedly received information from Walters about a spinoff of Dean Foods that was to occur in 2012. Allegedly armed with this material nonpublic information, Mickelson was said to have traded on this information and bought over two million dollars in Dean Food’s stock—netting him nearly a million dollars in profits when the spinoff was announced publicly. The allegations indicate that shortly thereafter, Mickelson purportedly paid back debts he owed to Walters with a portion of his earnings. Prior to Newman, these allegations alone would be sufficient to bring insider trading charges against Mickelson. However, in light of the heightened proof requirements under Newman, the allegations would not pass muster. Why? The government does not allege that Mickelson knew of any personal benefit Davis received from Walters in exchange for the inside information. Therefore, the government likely could not prove that Mickelson had knowledge that Walters and Davis received personal benefits in exchange for the material nonpublic information Walters provided to Mickelson. Without allegations to this effect, Mickelson could not be liable as a tippee for insider trading.

When asked in a May 19, 2016, press conference if the Newman decision was a basis for why Mickelson was not charged, US Attorney for the Southern District of New York, Preet Bharara, said “I will repeat what I’ve said many times: If the Newmandecision stands, it has an impact on our investigations . . . . Conduct we think is nefarious, and that undermines faith in the markets and the fairness of the markets, will not be able to be prosecuted because of the Newman decision.”

Before Newman, the definition of a “personal benefit” that a tipper received in exchange for the material nonpublic information could be something as ambiguous and seemingly insignificant from an economic perspective as a friendship with the tippee. Similarly, the tippee could be found liable for insider trading if the tippee knew, or should have known, about the breach of fiduciary duty by the tipper. Post-Newman, the government must prove that the tipper received a personal benefit that is akin to a quid pro quo, which is a much higher burden than showing, for example, a tip based merely on a favor to help a friend. See Newman, 773 F.3d at 452. The decision made it much harder to prosecute tippees as the government must prove that the tippee had actual knowledge that the insider disclosed material nonpublic information in exchange for a personal benefit. See id., at 450. Requiring proof of knowledge of this kind, however, becomes more difficult as tippees get more and more remote from the source of the confidential information. Applying this legal framework to the Mickelson situation clarifies the difficulties faced by the government and provides a potential explanation as to why he was not charged.

So how did Mickelson get out of this situation without being charged with insider trading? The answer seems to be that the government likely did not have evidence that Mickelson knew of the personal benefit that his tipper received and the personal benefit that the tipper conferred on the insider, i.e. the quid pro quo between the tipper (Walters) and Davis of Dean Foods. Without that information, there was likely not enough evidence to charge Mickelson, and he was instead named as a relief defendant in an attempt to recover the profits he allegedly obtained from the insider information. One thing the government has shown in its recent activity involving insider trading is that if it had sufficient evidence to charge Mickelson, it likely would have. In this case, we have seen the highest-profile effect of the Newman decision: the frequency of prosecutions of tippees will likely decrease in the Second Circuit. Not only did Newman increase the facts that the government must prove, but it also discouraged charges against tippees—even in cases where the behavior and timing of trading activity indicates “nefarious” conduct by those tippees. The result of this case may look like special treatment to a celebrity, but it is more likely the product of the Newman decision scaling back prosecution of tippees, and refocusing insider trading charges on insiders like Davis, and their immediate tippees, like Walters. The SEC Complaint can be found in SEC v. Walters, et al., 16-cv-03722 (S.D.N.Y 2016).