On April 3, 2015, the Second Circuit handed a significant victory to prospective defendants in insider trading cases — as well as the two defendants whose convictions had been reversed — by denying U.S. Attorney Preet Bharara’s request for both panel review and rehearing en banc in United States v. Newman, 773. F.3d 438 (2d Cir. 2014). In declining to rehear the case, the Second Circuit keeps in place a significant check on the government’s expansion of insider trading liability. Based on the court’s original ruling last December, prosecutors in the Second Circuit will continue to be required to prove that tippees who trade on confidential information do so knowing the company insider divulged the tip in exchange for a consequential personal benefit. The ruling applies especially to tippees several generations removed from the company insider.

In Newman, the government presented evidence at trial that financial analysts obtained confidential earnings information from company insiders, then passed it along to defendants, tippee portfolio managers, who traded on the information. None of the evidence indicated the defendants knew the source of the information. At trial, the defendants argued the evidence that the insiders had tipped in exchange for a personal benefit was insufficient, and that, even if a benefit had been provided, they were unaware of it. The trial court instructed the jury that to find them guilty the defendants needed only to “have known that [the confidential information] was originally disclosed by the insider in violation of a duty of confidentiality.” Both defendants were convicted and appealed the verdict.

The Second Circuit reversed, holding the jury instructions were erroneous; there was insufficient evidence of any personal benefit to the insiders, and no evidence the tippees knew about any such benefit. The court rejected the government’s argument the tippees could be found guilty even without knowing the tipper had received a personal benefit. Following the U.S. Supreme Court case of Dirks v. SEC, 463 U.S. 646, 662 (1983), which held that a corporate insider breaches his fiduciary duty only when he personally will benefit from his confidential disclosure, the Second Circuit here held, “[f]or 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 knows of a breach.”

The court order, declining reconsideration, reaffirms the heavier evidentiary burden imposed on insider trading prosecutions in the Second Circuit and has broader applications as well. In the wake ofNewman, several convicted defendants have petitioned for reversal of their own insider trading convictions and other dismissals. Following last week’s order, applications may well increase, and the number of insider trading prosecutions are expected to drop, especially where the subjects of U.S. Department of Justice investigations are downstream tippees (as in Newman). The ruling also may be instructive in the enforcement of the STOCK Act, under which members of Congress and employees of Congress are subject to insider trading proscriptions. No doubt the U.S. Securities and Exchange Commission will continue to turn to administrative proceedings, rather than federal district court, as its preferred forum for insider trading and other securities fraud cases. Absent a petition to the Supreme Court for review, the Justice Department may seek to prevail on Congress to enact a statute that would set forth the express elements of criminal insider trading.

Finally, the order preserves an important check on prosecutorial power. At least in the Second Circuit — and likely in other jurisdictions — the government will be required to prove criminal knowledge as an element of insider trading. Tippees will not be prosecuted for merely trading on inside information when they are unaware of a personal benefit to the insider; rather, the government must prove beyond a reasonable doubt they were aware of an insider’s breach of a fiduciary duty and personal benefit.