The full Second Circuit recently declined to grant rehearing en banc in its controversial Newman insider trading decision. United States v. Newman, No. 13-1837 (April 3, 2015). This denial is a blow to both Preet Bharara, the US Attorney in the SDNY seeking the rehearing, and to the SEC, which had filed a strongly wordedamicus brief in support of rehearing. Both the DOJ and the SEC sought rehearing of the Newman decision because that decision imposed substantial additional requirements of proof on the government in an insider trading case.

Newman redefined a critical element of insider trading liability — the requirement that the insider-tipper have acted for a "personal benefit." Moreover, the Court inNewman held for the first time that a culpable tippee must know that the insider-tipper who supplied the information acted for his or her own “personal benefit,” and that mere evidence of a friendship between the insider who tips and his or her tippee is insufficient to establish "personal benefit." Instead, the Newman held that “personal benefit” to the insider "must be of some consequence ... that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." With the denial by the Second Circuit of rehearing en banc, Newman’s new, more rigorous standard for establishing "personal benefit" will remain the law in criminal insider trading prosecutions in the important New York federal courts, at least until the DOJ and the SEC now almost certainly seek reversal in the United States Supreme Court.

This insider trading case arose out of the criminal prosecution of two hedge fund portfolio managers, Newman and Chiasson, who each employed an analyst who belonged to a small circle of friends in New York City — mostly other analysts — who allegedly conspired to share inside information they in turn mined from persons inside public companies. Newman and Chiasson were therefore far removed from the original tippers. The DOJ alleged that these analysts conspired to obtain inside information about various public companies' financial results during the period when a company's quarterly results were being compiled internally before being publicly released. When the analysts passed the information to their bosses Newman and Chiasson, the latter allegedly improperly traded and made substantial profits on the inside information for their firms.

The convictions of Newman and Chiasson were reversed by a three-judge panel of the Second Circuit on the ground that the government failed to prove that Newman and Chiasson "knew, or deliberately avoided knowing" that the company insider's improper disclosure of confidential information was made in exchange for a "personal benefit" to that insider, a number of steps removed from the traders. The Court held that the required "personal benefit" cannot be based on something vague like an existing friendship between the insider tipper and tippee, or the "goodwill" between them. Instead, the Newman court set the much higher bar that there must be proof of "a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." In their petitions for rehearing, both the DOJ and the SEC argued that this new standard was vague and would raise more questions about how it should be implemented in prosecutions going forward. The Newman Court also held that the government must prove that the remote tippee being prosecuted knew that when he tipped the initial tipper breached a duty, including receiving a benefit. This is an element of the decision that neither the DOJ nor the SEC chose to challenge in their petitions for rehearing. This is a most difficult hurdle where the tippee is remote from the initial tipper, perhaps not even knowing that some of the information on which the ultimate tippee based his trade came from an insider. On the contrary, the trader may believe that the information came from astute team members who had based their analysis on untainted sources of information.

As a practical matter, these new heightened requirements will have the effect of making much more difficult insider trading convictions where the inside information is received, as it was in Newman, by a tippee well down the chain of communications, and where the inside information was the result of a company insiders’ deliberate corporate leaks or inadvertent disclosures. Another effect of Newman will be to call into question several prior high profile insider trading convictions and guilty pleas, and presumably slow down or recast at least some SDNY and SEC NY insider trading investigations in process. The SEC has already made it clear in public pronouncements that they view Newman'scurrent reach as unique to the stricter requirements of criminal insider trading prosecutions, limited to the Second Circuit, and the SEC, at least, does not plan to follow it elsewhere for now. The SEC instead will almost certainly bring more of its civil insider trading cases in its own administrative forum, where it can better control the applicable law being applied. Preet Bharara will not have the same luxury for criminal prosecutions in New York, absent a Supreme Court reversal.

Notably, for many experienced Second Circuit watchers, this denial of rehearing en banc comes as no real surprise, because the three-judge panel in Newman included Yale Professor and Senior Circuit Judge Ralph K. Winter, long regarded as the Court's preeminent expert on securities law. We will now all wait to see if the United States Supreme Court is also willing to show Judge Winter the same degree of deference as did his colleagues in denying rehearing.