Stewart Conviction Reveals Government Blueprint for Proving Insider Trading Post-Newman

New York federal prosecutors found a way around U.S. v. Newman to win a major insider trading conviction against Sean Stewart, a former major investment bank Managing Director, which likely will become a blueprint for future tipper-tippee cases. Newman made it harder to prove tipper-tippee insider trading, by requiring "a meaningfully close personal relationship that generates an exchange that ... represents at least a potential gain of a pecuniary or similarly valuable nature," for the tipper. 773 F.3d 438, 452 (2d Cir. 2014). It led to the reversal of over a dozen insider trading convictions, and to government complaints that it "creat[ed] an obvious roadmap for unscrupulous investors" to avoid prosecution.[1] But Stewart's conviction shows prosecutors may have found a roadmap for success to get around Newman. The U.S. Attorney's Office used at least three tactics in Stewart to get around Newman. First, it conducted a thorough investigation to develop a creative argument that Sean Stewart received "pecuniary benefits" from the insider trading. Prosecutors closely examined Stewart's Father's bank accounts to find that the Father used proceeds of insider trading to pay "expenses related to Sean Stewart's wedding."[2] Although not the most convincing claim of a quid pro quo personal benefit to induce an investment bank Managing Director to risk his high-paying job, this showing was apparently enough to get the case to a jury and prevail. We can expect the government in future cases to bring similarly creative (if strained) pecuniary benefit arguments.

Second, the Stewart prosecution also avoided Newman by bringing an additional criminal charge under the easier standard for insider trading related to a tender offer. At least one of the five mergers Stewart tipped his Father about involved a tender offer.[3] The law for tender offer insider trading is unique because it does not require tipping for a personal benefit in violation of a fiduciary or similar relationship. Instead, the tender offer insider trading rules only require that the tipper have material information about a potential tender offer and know or have reason to know the information (i) is nonpublic; and (ii) has been acquired from the tender offeror or the issuer of securities offered to be purchased.[4] Importantly, Newman did not involve the tender offer insider trading rules. Thus, prosecutors could still have convicted Stewart on at least one insider trading charge, even if they failed to prove a pecuniary benefit under Newman.

Third, the Stewart prosecutors focused on the close Father-Son relationship between the tipper and the tippee,[5] which distinguished the case from the casual relationships between tippers-tippees in Newman.[6] By targeting an especially close relationship between tipper and tippee, the prosecutors had an angle to persuade a district court to limit Newman to its facts and be less strict in applying the "pecuniary or similarly valuable benefit" standard. This tactic worked in the Ninth Circuit in U.S. v. Salman, where the court relied on the tipper being the brother of one tippee and the brother-in-law of the other tippee to satisfy the personal benefit standard, even without finding a pecuniary quid pro quo.[7] The Salman case is pending before the U.S. Supreme Court, which is expected to address a conflict between that case and Newman. But it is very possible that the Supreme Court could find that a close family relationship is a case where a pecuniary benefit is unnecessary because gifting inside information to a close family member can be seen as effectively enriching the tipper himself.

In sum, the Stewart conviction shows that federal prosecutors and the SEC (a related SEC civil case is pending) have found a blueprint for overcoming their setback in Newman. The government may have taken a step back and altered its tactics - and cases involving multiple tippers and tippees may no longer be viable. But it is still aggressively targeting financial professionals for tipper-tippee insider trading cases, even using creative legal theories. Thus, clients should continue to give insider trading issues heightened attention, and be prepared to invest in legal counsel to avoid becoming the focus of an insider trading investigation. ___________ [1] M. Celarier, "Supreme Court Derails Bharara's Wall St. Crusade," N.Y. Post. (Oct. 5, 2015) (quoting P. Bharara), available at [2] U.S. v. Stewart, 15-CR-287 (LTS), Superseding Indictment ¶ 9 (filed July 15, 2015). [3] Id. ¶ 13 ("acquisition by tender offer of Lincare by Linde"). [4]U.S. v. O'Hagan, 521 U.S. 642, 668-69 (1997) (upholding tender offer insider trading standard in Rule 14e-3(a)). [5]U.S. v. Stewart, Superseding Indictment ¶ 4 (alleging that tippee "is the Father of SEAN STEWART"). [6]Newman, 773 at 452-53 (first tipper-tippee "not close friends" and second "merely casual acquaintances"). [7]U.S. v. Salman, 792 F.3d 1087 (9th Cir. 2015), cert. granted in part, 136 S. Ct. 899, 193 L. Ed. 2d 788 (2016), and cert. granted in part, 136 S. Ct. 899, 193 L.

Cheryl Spratt