Recent Insider Trading Cases in the US and Canada May Signal an Evidentiary Sea Change

As we noted previously on this blog, prosecutors in Canada and the United States have recently faced evidentiary challenges in prosecuting insider trading cases (Regulators Continue to Face Challenges Pursuing “Insider Trading”).

Two recent insider trading decisions overturned enforcement efforts in both countries, finding that inferences prosecutors relied upon were weak, and that strong evidence was required: United States v. Newman and Chiasson, (dated December 10, 2014),United States Second Circuit Court of Appeals (“Second Circuit”), and Walton v Alberta (Securities Commission), (dated August 29, 2014)  from the Alberta Court of Appeal (“Court of Appeal”). These cases suggest that on both sides of the border, prosecutors of insider trading cases face fairly tough evidentiary hurdles and arguably enhanced substantive pre-requisites.

In the US, the impact of Newman has already lead to further prosecutorial headaches.  Newman’s interpretation by a New York Federal Court earlier this month lead to four insider trading guilty pleas related to the acquisition of SPSS Inc. by IBM Corp. being vacated.   Concerns over the implications of the Newman decision have lead to an appeal by prosecutors asking the Second Circuit to reconsider its decision.

In Canada, authorities  have had difficulties establishing a meaningful track record of insider trading enforcement, in contrast to their American counterparts,  Recently, the Alberta Securities Commission has sought leave of the Alberta Court of Appeal’s decision in Walton,  which may provide the Supreme Court of Canada with the opportunity to clarify evidentiary issues in insider trading cases.

The Second Circuit Provides Evidentiary Guidance on “Tippee” Insider Trading Liability

In Newman, the Second Circuit overturned a New York District Court’s convictions of two portfolio managers. In doing so, the Second Circuit addressed the test to establish tippee liability for insider trading.  The Court held “a tippee’s knowledge of the insider’s breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit.”

The Second Circuit stated that for a tippee to be found liable of insider trading, a prosecutor must prove that:

  • the corporate insider was entrusted with a fiduciary duty
  • the corporate insider breached his/her fiduciary duty to the organization by disclosing confidential information to a tippee in exchange for a personal benefit
  • the tippee knew of the tipper’s breach, that is he/she knew the information was confidential and divulged for personal benefit; and
  • the tippee still used the information to trade in a security or tip another individual for personal benefit

After setting out the required test to determine tippee liability, the Second Circuit discussed the evidentiary requirement needed to support an inference that a personal benefit was gained by the corporate insider. While the Second Circuit stated that a personal benefit could be inferred from a personal relationship between a corporate insider and a tippee, the inference must be supported by evidence 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 other words, “a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter].”

The Newman decision also commented on the need for prosecutors to establish that a tippee had knowledge that the corporate insider disclosed confidential information in exchange for personal benefit. The Second Circuit observed that “it is easy to imagine a ... trader who receives a tip and is unaware that his conduct was illegal and therefore wrongful.”

The Alberta Securities Commission seeks leave to appeal the Alberta Court of Appeal’s insider trading decision in Walton v Alberta (Securities Commission)

As discussed previously on this blog in “Two Recent Alberta Court Cases Re-Emphasize the Desirability of Securities Enforcement Options”, in Walton, the Court of Appeal set aside certain findings of an ASC Panel related to the damages and culpability of individuals charged with breaching provisions of the Alberta Securities Act (the “Act) related to insider trading, tipping, and recommending or encouraging. The Court of Appeal’s findings may increase the evidentiary onus on the ASC to prove future insider trading cases.

Expectation of Reliance Needed to Prove Liability for Recommending or Encouraging/Tippee Liability Requires Proof of Knowledge 

The Court of Appeal held that an individual cannot be found liable for breaching the recommending or encouraging provision of the Act, unless the individual with knowledge of a material fact  conveys information to someone else “with the expectation that it might be relied on”.

The Court of Appeal’s analysis distinguished the tests for liability under the recommending or encouraging provision from the tipping provision. The Court noted that liability for a tipper under the recommending or encouraging provision requires an analysis of whether there was an expectation that the person receiving the information would rely on it, whereas tipping merely requires the passing on of information. In terms of a tippee the Court of Appeal stated that no liability flowed from a tippee trading as a result of merely being encouraged, however, liability would be found where a tippee made trades with the knowledge that he or she had confidential information, and the source of the confidential information was from a person in a special relationship

Notably, the Court of Appeal also provided a detailed discussion about the evidence necessary to prove insider trading. And while the Court confirmed that a finding of liability could result from an inference, the Court of Appeal held that the inference must be based on clear and cogent evidence, including the consideration of the specific factual context and the plausibility of alternative inferences that can be made on the same evidence. The Court of Appeal held that the ASC’s findings of culpability related to certain individuals in the Walton proceeding were speculative, and that the ASC failed to meet its onus to prove their culpability. Additionally, the Court of Appeal noted that what may seem to be unusual trading patterns may not in fact be unusual when the trading history of the individual charged is properly assessed. The Court of Appeal held that merely establishing the existence of a relationship between a corporate insider and tipper was not conclusive in determining whether a downstream tippee knew that the information he or she received came from someone in a special relationship.


The Second Circuit’s decision in Newman emphasized that prosecutors must prove a tippee had  knowledge of a personal benefit received by a corporate insider to find liability. This will present  evidentiary difficulties for prosecutors in successfully pursuing alleged insider trading cases.  The difficulty will increase in pursuing alleged tippees further down the chain of information from the original corporate insider.

Similarly, in Walton, the Alberta Court of Appeal’s confirmation that inferences regarding a tippee’s knowledge about the source of the information they trade upon must be based on clear and cogent evidence beyond speculation and suspicion reflects the evidentiary challenges that Canadian prosecutors continue to face when prosecuting insider trading.

In both cases, the Courts have made it clear that circumstantial evidence relied on by prosecutors to infer facts will be rigorously scrutinized to determine whether it is sufficient to support a finding of liability.

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Lawrence E. Ritchie

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