Hedge Fund Portfolio Managers Not Guilty of Insider Trading
The United States Court of Appeals overturned the insider trading convictions of two hedge fund portfolio managers because the SEC failed to prove that they knew that insiders received some personal benefit in exchange for the information. According to the Court, to establish the necessary intent requirement to sustain a criminal conviction for insider trading (the “mens rea” or state of mind), the SEC had to prove that the defendants knew that they were trading on material nonpublic information that they knew was passed by an insider fiduciary that received some personal benefit. In this case, the Court asserted that the SEC did not offer any such evidence, and it appeared that the tippers did not receive a sufficient quid pro quo to justify any such benefit. Had the Court sustained the convictions, the defendants would have faced 54 and 78 months in prison.
OUR TAKE: The Court seeks to limit downstream “tippee” liability so that the SEC cannot simply meet the intent requirement through circumstantial evidence. One question that still remains is whether a defendant without actual knowledge of the personal benefit received could still have liability if he intentionally or recklessly avoided getting such information, and by extension, how much due diligence is required. Industry players should note that the SEC has a much lower standard of proof in enforcement actions (as compared to criminal cases) where it generally can infer the necessary intent requirement.