February 27, 2017
Securities Law Alert
The First Circuit Court of Appeals held this week, in United States v. Bray, that the “surreptitious” circumstances surrounding a stock tip written on a bar napkin were sufficient to affirm an insider trading conviction. The court clarified the culpable state of mind required for a criminal insider trading charge, but left unanswered several lingering questions regarding insider trading law.
On February 24, 2017, the U.S. Court of Appeals for the First Circuit, in United States v. Bray, No. 16-1579, affirmed a criminal insider trading conviction involving an inside stock tip that was written on a napkin and “surreptitiously” slid across a country club bar to the defendant trader. The First Circuit decision clarified the culpable state of mind required for criminal insider trading cases, but found that there was sufficient evidence to sustain the conviction under the correct, heightened standard. Though the decision clarified parts of the intentstandard, other lingering issues for criminal insider trading defendants remain unanswered.
This decision comes in the wake of a series of recent insider trading decisions. Just three months ago, the Supreme Court held in United States v. Salman, No. 15-628, that proof of a family relationship between the tipper and tippee was sufficient to infer a quid pro quo exchange. The Salman decision partially rejected the Second Circuit’s higher standard for personal benefit articulated in United States v. Newman, 773 F. 3d 438 (2d Cir. 2014), but only on the limited facts of a family relationship (as opposed to friends or acquaintances). Additionally, Salman did not address Newman’s other holding—that a tippee is only liable for insider trading if he or she “kn[ew] that the insider disclosed confidential information in exchange for personal benefit.” Id. at 448-49.
The First Circuit also previously analyzed the issue of criminal intent for insider trading cases in United States v. Parigian, 824 F.3d 5 (1st Cir. 2016). That panel, which included Judge Stahl (author of the Bray decision), suggested that criminal precedent requires proof that the defendant know the facts that make the conduct illegal, but did not enter a holding on that issue after finding that the defendant had forfeited and waived that argument on appeal, leaving the question open.
In Bray, the government alleged that defendant Robert Bray received inside information, written on a napkin, from John Patrick O’Neill, a friend and fellow country club member. O’Neill, an executive at a local bank, had regularly shared stock tips with Bray based on publicly-available information. On one occasion, after Bray stated that he needed a “big score,” O’Neill penned the name of a public company bank on a napkin, and slid it across the bar to Bray. Bray traded in large volumes on the tip, netting about $300,000 after the public company bank announced an acquisition. The government charged violations of insider trading law under a misappropriation theory, as O’Neill was performing confidential due diligence on the public company bank at the time of the tip. A jury convicted Bray on the charges of insider trading.
On appeal, Bray argued that his conviction was in error because the government introduced insufficient evidence and the jury was improperly instructed as to his mental state.The three-judge panel held that the government’s evidence was sufficient to sustain Bray’s conviction. First, the court found that the jury could find that Bray and O’Neill were “close personal friends” and that O’Neill expected a personal benefit in exchange for his tip. The court’s personal benefit holding was limited to the particular facts of the case, which included Bray subsequently offering O’Neill a stake in one of his real estate investments. Second, the court found that there was sufficient evidence for the jury to infer that Bray “knew O’Neill had breached a duty of confidentiality by giving him the [public company bank] tip.” (Slip Op. at 19). The court allowed this inference based on minimal evidence including, among other things, that “[t]hough O’Neill did not tell Bray that he was working on the [public company bank] acquisition, Bray knew what O’Neill did for a living and, presumably that O’Neill had evaluated potential acquisition targets in the past.” Id. And then, of course, the secretive napkin exchange further supported this inference.
As to the jury instructions, the trial court instructed the jury that it could convict Bray by finding that he “knew or … should have known” of O’Neill’s violation. The First Circuit held that the trial court’s inclusion of “should have known” in the instructions of a criminal insider trading case was clear error. The court also found a second clear error in the jury instruction regarding “willful blindness,” which should have informed jurors that they could find criminal liability under that doctrine only if they found that Bray “consciously and deliberately avoided learning” about the violation. But the court held that both errors were harmless because the evidence sufficiently established that Bray actually knew O’Neill was sharing inside information in breach of his fiduciary duties. Id. at 24 (citing Parigian, 824 F.3d at 11).
Though Bray clarifies the level of intent for criminal insider trading convictions, the holdings of the case are somewhat limited. As this standard only applies to criminal cases, civil defendants (or individuals facing parallel government investigations) must still be mindful of the lower “should have known” standard applicable to civil charges. Bray also leaves unresolved several significant questions. First, although the facts in Bray did not test this issue, future tipper-defendants who have a more distant personal relationship with the tippee can still argue that Newman’s heightened personal benefit requirement applies in those circumstances. Whether the First Circuit will apply the higher Newman standard or extend the lower Salman standard has yet to be determined. Second, in Bray, the First Circuit assumed (because both parties assumed), but did not hold, that a criminal tippee must have the specific knowledge that the tipper “disclosed inside confidential information in exchange for a personal benefit.” This standard from Newman is not yet the express rule in the First Circuit. Although the government in Bray assumed this standard, the government may push for a lower level of tippee knowledge in future cases after the Bray court expressly noted this open question.
We will continue to carefully review the developing decisions concerning these critical securities-related issues. For additional background on this developing topic, please see our prior alerts: “Supreme Court finds that a family relationship is enough to establish the ‘tipper's benefit’ necessary to prove a charge of insider trading,” “First Circuit rejects Second Circuit's higher standard for insider trading, finds the promise of a steak dinner sufficient to sustain a criminal conviction,” and “United States v. Newman: Second Circuit clarifies its "Delphic" interpretation of insider trading laws in landmark ruling.”
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