(Article from Securities Law Alert, December 2014)
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Second Circuit Holds That the “Proper Standard” for a District Court’s Review of a Proposed Consent Decree Is Whether the Decree Is “Fair and Reasonable” and Does Not “Disserve” the Public Interest
On June 4, 2014, the Second Circuit vacated Judge Rakoff’s November 2011 order refusing to approve a proposed consent judgment in the SEC’s enforcement action against Citigroup Global Markets because the terms of the settlement provided that Citigroup neither admitted nor denied the allegations. U.S. Securities and Exchange Commission v. Citigroup Global Markets, Inc., 752 F.3d 285 (2d Cir. 2014) (Pooler, J.). Among other grounds, the Second Circuit held that it was an “abuse of discretion to require, as the district court did here, that the [SEC] establish the ‘truth’ of the allegations … as a condition for approving the consent decree[ ].”
As an initial matter, the Second Circuit stated that “there is no basis in the law for [a] district court to require an admission of liability as a condition for approving” a consent decree. The Second Circuit held that “the proper standard” for a district court’s review of a proposed consent judgment involving an enforcement agency is “whether the proposed consent decree is fair and reasonable.” If the consent decree imposes injunctive relief, then district courts must also consider “the additional requirement that the ‘public interest would not be disserved.’” The Second Circuit explained that “the district court is required to enter the order” unless there is “a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements.”
The Second Circuit stated that in “evaluating a proposed [SEC] consent decree for fairness and reasonableness,” a district court “should, at a minimum, assess” the following factors: (1) “the basic legality of the decree”; (2) “whether the terms of the decree, including its enforcement mechanism, are clear”; (3) “whether the consent decree reflects a resolution of the actual claims in the complaint”; and (4) “whether the consent decree is tainted by improper collusion or corruption of some kind.” The Second Circuit recognized that “depending on the decree a district court may need to make additional inquiry to ensure that the consent decree is fair and reasonable.” However, the Second Circuit cautioned that “the primary focus” of any additional inquiry “should be on ensuring the consent decree is procedurally proper, using objective measures … [and] taking care not to infringe on the [SEC]’s discretionary authority to settle on a particular set of terms.”
With respect to considerations of the public interest, the Second Circuit explained that a consent decree “may disserve the public interest” if, for example, “it bar[s] private litigants from pursuing their own claims independent of the relief obtained under the consent decree.” However, a district court may not “find the public interest disserved based on its disagreement with the [SEC]’s decisions on discretionary matters of policy, such as deciding to settle without requiring an admission of liability.” The Second Circuit emphasized that “[t]he job of determining whether [a] proposed [SEC] consent decree best serves the public interest … rests squarely with the [SEC], and its decision merits significant deference.”
On remand, the Southern District of New York issued an order stating that the proposed consent judgment in the SEC’s enforcement action against Citigroup Global Markets would be approved. SEC v. Citigroup Global Markets Inc., 2014 WL 3827497 (S.D.N.Y. Aug. 5, 2014) (Rakoff, J.). The court found that the proposed consent judgment was not “procedurally improper” nor did it “fail[ ] to comport with the very modest standard imposed by the” Second Circuit “in any material respect.” However, the court did express concern that “as a result of the [Second Circuit’s] decision, the settlements reached by governmental regulatory bodies and enforced by the judiciary’s contempt powers will in practice be subject to no meaningful oversight whatsoever.”
Second Circuit Holds That Tippee Liability for Insider Trading Attaches Only If the Tippee Knew That the Tipper Disclosed Confidential Information in Exchange for a Personal Benefit
Tippee liability for insider trading “reach[es] situations where the insider or misappropriator in possession of material nonpublic information (the ‘tipper’) does not himself trade but discloses the information to an outsider (a ‘tippee’) who then trades on the basis of the information before it is publicly disclosed.” United States v. Newman, 2014 WL 6911278 (2d Cir. Dec. 10, 2014) (Parker, J.).
On December 10, 2014, the Second Circuit held that “in order to sustain a conviction [against a tippee] for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.” Id. Applying this standard, the Second Circuit reversed the insider trading convictions of Todd Newman, a portfolio manager at Diamondback Capital Management, LLC, and Anthony Chiasson, a portfolio manager at Level Global Investors, L.P., based on the district court’s failure “to instruct the jury that the Government had to prove beyond a reasonable doubt that Newman and Chiasson knew that the tippers received a personal benefit for their disclosure.”
The Second Circuit rejected “the Government’s contention that knowledge of a breach of the duty of confidentiality without knowledge of the personal benefit is sufficient to impose criminal liability.” The Second Circuit found that “the Supreme Court was quite clear” on the elements for tippee liability in Dirks v. S.E.C., 463 U.S. 646 (1983):
First, the tippee’s liability derives only from the tipper’s breach of a fiduciary duty, not from trading on material, non-public information. Second, the corporate insider has committed no breach of fiduciary duty unless he receives a personal benefit in exchange for the disclosure. Third, even in the presence of a tipper’s breach, a tippee is liable only if he knows or should have known of the breach.
Newman, 2014 WL 6911278. The Second Circuit determined that under Dirks, “the exchange of confidential information for personal benefit is not separate from an insider’s fiduciary breach; it is the fiduciary breach that triggers liability for securities fraud under Rule 10b-5.” The Second Circuit therefore held that “the Government cannot meet its burden of showing that the tippee knew of a breach” unless it can “establish[ ] that the tippee [knew] of the personal benefit received by the insider in exchange for the disclosure.” The Second Circuit noted that its “conclusion … comports with well-settled principles of substantive criminal law … requir[ing] that the defendant know the facts that make his conduct illegal.” The court reasoned that “[s]uch a requirement is particularly appropriate in insider trading cases where … ‘it is easy to imagine a … trader who receives a tip and is unaware that his conduct was illegal and therefore wrongful.’”
The Second Circuit underscored that there is “nothing in the law [that] requires a symmetry of information in the nation’s securities markets.” Rather, “in both [Chiarella v. United States, 445 U.S. 222 (1980)] and Dirks, the Supreme Court affirmatively established that insider trading liability is based on breaches of fiduciary duty, not on informational asymmetries.” The Second Circuit observed that “[t]his is a critical limitation on insider trading liability that protects a corporation’s interests in confidentiality while promoting efficiency in the nation’s securities markets.”
The Second Circuit also clarified that “the personal benefit received in exchange for confidential information must be of some consequence” to form the basis of a claim for tippee liability. The court found that the Government may not “prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature.” “To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee,” the Second Circuit held that “such an inference is impermissible in the absence of 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.”
Notably, the Second Circuit criticized “the doctrinal novelty of [the Government’s] recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders.” The court observed that its “prior cases generally involved tippees who directly participated in the tipper’s breach (and therefore had knowledge of the tipper’s disclosure for personal benefit) or tippees who were explicitly apprised of the tipper’s gain by an intermediary tippee.” The Second Circuit “note[d] that the Government has not cited, nor [has the court] found, a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading.”
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