Whipping tipping: ‘Tippee’ now liable as insider trader

Securities regulation is based on the core idea that all investors should have equal access to the rewards of participation in securities transactions. Insider trading is the antithesis to this equal access theory.

Insider trading violations occur when an individual in possession of unpublished price sensitive information (UPSI) – a “tipper” – relays that information for personal gain (or in violation of a duty) to another person (a “tippee”), who trades on the basis of that information. One issue that frequently arises in such cases is proving that an individual who receives such a tip has the requisite scienter, or state of mind, to have committed a violation. A recent US court decision in United States v Newman has dealt a severe blow to the US government’s efforts to prosecute individuals who trade on inside information but have one or more “layers” between them and the insider who initially disclosed the tip.

The Newman case

The Newman decision followed a 2013 criminal insider trading trial in New York. Todd Newman, a former portfolio manager at Diamondback Capital Management, and Anthony Chiasson, a former portfolio manager at Level Global Investors, were charged with receiving confidential information about Dell’s and NVIDIA’s quarterly earnings through a series of intermediaries, and trading on that information prior to its public disclosure. The two portfolio managers’ trades in Dell and NVIDIA stock resulted in a combined US$72 million in profits for their respective funds.

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The court held that to sustain an insider trading conviction against a tippee, the government must prove each of the following elements beyond a reasonable doubt: (1) the tipper was entrusted with a fiduciary duty; (2) the tipper breached his fiduciary duty by disclosing confidential information to a tippee, in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach i.e. knew the information was confidential and divulged for personal benefit; and (4) the tippee used the information to trade in a security or to tip another individual for personal benefit. The court also held that the “personal benefit” received by the tipper must be “objective, consequential, and represent at least a potential gain of a pecuniary or similarly valuable nature”.

It may be difficult for the prosecution to demonstrate that the tippee was aware of the tipper’s breach of fiduciary duty and that the tip was disclosed for personal benefit, particularly when the tipper and tippee have no direct nexus and are separated by several layers.

Indian scenario

The Securities and Exchange Board of India (SEBI) notified the SEBI (Prohibition of Insider Trading) Regulations, 2015, on 15 January. Under regulation 2(g)(ii), any person who is in possession of or has access to UPSI is presumed to be an insider, with the onus to carve a defence under regulation 4. The note appended to regulation 4 states: “When a person who has traded in securities has been in possession of unpublished price sensitive information, his trades would be presumed to have been motivated by the knowledge and awareness of such information in his possession … Once this is established, it would be open to the insider to prove his innocence by demonstrating the circumstances mentioned in the proviso, failing which he would have violated the prohibition.”

The 2015 regulations thus clearly characterize insider trading as trading in securities with the advantage of having asymmetrical access to UPSI. The liability of tippees arises from their superior access to information. Therefore, anyone who is in possession of UPSI falls under the definition of “insider”.

The 2015 regulations have incorporated comments made in a 2008 SEBI consultative paper on amendments to the SEBI (Prohibition of Insider Trading) Regulations, 1992, which stated that “the regulations prohibit persons from tipping people about inside information by insiders i.e. the tipper. However, there seems to be no liability for a person who improperly receives a tip i.e. a tippee from trading. There is a vague prohibition against ‘procurement’ of information. However, it does not clearly prohibit a tippee from trading.” It was further proposed that “the language of the regulation may be improved by way of clarification to specifically penalize a tippee of information from trading.”

It is interesting to note that the Sodhi Committee in December 2013 proposed that tippees be allowed to raise a defence stating that they were an innocent recipient of UPSI and, having exercised the diligence expected of a reasonable person, had no reason to believe that the information in their possession was UPSI or that the person who communicated it to them had violated any law or confidentiality obligation owed by such person. However, this defence has not been incorporated in the 2015 regulations.

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Suhail Nathani is a partner, Yogesh Chande is an associate partner and Malek-ul-Ashtar Shipchandler is a trainee at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice