When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?

As evidenced by the ongoing series of enforcement actions, pleas and settlements of insider trading charges in the hedge fund context, social networks (primarily the old-fashioned kind) play an important role in the movement of corporate information from companies and their advisors to hedge fund managers.  See “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  College buddies, club acquaintances and former colleagues often talk investments.  But when one friend works at a company or for one of its advisors, and the other works at a hedge fund manager, such conversations are rife with insider trading risk.  In particular, such conversations create the possibility that the corporate insider or advisor may be considered a “tipper” under the misappropriation theory of insider trading; that the hedge fund manager employee may be considered a “tippee” vis-à-vis the corporate insider or advisor, and a “tipper” vis-à-vis his colleagues; and that everyone in the “chain” of tipping may be liable for insider trading.  In light of the ubiquity of social interactions with an investment component, and the ease with which such interactions can drift from the innocuous to the illegal, a recent federal appeals court decision merits close attention by hedge fund managers.  The decision offers the clearest and most authoritative recent statement of the standard for tipper or tippee liability under the misappropriation theory of insider trading.  In particular, the decision discusses the elements of tipper and tippee liability under the misappropriation theory, with a particular focus on the nature of the personal benefit required to trigger tipper liability; and the application of those elements to a fact pattern common in investment decision-making.  This article provides a comprehensive discussion of the appeals court decision; the trial court decision below; and analysis of what the decision means for the investment analysis process at hedge fund managers.  For a discussion of similar themes and challenges, see “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).

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