The Ever-Changing Scope of Insider Trading Liability for Tippees in the Second Circuit

Liability under insider trading law continues to change as federal courts attempt to find new ways to hold insiders liable under the law. As recently as two years ago, the Second Circuit—in analyzing past decisions regarding tipper-tippee insider trading violations—blurred the distinction between legal and illegal insider trading when it fundamentally altered the idea of “personal benefit.” These various decisions provide the basis for antifraud provisions of securities law applying to insider trading, the consequences of which can be detrimental. This Note will discuss the standard that the Second Circuit uses to hold tippees liable for insider trading violations under the Exchange Act Rule 10b-5. It will begin by exploring a line of cases that lead up to the Second Circuit’s decision to alter the personal benefit test, which shifted more responsibility than ever onto the tipper’s state of mind. This Note will analyze that test and discuss the implications and problems that come with it. These include a greater likelihood that tippees will engage in deceptive behavior to extract material, non-public information from tippers. They also increase the potential that more parties caught in the middle of these situations will receive hefty prison sentences. Following that analysis, this Note will suggest an alternative approach—qualifying the personal benefit test to make it depend on more objective factors than it currently does. It will then discuss the court’s decision to amend and supersede its initial holding and replace it with a test which did not have a substantive impact on the outcome. It will ultimately conclude that the same test should apply.