It is generally understood that it is unlawful to trade on nonpublic, market-moving information, or tips from someone with inside information—but what if the tip was not unlawful in the first place? When someone receives a tip of confidential information from a source who has not engaged in insider trading, can the recipient of that information, the “tippee,” be guilty of insider trading? Since tippee liability is generally derivative of the claims against the tipper, one might think that the answer should be no. However, a recent jury verdict in the Northern District of Illinois came to a different conclusion.
On January 19, 2023, following a multi-day trial, a jury found an alleged tipper not guilty while simultaneously finding the alleged tippee guilty of insider trading. Adding further confusion to the issue, the jury acquitted the tippee of conspiracy to commit insider trading. In other words, the jury squarely found that the tippee committed the crime of insider trading while the tipper did not. While this result seems inconsistent with basic principles of insider trading law, as discussed below, it finds support in controlling US Court of Appeals for the Seventh Circuit authority.
BACKGROUND ON TIPPEE INSIDER TRADING
Tippee liability for insider trading—that is, liability for non-insider recipients of “tips” of confidential information who trade on that information—was first recognized by the Supreme Court in Dirks v. SEC. [1] There, the Court held that not all tippers and recipients of material, nonpublic information (MNPI) face liability for subsequent trading. [2] Instead, a tippee assumes the tipper’s fiduciary duty to the company, and thus is prohibited from trading, only where the tipper “has breached his fiduciary duty . . . by disclosing the information to the tippee.” [3]
Further, the tipper’s tip is a breach of fiduciary duty only where the tipper receives a “personal benefit” from the disclosure. [4] In articulating this standard, the Dirks Court made clear that the liability of the tippee is derivative of the tipper: “the test is whether the insider personally will benefit, directly or indirectly, from [the] disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach” by the tippee. [5] The Court continued, “to determine whether the disclosure itself ‘[is deceptive],’ . . . the initial inquiry is whether there has been a breach of duty by the insider.” [6]
US V. KLUNDT AND SARGENT
On January 10, 2022, the US Attorney’s Office for the Northern District of Illinois indicted two defendants—Christopher Klundt and David Sargent—for a combined seven counts centered around illegal insider trading in US v. Klundt and Sargent. [7] Klundt and Sargent had been friends for years after going to college together, and had even gone into business together investing in a company that was ultimately sold to Chegg Inc. After that company was sold, Klundt went to work for Chegg while Sargent did not.
The indictment alleged that on May 1, 2020, while working at Chegg, Klundt attended a company meeting during which MNPI about the company’s first quarter 2020 earnings were discussed. These earnings were not scheduled to be released to the public until May 4, 2020. As is typical, Chegg had a policy against insider trading, which prohibited tipping others who might make an investment decision based on that information.
Prosecutors alleged that, after this May 1, 2020 company meeting, Klundt and Sargent spoke on the phone, and thereafter Sargent purchased hundreds of shares and almost 50 call options of Chegg stock. After Chegg’s earnings were publicly released on May 4, 2020, Sargent sold his positions for a profit of close to $110,000. According to the government, after the public earnings call, Klundt texted Sargent an emoji face with dollar signs for eyes. The government also alleged that Klundt falsely responded to a FINRA inquiry that asked him to identify a list of persons he knew that included Sargent’s name. In January 2022, both Klundt and Sargent were indicted. [8]
The indictment charged both Klundt and Sargent with multiple counts of insider trading and conspiracy to commit insider trading. Notably, the indictment did not allege that Sargent, the tippee, somehow breached a duty of trust and confidence to Klundt. Put another way, there was no allegation that Sargent misappropriated the information from Klundt or otherwise induced Klundt to provide him with the inside information. Indeed, that allegation would have been entirely inconsistent with the allegation that they conspired together to commit the crime.
Ultimately, the jury returned an unusual verdict on January 19, 2023 . The jury acquitted Klundt—the tipper— completely and found Sargent—the tippee—not guilty of the conspiracy count.
Notwithstanding Klundt’s complete acquittal, the jury found Sargent guilty on all other counts of the indictment. In other words, the jury found—conclusively—that Sargent committed insider trading alone.
SEVENTH CIRCUIT LAW ON JURY VERDICTS FOR TIPPERS AND TIPPEES
While the jury’s verdict in Sargent appears inconsistent with the basic premise that tippee liability is derivative of the tipper’s, it does find support in the Seventh Circuit, namely, US v. Evans, 486 F.3d 315 (7th Cir. 2007). In Evans, a financial analyst at an investment banking firm, Paul Gianamore, was alleged to have tipped his friend, Ryan Evans. Evans in turn traded profitably on the tip. Both Gianamore and Evans were indicted and went to trial.
At trial, the jury acquitted Gianamore—the tipper—in full, including on a conspiracy count. Evans too was acquitted on the conspiracy count. The jury, however, deadlocked on the substantive securities law counts and the trial court declared a mistrial. The government decided to retry Evans and this time succeeded; Evans was convicted on seven substantive violations of the federal securities laws.
Evans appealed his conviction to the Seventh Circuit arguing in part that, as the tipper was acquitted in the first trial, his conviction should be reversed because collateral estoppel prevented the government from proceeding on a theory that Gianamore illegally tipped him. The Seventh Circuit disagreed, holding that the tipper’s “acquittal did not foreclose Evan’s own liability as a matter of law.” [9] The Evans decision acknowledged that “the tippee’s duty to disclose or abstain is derivative from that of the insider’s duty.” [10] In affirming the lower court’s judgment, however, the court explained:
We do not know why the jury in the first trial was not convinced beyond a reasonable doubt that Evans and Gianamore had conspired with one another, or why it chose to acquit Gianamore on the substantive counts. The important point here is that those acquittals did not prevent a properly instructed second jury from finding both that Gianamore’s tips were unlawful and that Evans, by knowingly trading on that information, violated the law. [11]
In reaching its decision, the Seventh Circuit acknowledged that “it may be the rare case where the tipper is acquitted and yet the relationship between the tipper and the tippee is such that the tippee may yet be prosecuted for acting upon the tipper’s breach.” [12] The court continued that where the tippee has a relationship with a tipper and “knows the breach to be improper, the tippee may be liable for trading on the ill-gotten information.” [13] For example, the court explained that where a tippee “induces a tipper to breach her corporate duty, even if the tipper does not do so knowingly or willfully, the tippee can still be liable for trading on the improperly provided information.” [14]
TAKEAWAYS
While the jury’s verdict finds some support in Evans, it is important to note that, unlike in Evans, the same jury in Sargent reached the seemingly inconsistent verdicts itself. While Evans makes clear that it will be the “rare case” where a tipper is acquitted while a tippee is nevertheless convicted, there is nothing about Sargent that suggests that it is such a case. The government did not charge Sargent with acting alone, nor did it evidently argue that he did. Indeed, such an argument would have been inconsistent with the government’s decision to charge Sargent and Klundt with conspiring to commit securities fraud.
It remains to be seen if the mixed verdicts in Sargent will be a one-off or lead the government to aggressively pursue tippees with or without a theory of tipper culpability. If anything, the Sargent case demonstrates the importance of jury instructions in limiting the theories the government can rely upon. The government could have charged and proven Sargent with committing insider trading alone—assuming such a result is, in fact, legally permissible—but it should have been precluded from charging and trying to prove a joint offense while securing a conviction on a theory wholly inconsistent with that charge.
