President Barack Obama's administration said the decision immunizes conduct that had long been understood to be criminal. The ruling “insulates from liability deceptive acts that undermine the integrity of the markets,” U.S. Solicitor General Donald Verrilli argued in the government's appeal.

History of Criminalized Insider Trading

The Supreme Court said in 1983 that people who trade on confidential information can be prosecuted only if the insider reaped a benefit from the leak.

At issue in the appeal was whether that benefit must be a concrete one, as the lower court ruled. The Obama administration argued that it was enough if the insider made a gift of the information to a friend or relative.

Newman, a former portfolio manager at Diamondback Capital Management, and Chiasson, co-founder of Level Global Investors, were part of a group of information-swapping friends who called themselves the “Fight Club,” after a Brad Pitt film.

The two men were convicted of trading based on leaks that started with people at Dell Corp. and Nvidia Corp. In the case of Dell, the information came from an employee in the company's corporate-development department who gave pre-announcement earnings information to an analyst. The tip eventually reached Newman and Chiasson through analysts who worked for them.

With Nvidia, the disclosure began with an employee in the company's finance unit who provided earnings numbers to a friend, who then passed the information to an analyst. The information made its way to Newman and Chiasson through the same circle of analysts involved in the Dell leak.

Prosecutors said the information earned US$4 million for Newman's fund and $68 million for Chiasson's. Newman was sentenced to four and a half years in prison and Chiasson six and a half years.

“Unfortunately, this victory comes only after years of government overreaching,” Newman's lawyers, Stephen Fishbein and John Nathanson, said in a statement.

Chiasson's lawyer, Gregory Morvillo, said his client “is deeply gratified by this complete vindication, one that ends the five-year ordeal he and his family endured.”

Steinberg's attorney, Barry Berke, said in a statement that his client's conviction must now be tossed as well since it's now clear “he did not commit any crime.”

Bharara's spokesman, Jim Margolin, declined to comment.

Disclosure of Insider Information Must Provide Clear Benefit

In overturning the convictions, the appeals court said prosecutors needed to show that the person disclosing the information received a clear benefit—something more than the nurturing of a friendship.

The appeals court also said the person being prosecuted had to know about the benefit. That issue wasn't before the Supreme Court.

The high court rebuff “cements that decision's changes to the landscape of insider-trading law,” said John Zach, a former federal prosecutor who worked on the Newman and Chiasson case and is now a partner at Boies Schiller & Flexner. “With that increased benefit requirement now the law, an entire class of tippers who knowingly traffic in inside information are shielded from prosecution.”

The ruling has already prompted the dismissal of cases against five people, including four who had pleaded guilty. It undercut a crackdown that in 2012 won Bharara a spot on the cover of Time magazine under the headline “This man is busting Wall Street.”

Newman and Chiasson urged the Supreme Court not to take up the case, saying it was the Obama administration that was pushing for a sweeping change in the law. The administration “seems to advocate a rule that would bar trading based on any material nonpublic information—a rule that this court has consistently repudiated,” Chiasson argued.

The Supreme Court has defined insider trading to encompass only those instances where a person violates a fiduciary duty to shareholders—such as when an employee personally benefits from a leak of nonpublic information. In a 1980 case the Supreme Court rejected the idea of “a general duty between all participants in market transactions to forgo actions based on material, nonpublic information.”

The standards for insider trading are unclear in part because the 1934 law used for prosecutions doesn't specifically mention the practice. Over the years, the Supreme Court has concluded that insider trading is a type of fraud, which is explicitly covered by the Depression-era statute.

The case is United States v. Newman, 15-137.

–With assistance from Bob Van Voris in Federal court in Manhattan.

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