Supreme Court to Weigh In on Insider Trading Law: What Does It Mean to Financial Industry Professionals
By Steven D. Feldman, Attorney, Murphy & McGonigle
In January 2016, the U.S. Supreme Court waded into the debate on the contours of insider trading law. It is expected to release its decision in the next term, sometime between fall 2016 through spring 2017. At issue generally, when does a "tippee" (a recipient of material non-public information) violate the insider trading laws? For those involved in counseling traders and other financial industry participants, the hope is that the Supreme Court will clarify the apparent conflict among recent rulings by various appellate courts on the elements of insider trading, so professionals will have unambiguous guidance to comply with the law.
At present, insider trading law in the tipper-tippee context is ambiguous, creating uncertainty in certain trading scenarios. That uncertainty poses risks for traders. While the Second Circuit's decision in United States v. Newman garnered press coverage as it narrowed the ability of the U.S. Department of Justice ("DOJ") and Securities and Exchange Commission ("SEC") in the New York region to prosecute remote tippees of inside information, it does not generally permit trading on material non-public information ("MNPI") obtained in breach of a duty. Rather, a finance professional who determines to trade on MNPI in hopes of relying on the Newman decision may instead find himself or herself embroiled in a costly and time consuming investigation and prosecution. In contrast with Newman, the Ninth Circuit's decision in United States v. Salman -- the case the Supreme Court has now agreed to hear -- endorsed the more traditional view of tipper-tippee liability that Newman appeared to narrow. If the Supreme Court provides some clarity, responsible finance professionals will better be able to go about their business while complying with the law.
In December 2014, the United States Court of Appeals for the Second Circuit issued what was described as a landmark decision in United States v. Newman. 1 In its decision, the Second Circuit vacated the insider trading convictions and sentences of Anthony Chiasson and Todd Newman, two hedge fund professionals convicted of insider trading after trial in federal court in Manhattan. The decision has been greeted by the white collar defense bar as an important repudiation of the Government's heavy-handed pursuit of insider trading.
In Newman, Newman and Chiasson were hedge fund managers who traded on specific earnings information about Dell Inc. and NVIDIA Corporation. Both Newman and Chiasson were remote tippees, meaning that they were several degrees removed from the original corporate insiders who passed material information about the companies to others, who in turn passed the information to other individuals until it eventually arrived down the chain at Newman and Chiasson. The defendants purportedly did not even know the identity of the original tippers, and also did not know what "personal benefit," if any, the tippers received in exchange for providing information to the initial tippees. Traditionally, a personal benefit could include obvious benefits such as payments from the tippee back to the tipper, but also nonmonetary benefits such as appreciation where a family member tips a sibling, or a reputational benefit among those in business.
Following their convictions at trial, the defendants argued on appeal that a remote tippee must know that the original tipper received a concrete personal benefit in exchange for providing the initial tip. Because the Government failed to prove the Newman and Chiasson knew the tippers, or knew of any personal benefit received by the tippers for passing on the information to the tippees, the defendants argued that the Government failed to prove its case. In its December 10, 2014 decision, the Second Circuit agreed, stating, "[We] conclude that, in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit." Because there was no evidence that Newman or Chiasson knew of any exchange between the tipper and tippee that personally benefited the tipper, the prosecution's case failed.
In addition, the Court of Appeals in Newman went on to state that the "personal benefit" must be of some consequence. It must be of greater consequence than mere friendship and limited socializing. The Newman court explained that it requires "proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." Because the Government failed to show that the tipper personally benefited in any real way, it failed to prove the elements of the crime of insider trading.
Shortly after the Second Circuit's decision in Newman, the Ninth Circuit Court of Appeals weighed in on the concept of "personal benefit" in the context of insider trading in the case of United States v. Salman.2 In Salman, one brother worked in Citigroup's healthcare investment banking group, and passed on tips learned in his job to his older brother. The older brother, in turn, passed on the information to his brother-in-law, Salman. The evidence at trial included testimony that Salman knew that the information originated from the younger brother who worked at Citigroup, and that the two brothers were very close.
Following his conviction at trial, Salman appealed, arguing that there was no evidence that he knew that the tipper disclosed confidential information in exchange for a personal benefit. Following the Second Circuit's decision in Newman, Salman urged the court to find that the evidence was insufficient to find either that the younger brother (the original tipper) disclosed the information to the older brother in exchange for a personal benefit, or, if he did, that Salman knew of such benefit.
The Ninth Circuit upheld Salman's conviction and rejected his argument. Salman argued that Newman provided that evidence of a friendship or familial relationship between tipper and tippee, standing alone, is insufficient to demonstrate that the tipper received a benefit. Salman argued that because there was no evidence that the younger brother received any such tangible benefit in exchange for the inside information he provided to his older brother, or that Salman knew of any such benefit, the Government failed to carry its burden. Rejecting that argument, the Ninth Circuit stated, "To the extent Newman can be read to go so far, we decline to follow it. "Rather, the Ninth Circuit reiterated that the personal benefit test is fulfilled where an "insider makes a gift of confidential information to a trading relative or friend."
Salman appealed his conviction to the U.S. Supreme Court, which agreed to take his case. As presented by Salman, the question before the Supreme Court is whether the "personal benefit" to the insider requires proof of an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature, or whether it is enough that the insider and tippee shared a close family relationship. The Supreme Court is expected to decide the case next term.
What This Means for Financial Industry Professionals
Make no mistake, the Newman decision is important because it clearly limits the DOJ's and SEC's ability to prosecute insider trading cases against remote tippees. Where a trader is far removed from the initial source of the information, it will be more difficult for the prosecutors to prove that the trader knew that the original tipper received a personal benefit of some consequence in exchange for passing information on to a tippee. Salman did not contradict Newman in this regard. The knowledge requirement for a remote tippee is not at issue in the Salman appeal. As a consequence, it will be harder in the future for criminal prosecutors to bring insider trading cases against remote tippees.
However, this limitation should not provide traders with significant comfort. If one receives information that is clearly non-public and material, there remain significant risks in trading on that information even if the trader does not know the identity of the original tipper and tippee, their relationship, or any benefit exchanged between them. In the event that one trades on such information and the Government inquires about the trader's conduct, the investigatory process is burdensome, time consuming, anxiety inducing, and expensive. In some cases, traders lose their jobs based on the initiation of an investigation or prosecution, prior to any finding of wrongdoing. If the matter becomes public, it can also have significant reputational repercussions. Hiring a lawyer to defend against an insider trading case or prosecution is expensive, even if one ultimately prevails. In addition, even if the Government chooses not to proceed on an insider trading case, it is possible that the Government's investigation uncovers some other problematic conduct that would not have been found in the absence of the inquiry. Simply put, no one needs this kind of scrutiny.
While Newman narrows the DOJ's and SEC's ability to prosecute remote tippees of inside information, it does not generally permit trading on MNPI obtained in breach of a duty. Rather, a finance professional who determines to trade on MNPI in hopes of relying on the Newman decision may instead find himself or herself embroiled in a costly and time consuming investigation or prosecution. Even if one were to prevail, the collateral damage - to one's reputation, career, and finances - would likely be onerous. While the Newman decision is useful for understanding the current state of insider trading law, it should not be mistaken for a case permitting trading on MNPI, and should not change the way responsible finance professionals conduct business.
Finally, the Supreme Court's decision in the Salman case will likely provide some clarity in the tips-as-gifts situations. While the language of Newman seems to call into question whether a tip out of pure friendship provides enough of a benefit to the tipper to constitute insider trading, Salman clearly found such a tip sufficient in the context of a close family relationship. The harder question is not the close family context, but the context of friends and acquaintances who are less close, but are nevertheless willing to pass secret inside information from one to the other. Will the Supreme Court provide definitive guidance on the application of the insider trading laws for tippers and tippees in those circumstances? We will have to wait for the Supreme Court's decision to find out.
Steven D. Feldman is a partner at Murphy & McGonigle, P.C., a securities litigation firm. A former federal prosecutor in the Securities & Commodities Fraud Task Force for the U.S. Attorney's Office in Manhattan, Steven focuses his practice on white collar criminal litigation. He represents companies and individuals accused of business crimes, public corruption, securities law violations and fraudulent practices by the U.S. Attorney's Office, State Attorney General, District Attorney, Securities and Exchange Commission, and Commodity Futures Trading Commission.
1. United States v. Newman, 773 F.3d 438 (2d Cir. 2014), cert. denied, 136 S. Ct. 242, 193 L. Ed. 2d 133 (2015).
2. United States v. Salman, 792 F.3d 1087 (9th Cir. 2015), cert. granted in part, 136 S. Ct. 899, 193 L. Ed. 2d 788 (2016), and cert. granted in part, 136 S. Ct. 899, 193 L. Ed. 2d 788 (2016)