When asked to speak to clients and other groups about the perils of insider training, Rosemary Fanelli, managing director and head of U.S. compliance consulting at Duff & Phelps, faces a unique challenge: the lack of a formal definition of the trespass from regulators and legislators.

“I always ask a group, ‘Does anybody know which rule specifically prohibits insider trading?’ I wait to see if anybody is going to raise their hand. No one ever does. That’s because there isn’t one,” Fanelli says.

People are generally surprised to hear that, she adds, because they think there must be a specific statute, rule, or regulation that precisely spells out what constitutes insider trading and what doesn’t. They expect clear lines to mark where they might run afoul of the law, and where they would be safe, and are often frustrated to find that the line between the two is hazy at best. “It is just as frustrating for us as it is for our clients to try to understand where the line is, because the concept of insider trading has been judicially created,” Fanelli says.

As the market and the industry have changed over the years, and different ways of doing business have developed, government prosecutors kept up by developing new and creative theories of insider trading.

“On the one hand, you may say that is the government keeping up with an ever-changing industry and trying to get their arms around and capture bad behavior as it is newly created,” Fanelli says. “On the other hand, how do you know when you have stepped over the line? How do you know when you have committed a crime?”

“That’s what is fundamentally unfair about not having a definition and not having legislation on this issue,” she adds. “It isn’t just a matter of where there will be civil enforcement and, maybe, you pay a fine and face reputational damage. Those things are bad enough, but people are going to jail—and for a long time—for committing what the government is calling criminal-level fraud, but without a specific definition as to what constitutes that criminal fraud. You have a black area and a white area that are easy to define on both sides of the spectrum; then there is a grey area, and that’s when you need to be careful.”

But that all could change, thanks to a case before the Supreme Court. On Oct. 5, for the first time in more than two decades, the Supreme Court heard oral arguments in an insider-trading case, Salman v. United States. This case’s outcome could establish a national standard for what is and what is not insider trading.

The case now before the Supreme Court involves Illinois trader Bassam Salman. He was convicted on allegations of trading on information he learned from a friend who received the information from his brother, a former investment banker and Salman’s brother-in-law.

Among the questions inherent in the Court’s review: What constitutes a personal benefit for the offender? Is it always monetary value, or can the threshold be as simple as a gift, a reputation boost, or doing a kind deed? The court will revisit the 1983 case Dirks v. SEC regarding personal benefit as it seeks a compromise between more recent split decisions in the second and 9th district courts.

“Newman does set forth a narrower reading of what will be actionable under [SEC rule] 10b-5, although it does contain some broad and vague terminology because it is cast in terms of saying that the inference that a tipper received a personal benefit is impermissible in the absence of proof of a meaningfully close personal relationship.”
James McGuire, Partner, Holwell Shuster & Goldberg

The Second Circuit Court held in United States v. Newman that establishing actionable insider trading requires “an exchange that is objective, [is] consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” The 9th circuit, less concerned with a quid pro quo, set the bar as merely having a “close family relationship.”

“Newman does set forth a narrower reading of what will be actionable under [SEC rule] 10b-5, although it does contain some broad and vague terminology because it is cast in terms of saying that the inference that a tipper received a personal benefit is impermissible in the absence of proof of a meaningfully close personal relationship,” says James McGuire, a partner at law firm Holwell Shuster & Goldberg who previously served the state of New York as an appellate judge, trial court judge, and as chief counsel to former Gov. George Pataki. 

“The goal of the insider-trading laws is to protect the integrity of the markets, and the Supreme Court has not addressed it in decades,” says Hon. Richard Holwell, a founding partner of law firm Holwell Shuster & Goldberg and a former federal judge in the Southern District of New York (he presided over a number of insider-trading cases, including the trial of Galleon Group founder Raj Rajaratnam). “This case is going to give the Court the opportunity to expand upon, contract, or leave the same the body of law that has governed insider trading.”

The case before the Supreme Court case takes on enhanced relevance amid a push by the Securities and Exchange Commission to crack down on insider trading. Among its high-profile cases were the successful prosecution of celebrity homemaker Martha Stewart and its courtroom-defeated enforcement action against billionaire Mark Cuban.

While the Salman case was on the docket, the SEC has continued to be very active on the insider-trading enforcement front:

On Oct. 21, the SEC charged a Tennessee-based lawyer who served on the executive committee of the board of directors at Nashville-based Pinnacle Financial Partners with insider trading based on non-public information he learned about an impending merger. It alleges that James C. Cope obtained more than $56,000 in ill-gotten gains by purchasing securities in Pinnacle’s acquisition target, Avenue Financial Holdings, prior to a joint public announcement. The SEC alleges that he placed his first order to purchase Avenue Financial stock during a board meeting to discuss the acquisition.

On Oct. 13, the Commission announced that a hedge fund advisory firm, San Francisco-based Artis Capital Management, failed to maintain adequate policies and procedures to prevent insider trading at the firm. The firm agreed to settle the charges by disgorging the illicit trading profits generated for the firm plus a penalty of $2,582,931.

On Sept. 29, the Commission charged the former senior director of regulatory affairs for Puma Biotechnology with insider trading ahead of the company’s news announcements about its drug to treat breast cancer. It alleged that Robert Gadimian pocketed more than $1.1 million in illicit profits.

On Sept. 28, the Commission charged two lawyers and a brokerage firm manager in Peru with insider trading prior to the merger of two mining companies.

Independent of the Supreme Court’s considerations, Congress may eventually consider legislation to better define the crime. Traditionally, legislators have resisted a legal definition at the behest of regulators who enjoy the flexibility and adaptability the amorphousness provided them in enforcement actions. But that resistance shows signs of fading, with the introduction of H.R. 1625, the Insider Trading Prohibition Act, by Rep. Jim Himes (D-Conn.)

“The development of the law over time on a case-by-case basis has resulted in legal standards that have become ambiguous and problematic,” Himes says. He points to United States v. Newman, where the U.S. Court of Appeals for the Second Circuit reversed the 2013 insider-trading convictions of two hedge fund managers who traded on inside information because the government could not prove that the information was passed along by someone who received a “personal benefit” for doing so.

The proposed legislation:

Makes it unlawful for a person to trade on material, non-public information when the information was wrongfully obtained, or when the use of such information to make a trade would be deemed wrongful;

Makes it unlawful for a person who wrongfully obtains material, non-public information to communicate that “tip” to another person when it is reasonably foreseeable that the person is likely to trade on that information;

Defines "wrongful” as information that has been obtained through “theft, bribery, misrepresentation or espionage, a violation of any federal law protecting computer data or the intellectual property or privacy of computer users, conversion, misappropriation or other unauthorized and deceptive taking of such information, or a breach of any fiduciary duty or any other personal or other relationship of trust and confidence.”

Removes the requirement outlined in Newman that a person who receives a “tip” (a “tippee”) and trades on that information have any knowledge that the “tipper” received a personal benefit, so long as the tippee was aware, or recklessly disregarded, that the information was wrongfully obtained or communicated.

Authorizes the SEC to exempt any person or transaction from liability under this bill at the Commission’s discretion.

Meanwhile, Rep. Stephen Lynch (D-Mass.) has introduced H.R. 1173, the Ban Insider Trading Act, which would make it a federal crime to purchase or sell any security based on information that the individual knows or should know is material inside information. Pursuant to H.R. 1173, the factors used to determine whether an individual should know include financial sophistication, knowledge of and experience in financial matters, position in a company, and amount of assets under management. The legislation would also hold a person liable for insider trading if they intentionally disclose material information without a legitimate business purpose.


On October 5, the Supreme Court heard oral arguments in Salman v. United States, a case that could offer additional legal clarity on what constitutes insider trading. For our latest podcast, we spoke to a trio of experts at law firm Holwell Shuster & Goldberg who have closely followed the case.
Joining us were former Southern District of New York Judge Richard Holwell, a founding partner of the firm; Daniel Sullivan, an associate with the firm, served as a law clerk to Supreme Court Justice Antonin Scalia during October Term 2009; and James McGuire, a firm partner, who previously served the state of New York as an appellate judge and trial court judge.
We spoke to them about the case, what it means for enforcement efforts by the Securities and Exchange Commission, and what the late Justice Scalia, a longtime advocate for insider trading clarity and a skeptic of the SEC’s approach, might have made of the case.
You can tune into the discussion here.

“In the wake of the ill-advised Newman decision, it is important that Congress enact a robust insider-trading statute that unequivocally defines insider trading as a federal crime,” Lynch says. “It is obvious from the Newman case that we need clarity in this area in order to create a bright-line distinction between what is permissible and prohibited.”

Legislative or legal clarity could prove to be a mixed bag for the SEC.

On one hand, legislative clarity could “tie their hands and impair their ability to try to deter what may be by all accounts truly wrongful behavior,” Duff & Phelps’ Fanelli says. It could, however, help identify which cases they would like to prosecute.

Fanelli doesn’t expect to see the SEC’s zeal for insider-trading cases diminish any time soon.

“Insider trading is also something that the public readily understands,” she says. “They see it in movies, they see it on television. Everybody knows that insider trading is cheating and enforcement is a way to send a strong message to the marketplace that regulators are policing bad behavior … The political climate we are in now and the zeal with which the public wants to see Wall Street hurt and punished for real or perceived slights only encourages prosecutors to be more aggressive.

“No one is saying they shouldn’t have the ability to do their job, but it is fundamentally not right for anyone accused of a crime to not have an understanding of the parameters and limitations around the behavior, regardless of whether it is politically popular.”