For the first time in nearly two decades, the Supreme Court has ruled on what does, or does not, constitute insider trading. In doing so, the Court set the clock back to a time when government prosecutors enjoyed greater latitude in bringing, and winning, cases.
While the result empowers government prosecutors otherwise hamstrung by an influential lower court ruling, questions remain that will await resolution in future cases.
“The importance of this decision cannot be understated,” says David Miller, a partner at law firm Morgan Lewis and a former assistant U.S. attorney in Manhattan. “This is a big victory for the government.”
The Dec. 5 Supreme Court opinion follows oral arguments, heard in October, in the case Salman v. United States. It involved Illinois trader Bassam Salman, convicted on allegations of trading on information he learned from a friend who, in turn, received the information from his brother, an investment banker at Citigroup and Salman’s brother-in-law.
After a jury trial in the Northern District of California, Salman was convicted on all counts, sentenced to 36 months of imprisonment and three years of supervised release and ordered to pay $730,000 in restitution.
Salman’s subsequent and unsuccessful appeal in the Ninth Circuit Court found justices less concerned with quid pro quo and affirming the bar for insider trading as merely having a “close family relationship.”
While Salman’s appeal was pending, however, the Second Circuit issued an opinion in United States v. Newman, a similar insider-trading case. In that case, the court found that pecuniary value was needed for an insider-trading conviction. Lacking measurable personal gain, it said, the release of confidential information didn’t rise to a criminal standard.
Faced with a split among the circuit courts, the Supreme Court agreed to hear the case. In doing so, it revisited the 1983 case Dirks v. SEC. The foundation of insider-trading law for many years, it established that tippee liability hinges on whether the tipper’s disclosure breaches a fiduciary duty, which occurs when there is a personal benefit.
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 a kind deed?
Salman argued that a gift of confidential information to a friend or family member alone is insufficient to establish the personal benefit required for tippee liability, claiming there is no personal benefit unless the tipper’s goal in disclosing information is to obtain money, property, or something of tangible value.
The government countered that a gift of confidential information to anyone, not just a “trading relative or friend,” is enough to prove securities fraud because a tipper personally benefits through any disclosure of confidential trading information for a personal (non-corporate) purpose.
Justice Samuel Alito delivered the opinion of the Court, which upheld the standard set all those years ago in Dirks.
“We adhere to Dirks, which easily resolves the narrow issue presented here,” he wrote. “Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative,’ and that rule is sufficient to resolve the case at hand.”
“Dirks specifies that when a tipper gives inside information to ‘a trading relative or friend,’ the jury can infer that the tipper meant to provide the equivalent of a cash gift,” he added. “In such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds ... Making a gift of inside information to a relative is little different from trading on the information, obtaining the profits, and doling them out to the trading relative. The tipper benefits either way.”
“The government is going to feel as though they need to understand every nook and cranny of the relationship between two people who might potentially be tippers and tippees with each other.”
Ian Roffman, Partner, Nutter McClennen & Fish
The take from Morgan Lewis’ Miller: “This puts to bed the confusion that was created by the definition of personal benefit that was enunciated in [the previous] Newman and turns back the clock to before that decision was issued in 2014.”
Daniel Sullivan, a partner at law firm Holwell Shuster & Goldberg and former clerk to the late Justice Antonin Scalia, anticipated that the Court would hew closely to Dirks.
“The petitioner wanted the court to say that you always need a personal benefit regardless of how close the relationship is between the tipper and the tippee; the government said it is enough if you give inside information knowing that it will be used to trade,” he says. “The court rejected those two extremes and said Dirks means what it says.”
Proof of a personal benefit is still required for an insider prosecution. The Court, however, agreed that the benefit could be more amorphous than pecuniary when friends and family are involved.
“I’ve seen some reporting that this is a total rejection of Newman, but while it is obviously a victory for the government the Court is not saying that you don’t need to prove a personal benefit in the majority of cases,” Sullivan says. “It is saying that in the case of a gift to a relative or friend you can infer that the tipper is receiving a benefit.”
The Salman decision wasn't much of a surprise for Rita Glavin, a partner with law firm Seward & Kissel. It shows that, "Dirks is alive and well, and still carries the day.” In her view, the Salman and the Newman decisions were both consistent with Dirks.
“In Salman, the facts were a banker gifting material nonpublic information to his brother for the specific purpose of trading on it. In one instance, the brother who was receiving and trading on the information actually declined an offer of money from his banker brother and said he wanted the inside information instead,” she says. “Dirks covers that situation. Dirks, and now Salman reaffirms, that a personal benefit can be inferred when material nonpublic information is gifted to a trading relative or friend.”
Had the Second Circuit been confronted with the facts in Salman, “they would have applied Dirks in the same way as the Ninth Circuit and Supreme Court did in Salman,” she adds. “To the extent that prosecutors somehow viewed Newman as somehow drastically changing the landscape, or that the sky was falling, I don’t think it ever went that far.”
Nevertheless, the decision is “a game changer in many ways,” says Ian Roffman, a partner with law firm Nutter McClennen & Fish. “The Newman decision, at least upon first read, significantly narrowed the scope of claims the government could bring for insider trading. The Salman decision sends us back to the world pre-Newman, but it also makes it clear that there is going to have to be a very fact-intensive analysis of the relationship between tippers and tippees in any insider-trading investigation.
What that means, Roffman says, is that “government investigations are going to be very invasive.”
“The government is going to feel as though they need to understand every nook and cranny of the relationship between two people who might potentially be tippers and tippees with each other,” he says. “When you are dealing now with a tipper and tippee relationship, post-Salman, the invasive piece of this investigation is going to be what the relationship between those two people is, and it is not going to be limited to their professional relationship. It is going to include their personal relationships and their family’s personal relationships. The government is going to look under every rock to see if there is some kind of relationship where the tipper could somehow feel like he or she is getting an intangible benefit from the tippee.”
The court, however, left open what standards could, or should, be used to evaluate a relationship. “It very explicitly left that question open for another day,” Roffman says.
Lingering questions may be in play for years to come. The case is significant for what it does not say, “because some commentators had anticipated that some members of the court may try to use this case to reign in insider-trading prosecutions,” says Steven Paradise, a partner with law firm Richards Kibbe & Orbe.
“For the government and defense, the next battle line is likely to be drawn over whether a relationship between a tipper and tippee is sufficiently close to make them ‘friends’ or something akin to a relative and thereby eliminate the requirement that the tipper have received a tangible benefit in return for his information to have breached his fiduciary duty.”
SEC ON THE HUNT
Below is a summary of another SEC insider-trading case.
No matter the Supreme Court's decision in Salman v. United States, firms must remain vigilant in guarding against insider trading. A recent enforcement action by the Securities and Exchange Commission underscores the threat.
On Dec. 5, the SEC announced insider-trading charges against a San Francisco-based information technology specialist who allegedly hacked senior executives at online travel company Expedia and illegally traded on company secrets.
The SEC alleges that Jonathan Ly, who worked in Expedia’s corporate IT services department, illegally traded in advance of nine company news announcements from 2013 to 2016 and generated nearly $350,000 in profits. According to the SEC’s complaint, Ly exploited administrative access privileges designated for IT personnel to remotely hack into computers and e-mail accounts of senior executives and review confidential documents and pre-earnings reports.
Ly particularly targeted information prepared by Expedia’s head of investor relations summarizing Expedia’s yet-to-be-announced earnings and describing how the market could react to particular announcements. Ly allegedly used this nonpublic information to make highly profitable trades in Expedia securities ahead of the announcements.
In a parallel action, the U.S. Attorney’s Office for the Western District of Washington announced criminal charges against Ly.
To settle the charges in the SEC’s complaint, which was filed in federal court in Seattle, Ly agreed to pay disgorgement of $348,515.72 plus interest of $27,391.30 for a total of $375,907.02. The settlement is subject to court approval.
Until Congress “finally passes an actual insider-trading law, we will continue to see these same issues play out in the courts,” says John Zach, a partner at Boies, Schiller & Flexner, who—as a former assistant U.S. attorney—tried the Newman case.
“Prosecutors and defense lawyers will struggle to define the contours of insider trading in future cases while those caught up in government investigations are still faced with the ambiguities of the law,” he says.
In June, the Supreme Court vacated the conviction of former Virginia Gov. Bob McDonnell on corruption charges. The 2014 case involved gifts he and his wife received while in office. The Court’s majority ruled that prosecutors lacked definitive proof of a quid pro quo relationship.
Comparing that case to the Salman decision is alarming to Hampton Dellinger, a partner at law firm Boies, Schiller & Flexner and a former North Carolina Deputy Attorney General.
Taken together, the insider-trading decision and political pay-to-play ruling “mean that it may be safer to be a lobbyist on K Street than a stock picker on Wall Street,” he says. “In unanimous decisions, the Supreme Court offered two very different visions on how aggressive law enforcement can be in rooting out capitalist corruption as opposed to political corruption. A U.S. attorney such as Preet Bharara can still be a wolf against Wall Street, but prosecutors trying to police political corruption may feel more like lambs.”
Even with the latest ruling, not much should change for firms and training programs; and internal policies should maintain a zero-tolerance policy for leaking material, non-public information.
“If you are an issuer, nothing has changed for you,” says Jason de Bretteville, chair of the white-collar criminal defense practice group at law firm Stradling Yocca Carlson & Rauthand. “What evidence is sufficient to establish the type of relationship that would satisfy the personal benefits requirement? We are going to have district court and circuit court opinions over the next 10 years.”
The nearly philosophical question of what constitutes a “friend” will fuel many of those future cases. “[The opinion] leaves in play the question of what type of relationship or friendship is sufficient to support a conviction,” he says. “What is a friend? There are people you befriended on Facebook who are really more of acquaintances. Is that sufficient to sustain a conviction?
The bottom line for firms: continued vigilance.
“The fact that this case was decided the way it was shouldn’t really change the actual day-to-day approach that firms are taking,” says Marc Elovitz, a partner at law firm Schulte Roth & Zabel. “Even though this is an important decision in the sense that it’s the first insider-trading decision from the Supreme Court in 20 years, it is a very narrow decision. It doesn’t provide some sort of big overarching paradigm for insider-trading law. It very narrowly says that when you are taking about tipping cases involving friends and family that you don’t have to prove the specific pecuniary benefit. You don’t need to show the dollars.”
The practical difficulty for investment firms, Elovitz says, is that securities research and analysis always involves information.
“You cannot say, ‘I am not going to get involved with material non-public information.’ You don’t have that choice,” he says. “In doing legitimate securities research you may find out material non-public information, even if you didn’t want to. It is not a simple situation. That’s why it requires continued vigilance. Firms that are in the investment business understand that they have a very important obligation to carefully assess their risks.”
“When does someone go from being a business contact to being a friend? That’s not necessarily so clear and another reason that vigilance will be required,” he adds.