Three Insider Trading Hypotheticals From the Supreme Court That Indicate A Return To Normal
The Supremes Dominate the Day
Wednesday morning, the Supreme Court heard oral arguments in Salman v US, exemplifying government in action and the court at its best. Salman is the first insider trading case in nineteen years before the court and a case that hinges on the breadth of a holding in a thirty-three year old case, specifically whether this language is part of the holding — the binding legal authority:
The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient. — Dirks v SEC
The petitioner, Salman, convicted of insider trading, went first before the court on Wednesday arguing for a narrow holding of Dirks and echoing the arguments from US. v Newman. Newman v US went further than previous cases by requiring a real, non-ephemeral, almost pecuniary gain to satisfy the personal benefit requirement for insider trading liability and it responded to an increasingly aggressive line of cases: [t]he Government’s overreliance on our prior dicta merely highlights the doctrinal novelty of its recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders” — US v Newman
While over fourteen convictions were overturned on the basis of the Newman test, no other circuit, outside of the Second Circuit, which covers New York and Connecticut, has applied the more rigorous personal benefit standard.
To resolve a circuit split on the personal benefit requirement, the hypotheticals posed by the justices during oral arguments indicate a reading of a fuller, more encompassing holding in Dirks.
First Justice Ginsberg stopped the petitioner with this hypothetical:
What’s the difference if the insider trades and gives it — makes it the proceeds a gift, or if he just says, you do the trade; here’s the gift?
The petitioner argued that the in first instance, the securities transaction is completed by the insider and so it doesn’t matter what is done with the proceeds afterwards. To which, Justice Kennedy added that in Justice Ginsburg’s hypothetical, “the tippee is just an accomplice. This is standard accomplice stuff.” The petitioner countered that here Salman received no financial gain, to which Justice Sotomayor interjected that there is “always the quid pro quo of a gift, that you believe that if you give someone a gift, it’s going to cost you one way or another”. Justice Breyer followed on that logic, adding that “to help a close family member is like helping yourself.”
The petitioner changed course, citing that the Supreme Court only held once for the government in an insider trading case, in O’Hagan v US and that where the insider conducted the trades himself. At this point Justice Kagan pointed out to the petitioner that, “there is a lot of language in Dirks which is very specific about, it’s not only when there’s a quid pro quo from the tippee to the tipper, but when the tipper makes a gift to the tippee, and in particular to the relative or friend. The petitioner termed that part of Dirks as dictum, to which Justice Kagan replied “I don’t know what dictum means.” (Dictum is taught on the second day of law school, right after beating parking tickets, it is superfluous language that while interesting is not part of the binding legal authority.)
Justice Kagan followed with a second hypothetical:
Let’s suppose I would like to give a gift to a friend of mine, but it’s just too expensive for me to give it. And then I pass a coworker’s desk, and I see a hundred dollar bill sitting there, and I take the hundred dollar bill; and now I can give a gift that I had wanted to give, but I couldn’t. Now, have I benefited from stealing the hundred dollar bill?
The petitioner countered that there needs to be clear line and that the gift language in Dirks is not the holding of the case, but admitted that if the justices do not agree with her narrow holding, then there is no other rule to limit liability. Justice Kagan ended the hypothetical asserting, “that it’s a reason for caution in changing a 30-year-old rule that everybody has understood and lived by, and that — that Congress has shown no indication it’s unhappy with.” The petitioner asked to reserve the remaining time for rebuttal, which was uneventful.
Next the Government, the respondant, argued for expanding insider trading liability to any instance where there is an impermissible or personal use of that information based on conceptions of duty of loyalty from corporate law. Chief Justice Roberts noted that the problem with that rule is where to draw the line as did Justice Breyer and Justice Alito spoke up for the first time, “It doesn’t seem to me that your argument is much more consistent with Dirks than Ms. Shapiro’s.[the petitioner]
Justice Alito then offered a third hypothetical:
Now suppose someone, the insider is walking down the street and sees someone who has a really unhappy look on his face and says, I want to do something to make this person’s day. And so he provides the inside information to that person and says, you can make some money if you trade on this. Is that a violation?
Yes, the government responded because that’s an impermissible use of the information, however, Justices Alito, Roberts, Breyer, and Sotomayor didn’t seem to buy into that with Sotomayor stating “I’m not sure your solution is going to clarify much of this area, because now I think the fight is going to be over what was the reason that tipper gave for giving the tip.” Finally, the government fell back, submitting that upholding the gift rule from Dirks would be adequate here.
Insider Trading Risk On
At least for this hour on their home court, the justices dominated as neither side convincingly made a case and that would infer a return to Dirks. By framing the questions in their terms, using every-day analogies, avoiding industry minutia, the justices gained the upper hand in defending a thirty-three year old ruling. The petitioner’s strongest point — that only once has the court found for insider trading liability, may be exactly what the court seeks to change.
A return to a pre-Newman standard in the Second Circuit could lead to a second round of aggressive insider trading prosecutions by Manhattan US Attorney Preet Baharara’s office. Fourteen of the 96 people criminally charged in the Second Circuit since 2009 have had their cases dropped or overturned. (More on that here — a 2013 conviction of an SAC employee overturned.) The SEC also settled its wide ranging investigation of SAC Capital (more on that capitulation here and and SAC’s second act here). An affirmation of the full holding of Dirks would give a green light to aggressive prosecutors. Aggressive prosecutors would likely target financial industry professionals like Newman and their contacts.
Actionable Advice
Compliance officers would do well to review their personal trading policies and how those policies are carried out and documented. It’s not expected that all insider trading can be caught, but a finding of a failure to supervise like at SAC Capital could doom a firm and questions of increased CCO liability still persist. Compliance officers can start by getting an update on the compliance landscape by reviewing these articles on establishing a culture of compliance and eliminating conflicts of interest:
