Cui Bono? Tippee Liability for Insider Trading after Newman, pending Salman
Between the Supreme Court’s recent decision not to grant certiorari to US v. Newman, and signals the Justices gave during oral arguments in Salman v. US, it is unclear whether anyone other than close relatives and friends will be liable for insider trading based on information obtained from a tip, and to what extent the tipper must benefit personally from the tip.
Tipping, which involves a person who breaches a fiduciary or similar duty by providing inside information to a “tippee” who then trades based on the tip, is a form of illegal insider trading. But proving liability for tipping is complicated, especially in light of Newman and Salman.
Past as Precedent: US v. Newman
Todd Newman and Anthony Chiasson were portfolio managers at two different investment firms (Diamondback Capital Management, LLC, and Level Global Investors, LP, respectively). The US Department of Justice charged that the portfolio managers used tips of inside information to trade stock in Dell and NVIDIA that earned between $4 and $68 million for their respective funds. The DOJ claimed the tips came from a cohort of financial analysts at Dell and NVIDIA, and comprised earning reports that had not yet been publicly disclosed.
Based on this evidence, a jury convicted Newman and Chiasson of insider trading. Facing years of imprisonment and millions of dollars in fines, the portfolio managers appealed the guilty verdict. On appeal, the Second Circuit Court of Appeals ruled that the evidence was inadequate for either conviction.
For one, the analysts did not directly share the earnings reports with Newman or Chiasson. Rather, each of the analysts tipped the reports to acquaintances at other firms, who in turn told their acquaintances, until the information eventually reached Newman and Chiasson. Hence, the portfolio managers “were several steps removed from the corporate insiders and there was no evidence that either was aware of the source of the inside information,” wrote a skeptical court. Additionally, the DOJ presented no evidence that Newman and Chiasson knew whether the financial-analyst-tippers at Dell and NVIDIA received a personal benefit from the tips.
Following the precedential 1983 Supreme Court case, Dirks v. SEC, the appeals court held that the DOJ failed to prove that the tippers and the tippees had “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.”
The DOJ petitioned the US Supreme Court for review of the case (certiorari), but the petition was denied on October 5,2015. This means that Newman and Chiasson will not face criminal penalties, and suggests that the Supreme Court did not find fault with the Second Circuit Court’s reasoning.
Reading the Tea Leaves: Salman v. US
Salman v. US presents quite a contrasting scenario from Newman. In this case, an investment banker at Citigroup tipped his older brother with inside information, which the older brother in turn shared with his sister-in-law’s brother, a grocer. The grocer then traded based on the information, yielding thousands of dollars in returns. The DOJ charged Bassam Salman, the grocer, with insider trading for trading on the tip.
Salman was argued before the US Supreme Court on October 5, 2016 (a year to the day after the Newman petition was denied). The issue centered on whether a family member of an insider, who trades on the insider’s tip, must also receive a tangible personal benefit for the tippee to be liable.
In oral argument, at least five of the Supreme Court Justices signaled discomfort with Salman’s argument that a tipper must receive pecuniary gain for the tippee to be liable, but appeared reluctant to extend liability (even if there was no pecuniary gain) beyond close friends and family tippees, according to a SCOTUSblog analysis.
Regarding the personal benefit analysis, the Justices resisted a literal interpretation of the Dirks/Newman requirement that the tipper must attain “at least a potential gain of a pecuniary or similarly valuable nature” in exchange for the tip, and chipped away at Salman’s defense that he could not be liable because the tipper did not receive a pecuniary gain. For example, Justice Stephen Breyer asked why the insider’s tip to a family member would not confer liability on both parties, given that “helping a close family member is like helping yourself.”
It may be tempting to conclude that the Supreme Court will rule that a tippee is liable when a tipper gains a “personal benefit” by tipping a family member, and further scale back the US government’s authority to prosecute tippees who are not family or friends when the tipper does not receive a tangible benefit. However, it would be premature to assume that the Court’s signals indicate a final position.
The Responsible Response
Although the temptation may be to freeze up in the face of mixed signals from the highest court in the land, it’s important to remember that the US Securities and Exchange Commission (SEC) and the DOJ continue to vigorously litigate securities fraud and insider trading cases, including cases based on tipping. The SEC encourages employees to report by rewarding whistleblowers, and uses big data to track and prosecute illegal insider trading. Even outside the SEC, ever more sophisticated methods of detecting insider trading are being tested and built, for the purpose of helping to investigate and deter illicit activity.
Perhaps even more important, insider trading hurts investors, undermines confidence in the markets, and implicates conflicts of interest — regardless of whether the tip was clearly illegal or falls into a gray area. That means that despite any head-scratching brought on by Newman and Salman, employees still need to know the red flags of insider trading and be encouraged to avoid and report it.
Rather than taking a “wait-and-see” approach, forward-thinking corporate leaders will grasp the continuing imperative to shore up compliance programs and effectively communicate them to every employee — not just executives and financial high-flyers. As Salman illustrates, the long arm of insider trading enforcement reaches well beyond the C-Suite and into the lives of ordinary workers, such as the grocer who traded based on insider tips in that case.
Update: As this article was preparing for publication, the US Supreme Court issued an opinion in Salman, upholding Bassam Salman’s insider trading conviction. An initial reading suggests that the Court ruled that even though the Citigroup investment banker who tipped inside information did not gain a pecuniary benefit by doing so, Salman’s relationship with him was sufficiently close to make proving the existence of such a benefit unnecessary. We will update you with our analysis of Salman in our next blog.
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