‘Tis the Season of Giving: Supreme Court Expands Insider Trading Liability to Recipients of “Gift” Stock Tips
Just in time for the holiday season, the Supreme Court has ruled that gift-giving is truly its own reward. But far from embodying the spirit of generosity that typically goes with that saying, the Court has ruled that the warm feeling one gets from giving to others can give rise to criminal insider trading liability. This ruling will extend insider trading liability for the recipients of tips, who were previously thought to be protected where they obtained information from an insider that was not the result of a quid pro quo exchange.
The case, Salman v. United States, dealt with a defendant who had received tips second-hand from a friend, Michael Kara, whose brother Maher was a trader at Citigroup. Maher had initially turned to his brother for help understanding technical issues he encountered in his job but, eventually, began to share inside information with Maher with knowledge that Maher intended to trade on it. Unknown to Maher, Michael shared some of these tips with his own friends, including Bassam Salman. After making a significant amount of money trading on those tips, Salman was charged with insider trading and convicted following a jury trial.
Under a major 2014 ruling from a federal court in New York, Michael and Salman would have been protected from liability because they did not buy any stock tips from Maher or give him a share of their gains. That 2014 case, United States v. Newman, emphasized the legal requirement that an insider receive a “personal benefit” from the recipient of a tip before the tippee could be charged with insider trading. This requirement offered powerful protections for innocent parties who traded on tips they received without doing anything wrong.
But the Supreme Court ruled today that the personal gratification that a tipper enjoys when giving free information as a gift to a friend or relative is enough of a “personal benefit” to satisfy insider trading laws. This all but does away with the personal benefit requirement, since it presumes that an insider benefits even when he receives nothing for information that he shares with another.
At one level, this may seem to make sense on the facts of Salman’s case. One of the Court’s concerns was that a free stock tip may be no different from an insider trading on his own behalf and then giving the money away. And that concern applied with particular force to Maher and Michael, since on one occasion Maher actually offered his brother money but was asked to give him inside information instead.
But the Court easily could have ruled narrowly on that basis; it did not. Instead, by ruling that “the benefit one would obtain from simply making a gift of confidential information to a trading relative” is sufficient to satisfy insider trading laws, it has essentially removed one of the key limitations to the scope of insider trading laws, allowing for even an unthinking tip to a friend or relative to be the basis for criminal prosecution. And although the Court left open the possibility that some gifts may not be meaningful enough to give rise to criminal liability, the breadth of today’s ruling suggests that exception is likely to be both small and difficult to prove.
That means that we should all be particularly careful as we get together with our families this December, particularly if a relative in the finance industry—or, indeed, in the corporate sector at all—offers up a stock tip at a family gathering. Because the joy of giving can now lead to criminal exposure for the whole family.
In an effort to reinstate powers stripped from them by the Court of Appeals in U.S. v. Newman and Chiasson, prosecutors have sought a rehearing of the landmark Second Circuit decision which severely curtailed the scope of insider trading cases.
The case is one which has already seen a dramatic reversal, so it is perhaps no surprise that prosecutors are hoping for the tide to turn in their favor. In trial court, the jury heard evidence that financial analysts received insider information from sources at two companies, Dell and NVIDIA, disclosing the companies’ earnings before those numbers were publicly released. The financial analysts in turn passed that information along to hedge fund traders Todd Newman and Anthony Chiasson, who executed trades in the companies’ stock.
Those transactions earned Newman’s funds approximately $4 million and Chiasson’s funds approximately $68 million. The prosecution charged both defendants with insider trading based on the trades they made with early knowledge of the earnings reports. The trial judge instructed the jury that the defendants could be found guilty if they had knowledge that the information “was originally disclosed by the insider in violation of a duty of confidentiality.” On December 12, 2012, the jury returned guilty verdicts for both defendants on all counts.
Newman and Chiasson appealed their convictions, arguing among other things that the prosecution had failed to present evidence that they had engaged in insider trading and that the trial judge improperly instructed the jury as to the level of knowledge required to sustain a conviction. Newman and Chiasson argued that the government must prove beyond a reasonable doubt not only that the information was originally disclosed by the insider in violation of the duty of confidentiality, but that the insider disclosed the information in exchange for personal benefit.
The Court of Appeals agreed with their arguments, and found that the government had failed to present sufficient evidence that the insider received any personal benefit from sharing the information, or that Newman and Chiasson had knowledge of any such personal benefit an insider received from sharing the tip.
The Second Circuit’s December 10, 2014 opinion clearly lays out the requirements for “tippee liability,” that is, liability for one who received a tip originating from a corporate insider:
(1) The corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached the fiduciary duty by (a) disclosing confidential information to a tippee (b) in exchange for personal benefit; (3) the tippee knew of the tipper’s breach, that is, he know the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade in a security or tip another individual for personal benefit.
Based on this standard, the Court of Appeals concluded that “without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knew of a breach.”
The opinion also issued a stern rebuke of “recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders.” This admonition could be fairly interpreted as being directed toward Manhattan United States Attorney Preet Bharara, who has been aggressively prosecuting Wall Street insider trading cases and has obtained approximated 85 convictions so far. Mr. Bharara issued a statement saying that the decision “interprets the securities law in a way that will limit the ability to prosecute people who trade on leaked inside information.”
The court has yet to rule on the prosecution’s January 23, 2015 request for a rehearing of the case. Until any modification is issued, the Newman ruling remains the controlling law of the Second Circuit and it will affect other cases. Already, at least a dozen criminal defendants in the Southern District of New York have cited to the case in requesting to overturn their conviction or vacate their guilty pleas.
For instance, soon after the Second Circuit issued its ruling in Newman, a federal judge in Manhattan vacated the guilty pleas of four men charged with insider trading related to IBM: Daryl Payton, Thomas Conradt, David Weishaus, and Trent Martin. Instead of bringing the case to trial, the prosecutors instead asked Judge Andrew Carter to dismiss the indictment. However, the prosecutors indicated that if the Newman decision is altered on rehearing or appeal, they might consider bringing the charges again. Appeals of previously convicted defendants will likely remain on hold pending the court’s decision on the requested Newman rehearing. Regardless of the outcome on rehearing, the Newman decision is a strong indication that courts are making a concerted effort to rein in prosecutorial overreach.